Upscale Warning for the Startup Nation

March 12, 2019

The proposed Digital Services Tax will have serious ramifications for France’s ambitions to be a startup nation. It misunderstands startups’ focus on growth by taxing revenues and mistakenly thinks startups are exempted by using a threshold. Moreover, it distracts from the prospects of a multilateral solution in the OECD framework.

Taxing revenue is like launching a rocket with a leaking fuel cell

Startups pay taxes like all other businesses. One characteristic that separates them from other businesses is their focus on scale. In pursuit of these ambitions, entrepreneurs invest a lot of their revenue into growth. Often they do not become profitable for years. Siphoning off this process by introducing France’s proposed 3% tax on turnover leads to a lose-lose scenario: It fails to recognize the potential future size and economic impact of a startup while inhibiting it from getting there. It’s a bit like launching a startup rocket with a leaking fuel cell.

74% of
French investors agreed that “A digital tax on turnover would drive tech entrepreneurs to set up in other regions.” In his Sorbonne speech, President Macron said: “We are no longer living in times in which our economies can develop as if they were closed, as if talented people no longer moved around and as if entrepreneurs were tied to a post.” In other words, if France wants to be the Startup Nation, a direct tax on turnover kneecaps these ambitions. This will not add up.

For startups, thresholds are synonymous to glass ceilings. At worst they can incentivize startups to stay small, but at least they reduce incentives to grow. Building on this, if a tax is collected retroactively, as the French Digital Services Tax proposes, then such an effect would be amplified and felt at an even earlier revenue stage. This would add uncertainty and question the rule of law.

Not in scope ≠ Not affected

Most startups may not be directly subjected to the tax, but will suffer indirectly. Those who do not yet meet one of the thresholds (25M€ locally and 750M€ globally), are simply not paying directly but through the services they use. All startups operate in a vibrant platform ecosystem, where costs will trickle-down to them, ultimately leading to a slowdown of investment and growth and taxing those who least deserve it.

This is part of a broader trend, that of using blunt legislation to target specific actors. We asked investors in France whether “The principle of designing policy and/or legislation in order to target specific companies (i.e. global giants) could lead to poor outcomes that inadvertently hurt or hinder tech startups”? Over 70% agreed. Perhaps legislators should consider a proposal where startups are not left in the crosshairs at the end of the day?

Update taxation ensemble!

The digital economy is changing rapidly. Startups are living proof of it. It is normal to overhaul the tax systems to reflect these changes. In this case, there is a debate to be held around value creation and also one about where scaleups are paying taxes. Regarding the latter, if one country considers that tech firms aren’t paying enough in its jurisdiction, then surely the solution to this must be a multilateral one. When has going alone on tax led to long-term gains?

There is a process underway in the OECD which deserves to be taken seriously. Going alone is not sending a sign of confidence in this process. The OECD said as much when it commented on the EU Digital Services Tax, which was at least still multilateral: “ [The OECD] considers that the development of an EU-level solution, in form of an equalisation tax based on revenues, before a global one, while likely to increase taxation of the digital economy, comes with the risk of ‘economic distortions, double taxation, increased uncertainty and complexity, and associated compliance costs for businesses operating cross-border’, in some cases potentially conflicting with pre-existing bilateral tax treaties.”

Startups are the most mobile businesses in history, as President Macron rightly identified. They make business choices based on a variety of variables, including market size, the surrounding regulatory framework, access to talent, and tax. Going alone with a Digital Services Tax will add complexity and fragmentation for startups. It would be like throwing a wrench in the plans of the French Startup Nation.