This blog was first published in Swedish on October 15, 2021. It is published "as is" with no amendments made because of subsequent events
It is often joked about in philosophical circles that Sweden's main contribution to modern philosophy is that we killed the father of modern philosophy, René Descartes. The already weakened Descartes received an invitation and traveled in 1649 (somewhat reluctantly) to Sweden to teach Queen Kristina philosophy. After only a few months in a freezing cold Stockholm and in an equally freezing cold castle, he died of pneumonia.
The question is whether Sweden's contribution to recent developments in the international tax area does not reach the same heights in terms of merit. The government - seemingly with support of the Confederation of Swedish Enterprise - can in fact take credit for the G20 agreement to introduce both a destination-based corporate tax and a global minimum tax.
Both sets of rules threaten in the longer term both Sweden and other smaller OECD countries positions as advanced industrial nations (through the slippery slope effect). (1)
To understand what has happened, let's go back a few years, to October 2015, when the BEPS project was completed.
1. BEPS
From a purely economic perspective, the BEPS outcome can largely to be regarded as a success for Sweden.
The hopes of the larger countries (mainly the United States) to be able to agree on global CFC rules (in practice a rudimentary version of the current global minimum tax) were buried deep in the ground (action point 3). Sweden taxes foreign company income only nominally and when such rules do apply, the purpose is primarily to protect the Swedish tax base. The less corporate tax Swedish MNEs pay on foreign company income, the better for Sweden.
All attempts during the BEPS work to extend source taxation rights in tax treaties (action point 7) succumbed to the same fate. Swedish MNEs have nothing to gain from increased source taxation. Sweden did not even implement BEPS' 'watered down recommendations. The less foreign corporate tax Swedish MNEs pay in source countries, the better for Sweden.
Several academics have compared the GAFAM companies' information gathering with the extraction of crude oil and other minerals
Sweden was "forced" to implement the BEPS recommendations regarding hybrid transactions (action point 2) and interest deduction limitations (action point 4) via EU Directives. Despite that these rules are primarily aimed at protecting the Swedish tax base, the government did not take any risks and therefore compensated the industry for the cost by reducing the corporate rate from 22 to 20.6 percent. Accordingly, Swedish MNEs suffered no injury here either.
The question how to tax the digital economy (action point 1) was left unresolved. In practice, this work is essentially about how a handful of American (and Chinese) digital mega-corporations ("GAFAM companies") should be taxed in the future.
GAFAM companies' innovative internet-based business models enable them to more or less completely avoid taxation in source states. Simply put, the GAFAM companies extract information from the countries in which they operate and then systematize and use it for commercial purposes. Several academics have compared the GAFAM companies' information gathering with the extraction of crude oil and other minerals.
Sweden had no reason to rock the boat on this issue and I can't see that it was a problem for Sweden that the BEPS participants agreed to pursue this work after the completion of the BEPS project.
2. The EU Commission Proposal for a Digital Services Tax
In the following years, the United States stalled all work on the taxation of the digital economy since the issue was mainly about how American GAFAM companies should be taxed. The United States argued (obstructively) at the OECD that the information collected in the countries of activity should be seen as remuneration from the users for their access to social and commercial platforms.
The consequence of the US obstruction policy at the OECD was that the Commission in March 2018 presented its own proposal for an EU-wide digital services tax.
The proposed digital services tax is a cleverly designed tax. It is easy to apply (particularly for developing countries) and focuses mainly on the information gathering in the country of activity. The tax targets a few digital mega-sized corporate groups that annually make astronomical profits, but do not affect other industry sectors. Moreover, the digital services tax operates (almost completely) outside the framework of domestic tax law and treaties and therefore does not put their basic principles into question.
Suddenly, the US rhetoric changed. The digital services tax was depicted as "a unilateral measure" that was contrary to the BEPS agreement. It violated basic corporate tax principles because it was both gross and destination based. Furthermore, the United States claimed that the tax was discriminatory because it mainly targeted US companies and therefore threatened the EU with trade sanctions.
3. Sweden torpedoes the Commission proposal and transfers the issue to the OECD
It remains a mystery why the Swedish government decided to carry out the dirty work on the US behalf to kill the Commission proposal. Did Swedish government officials become "intoxicated" in holding for once the center stage of an EU debate? Sweden even succeeded in convincing the other Nordic EU countries to sign a joint statement in which they argued that the proposed tax should be dropped and the issue transferred to the OECD.
