Neither trade nor tax are new issues. What is new are the types of challenges that digital trade poses to revenue collection. As the digital economy has grown significantly, governments have watched with increasing dismay as taxes have not been collected from a steeply growing volume of transactions. Fiscal pressures in the wake of pandemic spending have accelerated the quest to appropriately tax companies and purchases made in the digital or online environment.

Until recently, trade experts could avoid most discussions about tax and tax experts could overlook trade implications of tax policies. Trade has typically been handled by trade and commerce ministries while tax is managed by finance ministries or central banks. Communication between the two sides, even in a domestic setting, can be limited. International opportunities for conversations between tax and trade are even more rare. The growing strength of the digital economy and new types of cross-border trade activities have eroded this previous division of labor. Increasingly, trade policies need to reflect changes in tax policies and vice versa.

The rise of the digital economy has complicated the traditional tax environment. Firms can be located anywhere and provide goods and services online to suppliers, vendors and customers without any need for a physical presence. The digital economy allows firms to scale up substantially at often minimal direct costs, creating a small set of super firms generating outsized profits. Such technology or digital firms present tempting targets for cash- strapped governments looking for revenue.

However, it is not just large firms that can take advantage of new ways to find customers. A vital aspect of the digital economy is how it enables even the smallest companies to engage in cross-border trade. Firms that might never have been tempted to trade outside their own villages are increasingly finding key markets halfway around the globe.

In short, there are at least three important ways that the digital economy has affected traditional tax systems: by allowing firms to compete in markets without a physical presence; by the proliferation of approaches, mostly used by large firms, to more carefully manage tax; and by the participation in cross- border trade by companies previously not engaged in such transactions.

Changes in tax policy to address these challenges run a significant risk of upending cross-border trade opportunities and burdening firms of all sizes with substantial new compliance costs. As tax and trade have been considered largely in silos, unintended consequences are likely to rise.

The Organisation for Economic Co-operation and Development (OECD) and G20 countries began negotiations in 2013 to address tax matters related to the digitalization of the economy as part of a broader review of international tax rules. Additional multilateral negotiations in that area are ongoing at the OECD.

On July 22, 2020, despite ongoing negotiations at the OECD, the United Kingdom adopted a Digital Services Tax (DST). The UK’s unilateral DST applies a two percent tax on the revenues of certain search engines, social media platforms and online marketplaces. The UK DST applies only to companies with “digital services revenues” exceeding £500 million and “UK digital services revenues” exceeding £25 million. Companies became liable for the DST on April 1, 2020.

On June 2, 2020, the U.S. Trade Representative initiated an investigation of the UK DST under section 302(b)(1)(A) of the Trade Act of 1974, as amended (the Trade Act). Section 301 of the Trade Act sets out three types of acts, policies, or practices of a foreign country that are actionable: (i) trade agreement violations; (ii) acts, policies or practices that are unjustifiable (defined as those that are inconsistent with U.S. international legal rights) and burden or restrict U.S. commerce; and (iii) acts, policies or practices that are unreasonable or discriminatory and burden or restrict U.S. commerce. If the Trade Representative determines that an act, policy, or practice of a foreign country falls within any of the categories of actionable conduct, the Trade Representative must determine what action, if any, to take.