GAFA Tax : towards a transfer pricing revolution ?


On Thursday, July 11, 2019, the GAFA tax (Google, Apple, Facebook, Amazon) was finally adopted by French Parliament. Indeed, the law plans to tax 3% of the sales of the digital giants. The companies concerned are those whose global sales on their digital activities exceed 750 million euros, including 25 million euros related to users located in France. Thus, about thirty companies would fall within the scope of the law. In addition to the GAFA, French companies such as Critéo could also be within scope. According to preliminary estimates, this new tax should bring 400 million euros in 2019, then 650 million euros in 2020.

A first step that can lead to others

This GAFA tax is an interim measure, awaiting a broader consensus at the OECD level. The latter, in response to the challenges concerning the taxation of multinationals’ profits, has implemented since 2015 the project entitled BEPS (Base Erosion Profit Shifting). This acronym covers the issues related to the transfer of profits from multinationals to states offering lower tax rates. More specifically, Action 1 of BEPS addresses the tax challenges posed by the digital economy. In addition, countries have introduced country-by-country reporting (CBCR) for very large companies, the key elements of which we have recalled in this article.

Moreover, the concept of permanent establishment seems outdated today. Indeed, this notion appeared in the 1920s to lay the first foundations of international taxation. In France, it aims to identify taxable income. However, this notion is often circumvented in practice. As a result, the loss for the tax administration is significant. As a reminder, the criteria defining a permanent establishment are as follows :

  • An autonomous establishment
  • A dependent representative
  • A complete business cycle

Nowadays, advances in digital technology enable many multinationals to make business without physical representation in a country. Then, they escape the status of permanent establishment and are therefore not liable for tax.

Towards a formulary apportionment ?

The GAFA tax, based on a percentage of sales, highlights a new principle of taxation. Indeed, the underlying idea is to tax from now on the place where the consumer benefits from the service, and no longer the place of production or possession of intellectual property.

To achieve this, one solution is to determine first the residual tax benefit of a company. Then, this profit is allocated among the countries where the group operates according to allocation keys such as the sales or the number of users. This new solution is called formulary apportionment. It is a paradigm shift in relation to the arm’s length principle that currently underlies transfer pricing regulations. As a reminder, this principle indicates that the prices charged between companies of the same group must be comparable to those observed between independent companies. If the principle appears relevant in theory, the practical application is often tricky. Indeed, litigation with the tax authorities regularly focuses on an application deemed erroneous of the transfer pricing methods.

To date, the OECD does explicitly not recognize formulary apportionment as an acceptable transfer pricing method. However, the implementation of the GAFA tax could turn the tables.

Adopting and generalizing this formulary apportionment principle would simplify the procedures for determining transfer prices. Indeed, the profit can nowadays be distributed by determining what would have done independent companies (TNMM or profit split). This often causes problems when it comes to benchmarking with comparable companies. With the formulary apportionment, the tax authorities would simply allocate the profit in proportion to the sales achieved in each country. Without having to look for comparables. The problems encountered when implementing the current methods, which are an abundant source of disputes with the tax authorities, would be diminished.

The GAFA tax effects on countries

Other countries beside France are also considering applying a comparable tax. However, it is advisable to remain cautious about the potential “winners” and “losers” in case of a wider application of the GAFA tax principle. The cascading effects are extremely difficult to measure at this stage. Nevertheless, we can note the following main points of attention :

  • Differences in tax attractiveness between countries could be reduced, thus rendering attraction strategies based on low tax rates obsolete.
  • Taxation would shift from the place of production to the place of consumption. Thus, major markets such as the United States and China could be favored. On the other hand, less populated countries such as Ireland or Switzerland could be penalized.
  • Both the United States and China argue in favor of an extension of taxation to sectors other than the digital economy. This point is based on the fact that in the future, value will derive entirely from data.

While the principle of formulary apportionment makes economic sense, the difference of interests as to its wider application remains important. For example, the United States, whose trade deficit is structural, has a greater interest in taxing the place of consumption. On the other hand, countries such as Germany, whose exportations are in excess, could instead favor taxation of the place of production.

Ultimately, there is still a long way to go to achieve a tax policy dealing appropriately with the digital challenges. The OECD has set a deadline of 2020 for a global agreement on the taxation of the digital economy. In the light of these developments, there is no doubt that companies will have to thoroughly review their practice of transfer pricing in the short / medium term.