The assertion that worldwide adoption of digital services taxes would cause "global chaos" is pure scare tactics
From a Swedish point of view, the digital services tax is actually a "non-issue", a tax that neither benefits nor adversely affects Sweden. Spotify and its CEO Daniel Ek's concern that the tax would hit digital loss companies was an easy problem to resolve (which the UK also showed when it designed its national digital services tax). Besides, Spotify was barely targeted by the proposed tax.
Moreover, much of the criticism raised by the United States is simply unfounded. The US knew very well that their digital mega-corporations could not escape taxation abroad forever. The US had also been rather uncooperative in the OECD during the post-BEPS follow-up work. The claim that the tax is discriminatory under current trade rules is simply not valid. Note that the United States has carefully avoided taking the issue to the WTO. The reason is simple. They know they would lose the case. (2)
The assertion that worldwide adoption of digital services taxes would cause "global chaos" is pure scare tactics. In the EU alone, we have 27 different tax systems for calculating the tax base of companies and other entities and it works perfectly fine. Why do "the Big Four" have offices in every single country of the world? Because national tax legislation differs from one country to another.
The US arguments and claims were further undermined by their own Federal Supreme Court. In April 2018, in the Wayfair case, the Court stated that it is no longer acceptable to base sales tax nexus rules solely on the existence of local branches in US states. When they judgment was published, Treasury pretended it didn't happen and never uttered a word about the case.
Since the United States turned the digital tax proposal into a trade issue, the EU was well equipped to take the fight with the United States. Trade issues are handled by the Commission on an EU-wide basis and the EU could have responded to any threats of US sanctions on a joint basis (as was the case with the US import duties on steel and aluminum). Sweden could have kept a low profile during the whole process and not uttered a word.
The Swedish Government's stubborn opposition to the digital services tax led Germany and France, during the second half of 2018, to suggest that a global minimum tax be introduced (the GLOBE proposal), a proposal that was immediately taken up by the OECD Secretariat (the initiative was probably coordinated with the Secretariat). Germany in particular began to doubt that it was possible to reach EU agreement on the tax and therefore saw the GLOBE proposal as an alternative way forward.
Frustrated with the consequences of the Swedish government's resistance to the proposed digital services tax, I wrote in December 2018 a draft article entitled "Digital taxation; Is Sweden Betting on the Wrong Horse?", meant for publication in Tax Notes International. In the end, however, I felt uncomfortable exposing my government's action internationally while the discussions on the issue were ongoing, so the draft was left in the drawer.
Instead, I published an opinion in the business paper 'Dagens Industri' in March 2019 that summarizes the content of the Tax Notes draft. A representative linked to the Confederation of Swedish Enterprise immediately responded to my article, which resulted in my publishing a closing remark.
Swedish MNEs will now be taxed globally (under pillar 2 and subsequently also under pillar 1) because Sweden managed to torpedo a tax in the EU that never targeted the Swedish industry
I will not discuss here the contents of these three opinions pieces. I leave it to you readers (if you wish) to compare the three opinions and our respective predictions on the outcome of the G20/OECD's work on pillars 1 and 2. (3)
4. The consequences of the Swedish government's actions
The dynamic effects of the Swedish government's actions at the EU level and its insistence that the issue be transferred to the OECD are the following:
The OECD has legitimized the use in the corporate context of both formulary apportionment and destination-based taxation (pillar 1);
The OECD has agreed on a global minimum tax (pillar 2); and
The OECD has agreed on new withholding tax rules in tax treaties through the "subject-to-tax rules" (pillar 2).
What Sweden believed it had successfully combated at the EU level has now been introduced by the OECD - in steroid form. This also means that the - from the Swedish perspective - successful BEPS outcome has largely been neutralized.
Swedish MNEs will now be taxed globally (under pillar 2 and subsequently also under pillar 1) because Sweden managed to torpedo a tax in the EU that never targeted the Swedish industry. It is difficult to do worse.
5. Lessons to be learned from the Swedish government's actions in the EU
What can we learn from the above and how should the government act in the future?
My closing remark in 'Dagens Industri' is a crash course on international tax policy.
