VAT vs. Digital Services Tax – Who Really Delivers?

Do you know that the EU’s failed attempt to tax tech giants through Digital Services Tax could have been solved differently? In today’s podcast episode, we’ll discuss how VAT might be something to consider instead of Digital Services Tax – a topic that at first glance seems like international tax theory, but in reality affects how European countries collect billions in revenue from tech giants.

Paweł Mikuła talks with Leopoldo Parada, Reader in Tax Law at King’s College London and international tax expert, about why the EU’s Digital Services Tax proposal failed in 2018, how individual countries implemented their own versions despite US retaliation threats, and most importantly – how existing VAT rules could achieve the same revenue goals without the geopolitical risks. We’ll explore whether taxing user data as „consideration” under VAT law could be the key to finally capturing value from „free” digital services.

Links to the materials mentioned:

Balancing DSTs and Geopolitics: The European Dilemma – Tax Notes International, Vol. 117, No. 19 (2025) – https://papers.ssrn.com/sol3/papers.cfm?abstract_id=5662270

This article summarizes a discussion with tax law expert Leopoldo Parada and does not constitute a sourced academic paper. The analysis presented reflects the conversation’s key insights rather than comprehensive research.

The Geopolitical Crossroads of Digital Tax: DST Failure, Trade Wars, and the Trade-Neutral Potential of VAT

This article offers an essential synthesis of the critical challenges and global trends concerning the taxation of the digital economy, drawing from a key discussion with Leopoldo Parada, a Reader in Tax Law at King’s College London. The analysis focuses squarely on the Digital Services Tax (DST), its complex and often fraught interaction with global geopolitics, and meticulously examines the enduring potential of the Value Added Tax (VAT) as a structurally superior, more stable, and less contentious solution for capturing revenue from the contemporary digital marketplace.

From Physical Presence to Market Authority: The Genesis of Digital Services Taxes (DST)

The push for Digital Services Taxes emerged from the fundamental realization that the established international tax architecture—built primarily on the concept of physical presence via bilateral tax treaties—was woefully inadequate for capturing the true profits of large technology companies. These companies, providing services such as online advertisement and digital intermediary activities, could establish a powerful strong economic presence and generate vast revenues in numerous countries without needing any fixed physical establishment. This critical disconnect meant that significant business profits could not be effectively taxed in the market jurisdiction where the value was generated, leading to uncollected revenues. While global bodies, notably the OECD, embarked on developing a multilateral solution (which later materialized as Pillar One), the speed and scale of digital value extraction prompted individual countries and blocs, particularly within the EU, to seek immediate, unilateral measures to close this gaping tax hole.

The Failure of the European DST Directive: Legal Challenges and the Risk of Retaliation

The European Commission’s 2018 proposal for a temporary DST directive, intended to harmonize a tax across all member states, ultimately collapsed, not only due to a lack of political unanimity but fundamentally because of its discriminatory design and the intense geopolitical pushback it provoked. The proposed tax featured a low 3% rate applied to turnover derived from specific digital services, but its structure was problematic: it applied only to companies with a high global revenue exceeding €750 million and an EU revenue of at least €50 million.

While the low rate and turnover base were intended to secure tax revenues without waiting for the slow-moving OECD negotiations, the high thresholds created an inherent, legally significant problem: de facto discrimination. Due to the global dominance of large US tech firms in the targeted sectors, the tax disproportionately impacted non-EU companies. This targeting, often overtly referred to by politicians as the „GAFA tax” (Google, Apple, Facebook, Amazon), created acute legal vulnerability, particularly concerning compliance with World Trade Organization (WTO) rules against discriminatory trade practices. The most damaging consequence of this perceived discrimination was the immediate launch of an official US investigation under its trade act. The US investigation concluded that the proposed DSTs were discriminatory and, crucially, threatened to impose crippling retaliatory tariffs on goods imported from adopting countries (e.g., France’s luxury goods). This direct threat of a trade war successfully paralyzed the EU initiative, demonstrating that the tax’s design was legally and politically untenable.

