Risk to Competitiveness and Profitability If Poorly Implemented
ResearchTaxing Digital Enterprises
Last year, the EU Commission proposed Europe-wide directives for the taxation of digital companies. Capital markets reacted vigorously, causing the market value of many digital companies to plummet in the short term to the tune of billions. In the long term, the proposed digital taxation directives could harm the profitability and competitiveness of digital enterprises. These are the findings of a study conducted by ZEW Mannheim together with the University of Mannheim.
The study examines how capital providers investing in digital companies react to the planned introduction of digital tax directives in Europe. To this end, the researchers evaluated data from 222 potentially affected digital companies and examined their stock returns both on 21 March 2018, when the EU Commission published the draft directives, and on the following day. The result shows a significant decrease in the market value of digital enterprises that would be affected by the directive. “Due to the proposed measures, the overall market value of digital companies fell by at least 52 billion euros beyond the normal market movement during these two days,” says Christopher Ludwig, a researcher in the ZEW Research Department “Corporate Taxation and Public Finance” and co-author of the study. Around 40 per cent of the companies affected are based in the USA.
Most affected by the extraordinary market reaction are EU-based companies with higher profits. Capital markets are also reacting more strongly to companies actively engaging in tax avoidance, as well as companies with higher potential for profit shifting. “It seems that some digital companies are currently still able to largely avoid taxation in the EU. According to investors, this would probably be much more difficult in the future once the proposed digital taxation comes into force, and this is why they react accordingly,” says Christopher Ludwig.
Caution when introducing digital taxation measures
The EU Commission has proposed two directives for digital taxation. The first – conceived of as an interim solution – introduces a tax of three per cent on the gross revenue of certain digital services. This concerns companies with a worldwide turnover of more than 750 million euros within a financial year and a turnover of more than 50 million euros from digital services within the EU. The second directive seeks a longer-term solution to the digital tax problem, creating a new taxable link for companies with a non-physical but significant digital presence in one or more EU Member States.
The reaction of the capital markets also provides information on the potential long-term consequences for companies. “Investors assume that the proposed digital tax measures are very likely to be implemented and are therefore expecting negative effects on the future profitability and competitiveness of digital companies,” explains co-author of the study and ZEW Research Associate Professor Christoph Spengel. “This may also translate into less willingness to invest in digital businesses, which in the future could mean fewer growth opportunities.”
In light of the current shortcomings in the design of the draft directives and their potentially harmful impact on digital enterprises, the researchers are therefore advising caution when introducing digital tax measures. The latter should be carefully checked in advance with regard to their exact effect.