A small country should always avoid taking firm positions. Keep your head down and never close any doors. Instead, act behind the scene to create alliances or to identify countries' (hidden) agendas. If you feel absolutely compelled to say "no" unconditionally to a particular proposal, you should first have considered all the potential consequences of such conduct.
It became clear to political insiders that the Swedish unconditional nay-saying policy in the EU on the digital service tax proposal laid the foundation for "the perfect storm" at the OECD.
It is naive to believe that global tax competition can be dismantled voluntarily overnight
The Netherlands is a good example of how you should act in a tax policy context. During my time as an employee, negotiator and delegate to the OECD, I admired several of their delegates. They fully master the strategies that I briefly describe in 'Dagens Industri's close remark. Notwithstanding the Dutch are almost always one of the targets of the OECD's and EU's initiatives against international tax avoidance, they always, like the cat, get back on their feet after the fall and appear to be one of "the good guys" on the issue addressed. This is the kind of political tax diplomacy that Sweden must become better at in the future.
Expect the G20/OECD/EU to celebrate the global agreement in colorful terms and to establish the necessary multilateral agreements, model legislation and EU directives at record speed in order to facilitate and accelerate implementation. The momentum that now prevails is also likely to create sufficient political pressure on still reluctant countries to compromise on the remaining outstanding issues. (4)
Despite the above, it is far from certain that the agreement will ultimately see the light of day in its current form, if at all. After all, I have personally experienced how OECD projects that I thought were written in stone were dismantled in a couple of months.
The United States currently lacks necessary domestic political support to implement Pillar 1 due to Republican opposition in the Senate. Treasury has raised the idea of trying to circumvent the requirement in the Senate that international agreements must be adopted by a two-thirds majority. However, this is so far only speculation and such an attempt by Treasury could cause a constitutional crisis in the United States. Remember that the United States may ultimately be content with just implementing Pillar 2.
The implementation process may ultimately develop into a "chicken-race"
It is also not certain that Treasury will succeed in implementing Pillar 2 as the Democrats mutually disagree on Biden's Build Back Better package. Also note that the Democrats may have lost control of both chambers of Congress by the end of next year.
If Treasury fails to partially or fully implement the agreement, the future of both pillars 1 and 2 would be uncertain. Note that it will take a year or two before we know exactly how Congress will act on these issues.
Another factor of uncertainty is the frictions that will inevitably arise when it is clarified in real money which countries will have to pay for pillars 1 and 2. Furthermore, some countries will be forced to phase out their digital taxes without receiving any compensation. Others will feel ripped off when they realize that pillars 1 and 2 are primarily about redistributing income between the large and rich countries. The frictions could become even worse if the agreement provokes relocations of international investment.
It is also naive to believe that global tax competition can be abolished voluntarily overnight. Countries will cheat and rules will be circumvented when the minimum tax is implemented and applied in practice. The mere suspicion of such conduct may provoke frictions that could undermine the entire pillars 1 and 2 framework. A peer review process can only verify if rules are implemented, not how the rules are applied.
We must not be blinded by the fact that the G20/OECD agreement is currently presented as and in fact appears to be the successful end point to the OECD's work on the issue. The agreement contains so many uncertainties that it can collapse like a house of cards at any moment.
The Swedish government should keep a low profile throughout the process and, above all, not be best in class in implementing pillars 1 and 2. The government also needs to ensure that applicable deadlines for the implementation of any EU directives are conditioned on the actions taken by other key countries. The implementation process may well develop into a "chicken race" where some countries wait until the very end before deciding how to act.
Through its actions, the Swedish government has shot the Swedish MNE industry in one foot. Try to avoid during the implementation process to also shoot the industry in the other foot.
(1) Small countries such as Sweden can only lose out when taxing rights are gradually transferred to market countries. Minimum taxes lead to an increase in Swedish MNE's global tax burden, which in turn adversely affect their relative competitiveness. See further Fensby, "Why Sweden Should Lobby for an OECD-Approved Digital Services Tax", Tax Notes International, 13 July, 2020.
(2) Robert Goulder, “The Futility of Challenging DSTs under International Law, Tax Notes International, June 23, 2020.
(3) For a translation of my two opinions in Dagens Industri, go to the Startup Page and click on the sub-heading "Opinions" under the heading "Press".
(4) For example, it is still unclear what tax regimes constitute digital taxes that need to be phased out.
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