Trade War and Strategic Diplomacy: Geopolitical Constraints on Unilateral DSTs

Following the failure of the EU directive, countries like France, Spain, Austria, and Italy forged ahead with the unilateral implementation of their own DSTs. Economically, these taxes were often viewed as a „brilliant tax” structure—resembling a withholding mechanism that effectively captured revenue from a captive user base. However, this fragmented approach failed to shield the implementing nations from the overarching geopolitical risk. The decisive factor in the digital tax debate was not domestic tax policy but the demonstration of power dynamics on the international stage. The credible threat of US tariffs proved that the unilateral implementation of a tax targeting foreign firms is ultimately subordinate to global trade and diplomatic pressures.

Any future EU-wide DST initiative must be strategically reformed to succeed. Parada suggests that the approach must adhere to three minimum standards. First, there must be clear strategic intent: the DST must be defined either as a temporary stop-gap pending global solutions (Pillar One/UN) or as a permanent, standalone EU regime. Second, the discriminatory thresholds must be fundamentally rethought. To avoid the appearance of targeting, the low DST rate should be applied to the revenue of all companies (with adequate protection for SMEs potentially provided through subsidies rather than exemptions). Finally, and most critically, any proposal requires a radically different strategic diplomacy. The hostile, anti-American rhetoric and overt use of terms like „GAFA tax” must be abandoned. A smarter political framing would embed the tax element within a larger, trade-neutral piece of EU legislation, such as a general regulation on the Digital Market, thus shifting the focus away from the specific tax on foreign firms.

Global Context: Digital Services Tax and the Relationship with OECD’s Pillar One

The proliferation of unilateral DSTs created immense pressure on the OECD to finalize its Pillar One initiative. Pillar One is, in essence, a sophisticated, global alternative mechanism designed to achieve the same reallocation objective as the DSTs: shifting taxing rights of highly profitable multinational enterprises to the market jurisdictions where users are located. Specifically, the framework, through its Amount A provision, reallocates a portion of the excess profit (defined as 25% of profits exceeding a 10% profitability threshold) of the world’s largest and most profitable companies—those with global revenues exceeding €20 billion—among the market countries. The two solutions are fundamentally competitive: Pillar One, which requires a multilateral convention to enter into force, includes an explicit mandate that any country applying it must simultaneously withdraw all existing unilateral DSTs. The global tax community is therefore facing a clear choice between a slow, complex, multilateral agreement and rapid, yet legally and geopolitically contentious, unilateral actions.

VAT as a Trade Neutral Instrument: Why Consumption Tax is a Better Alternative to DST

In light of the significant legal, political, and trade-related risks associated with the DST framework, the established Value Added Tax (VAT) system presents a compelling, structurally superior, and more stable alternative. VAT is powerful because it is highly harmonized across the European Union, is inherently non-discriminatory, and is internationally recognized as being trade neutral under WTO rules. Unlike a DST, which taxes turnover and invites tariffs, VAT is a tax on consumption and, by its design, avoids the type of international trade clashes that plagued the DST debate.

The VAT system benefits from being mature, efficient, and well-supported by recent technological reforms, such as the One-Stop Shop (OSS). While many digital services are already taxed under the VAT regime, the central problem remains: the specific services targeted by DSTs—those provided to users without a direct, explicit monetary transaction—currently escape the VAT base, requiring an interpretation of whether value is being exchanged.

Valuing User Data: The Potential of VAT in Taxing „Free” Digital Services

The most significant legal and economic challenge for modern consumption taxes lies in establishing a taxable base for services like social media platforms that are presented to users as „free.” Under the EU VAT Directive, a supply of services must be made for consideration to be taxable. However, in the context of „free” services, the user provides a measurable form of non-monetary consideration: the supply of their personal data and their valuable activity on the platform.

VAT experts, including Parada, have explored the potential to reinterpret the existing VAT Directive to accept this transfer of data as a valid, quantifiable taxable consideration. Should the value of this non-monetary consideration be reliably assessed, the VAT base could be significantly broadened to include what is now perceived as a tax-free service. Critically, this approach holds significant political advantage: although VAT is technically a consumption tax, the administrative burden of paying the VAT would fall on the service provider (e.g., Meta, X), not the consumer. This crucial distinction allows policymakers to frame the measure as a tax on „big tech” while relying on a trade-neutral system. While a formal amendment to the VAT Directive would provide the highest level of legal certainty, ongoing legal cases (such as those being pursued in Italy against Meta) are actively testing the interpretation that the current law may already be sufficient to treat the provision of user data as a taxable consideration, making VAT a potent and pragmatic long-term solution.

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