Are DSTs creditable in the us as a foreign tax credit 8.3.2021 Educational and hypothetical uses only (c) Charles Edward Andrew Lincoln IV

1. ARE DSTS CREDITABLE
IN THE US AS A FOREIGN
TAX CREDIT?
OR ARE DSTS "IN LIEU" OF AN INCOME TAX UNDER IRC 903 LANGUAGE?
CEALIV@BU.EDU

2. MAP OF DST PROPOSALS
Source:
Elke Asen, What European OECD
Countries Are Doing about Digital
Services Taxes, Tax Foundation
March 25, 2011
BUT ARE THEY CREDITABLE IN THE US?

3. RULE FOR TAXPAYER FOR WHO MAY CLAIM A TAX
CREDIT
• Treas. Reg. § 1.901-2(f)(1): Only the person with legal liability for a tax may claim an FTC
• To be creditable, a foreign levy must:
• Be a tax (not a penalty, fine, duty etc.)
• Imposed by a foreign tax authority
• Not in exchange for a “specific benefit”
• Have the predominant character of an income tax in the US sense
• Touches on “net gain” in normal cases
• Not a soak-up tax – a tax imposed only if a credit is provided by another country
• Rarely, a tax treaty may grant a credit for an otherwise non-creditable tax
• Example German Trade Tax – calculated in three parts (1) business profits, (2) business value, (3) business payroll. Only
the part (1) business profits are creditable based on the treaty

4. “IN LIEU OF” TAXES – SECTION 903
• NOT Imposed on a net income basis. E.g., gross basis withholding taxes
• Imposed “in lieu” of an income tax
• Must be in substitution for, and not in addition to, an income tax that is otherwise generally
imposed
• Must meet the definition of a tax
• Must not be a “soak-up” tax
• A soak-up tax is a tax that the U.S. taxpayer is liable for only if a credit is available to offset
that tax - Treas. Reg. 1.901-2(c)

5. HOW DSTS WORK
• A digital services tax purports to tax transactions that occur digitally through an
expanded concept of nexus
• For the French DST to apply, the following elements must be met:
• (1) a company must make more than €750 million of gross profit a year
• (2) a company that provides digital services
• The French Government defines digital services as services that require user participation for
creating value, such as through advertising, sale of data, etc. (See, Professor Ainsworth’s PPT 7(b)
CTP slides 10-14 for how these digital services work).

6. APPLIED TO FTC REGIME
• Treas. Reg. § 1.901-2(f)(1): Only the person with legal liability for a tax may claim an FTC - Yes, legal
liability exists
• Is the levy a penalty, fine, duty, etc.? - Maybe – but perhaps not. Closest to a duty/withholding
• Imposed by a foreign tax authority? - Yes
• Exchange for a “specific benefit”? - No
• Character of tax – as in “net gain” on income? – No, French government taxing gross profits
• Is this a soak-up tax? – No, French government is taxing regardless if there is a credit in the
US
• Exception – is there a treaty provision that would provide a credit? – Not yet, but given that the
tests failed, a provision would need to be negotiated

7. APPLIED TO “IN LIEU OF” REGIME
• NOT Imposed on a net income basis. E.g., gross basis withholding taxes - French
government imposes on gross basis NOT on net income.
• Imposed in lieu of an income tax – there is no evidence the French government
intends or will impose in substitution of an income tax. It will be an additional
tax.
• Revenue Rulings have shown such taxes must be substitutes not additional taxes – see
comparison asset/gross tax instead of income tax
• Must meet the definition of a tax – Not in the character of a tax other than gross
income
• Must not be a “soak-up” tax – French government will apply the tax regardless of
whether there is a credit in the US or not

8. CONCLUSION – FURTHER THOUGHTS
• It's all up in the air, thus nothing is for certain
• Proposed US Regulations would deny a credit – more to be seen
• Policy-wise - EU countries want to get that share of income. This makes economic sense in the aftermath of
the 2008 economic crisis and the COVID-19 epidemic
• The OECD BEPS project (such as Action 1) and subsequent proposals hold firmly to the two foundations of international
tax:
• (1) residency/source, and
• (2) the arm's length principle. These principles made sense in the pre-digital world of commerce. These standards have existed since
the 1920s when the League of Nations developed these rules and have origins in the 1800s with the first tax treaties.
• Arguably, these two foundations of (1) residency/source and (2) the arm's length principle no longer apply in the digital
world. Cf. Formulary apportionment and single taxation theory
• Professor Ainsworth’s class slide 3 from Class 7(a) – should the UN Model Tax Treaty (Article 12A/12B) adopt
a new article to deal with these DSTs? Should the U.S. Model/OECD Model also adopt it?
• Tax Planning ideas?