What Is a Digital Services Tax and How Does It Impact Businesses?

Governments are increasingly seeking ways to tax digital businesses that operate across borders but don’t always pay corporate taxes where they generate revenue. Digital Services Taxes (DSTs) have emerged as a response, targeting large technology companies that benefit from users in multiple jurisdictions without maintaining a significant physical presence.

These taxes create financial obligations for businesses and influence pricing strategies, profitability, and market operations. Understanding how DSTs work is essential for companies in the digital economy.

Categories of Taxable Digital Services

Governments implementing DSTs focus on revenue-generating activities tied to user engagement rather than traditional corporate income. The types of services subject to these taxes vary by country but often include online advertising, streaming media, and eCommerce platforms.

Online Advertising Platforms

Companies that generate revenue by selling digital ad space are a common target for DSTs. These platforms collect user data and sell targeted advertising, often earning substantial revenue without a physical presence in the countries where their ads appear.

France’s DST, introduced in 2019, applies a 3% tax on revenue from digital advertising services when companies exceed €750 million in global revenue and €25 million in French revenue. This tax affects businesses that facilitate online advertising, including search engines and social media networks.

Spain and Italy have implemented similar levies, focusing on digital ad networks that monetize user data. Affected businesses often pass these costs onto advertisers, leading to higher prices for companies relying on online ads.

Streaming Media Providers

Digital entertainment services offering video, music, or gaming content through online platforms are frequently included in DST frameworks. These companies earn revenue through subscriptions, pay-per-view models, or ad-supported content.

In the UK, the DST applies a 2% charge on revenues from digital services, including streaming platforms, if a company exceeds £500 million in global revenue and £25 million in UK revenue. This affects providers offering on-demand content, such as video-sharing websites, movie rental services, and premium music platforms.

Since users can access content from anywhere, tax authorities rely on user location rather than company headquarters to assess liabilities. Some platforms have adjusted pricing or reconsidered service availability in certain countries to manage the additional tax burden.

eCommerce Marketplaces

Online marketplaces that facilitate transactions between buyers and sellers are another category subject to DSTs. These platforms generate revenue by charging commissions, listing fees, or transaction-based charges, even if they do not directly sell goods or services.

India’s Equalisation Levy, introduced in 2016 and expanded in 2020, imposes a 2% tax on revenue from eCommerce operators that sell goods or services to Indian customers, regardless of physical presence. This applies to international businesses running digital marketplaces, including those offering retail, travel bookings, and freelance services.

Taxing eCommerce intermediaries can impact small businesses and independent sellers. When platforms pass on tax costs through higher fees, smaller merchants may struggle with reduced margins or pricing pressure, making it harder to compete.

Revenue or User-Based Thresholds

To ensure DSTs primarily affect large multinational corporations rather than smaller businesses, governments set financial thresholds based on revenue or user activity. These thresholds help distinguish between global tech giants and smaller firms.

Many DST regimes establish minimum revenue requirements before a company becomes liable for the tax. Canada’s proposed DST, for example, would apply a 3% tax on digital services revenue if a company generates at least CAD 750 million globally and CAD 20 million from Canadian users.

Some jurisdictions assess tax liability based on user numbers rather than revenue. The European Commission’s original DST proposal suggested taxing companies with at least 100,000 users in a member state, arguing that digital businesses derive value from user engagement rather than just direct sales.

Governments also use these thresholds to address tax avoidance. By setting clear financial and user-based criteria, authorities can prevent companies from structuring operations to artificially reduce taxable revenue in a given country. Some firms have attempted to shift earnings to lower-tax jurisdictions through transfer pricing strategies, but DSTs based on user location make it harder to minimize tax obligations.

Calculating Tax Liabilities

Determining how much a company owes under a DST requires assessing taxable revenue, applicable deductions, and jurisdiction-specific rates. Unlike corporate income taxes, which consider net profits, DSTs are typically levied on gross revenue derived from digital activities, meaning businesses must calculate obligations based on total earnings before expenses. This structure can significantly impact cash flow, especially for companies operating on thin margins.

Taxable revenue is defined by the legislation of each country imposing a DST. Some jurisdictions, such as Austria, allow companies to exclude certain costs like refunds or chargebacks from their taxable base, while others, like Turkey, impose the tax on all gross receipts without deductions. Businesses must review local tax laws to determine what portion of their revenue is subject to taxation and whether any exemptions apply. Incorrect calculations can lead to underpayment, resulting in penalties and interest charges.

Exchange rates add another layer of complexity for multinational firms. Since revenue is often earned in multiple currencies, companies must convert foreign earnings into the local currency of the taxing jurisdiction. Many governments require the use of official exchange rates published by central banks on a specific date, but fluctuations can affect the final tax liability. Businesses must also ensure consistency in reporting to avoid discrepancies that could trigger audits.

International Coordination Among Jurisdictions

As more countries implement DSTs, the challenge of international coordination has grown. Without a standardized framework, businesses operating across multiple jurisdictions face overlapping tax obligations, leading to double taxation and administrative burdens. The Organization for Economic Co-operation and Development (OECD) has sought to address this issue through its Two-Pillar Solution, which aims to reallocate taxing rights and establish a global minimum tax, but progress has been slow, leaving companies to navigate a patchwork of national policies.

Bilateral tax treaties traditionally prevent double taxation, but most were designed for brick-and-mortar businesses and do not adequately address digital revenue. Some countries, such as the United States, have pushed back against unilateral DSTs, arguing that they unfairly target American technology firms. In response, trade tensions have escalated, with the U.S. threatening retaliatory tariffs against countries imposing DSTs on American companies. These disputes create uncertainty for multinational firms, which must weigh the risks of potential trade conflicts when planning tax strategies.

Enforcement and Penalties

Governments rely on reporting requirements, audits, and financial penalties to ensure compliance with DSTs. Since these taxes apply to companies that may not have a physical presence in the taxing country, enforcement mechanisms often focus on mandatory disclosures and cooperation with financial institutions to track taxable revenue. Many jurisdictions require affected businesses to register with local tax authorities and submit periodic filings detailing digital service earnings, user locations, and tax calculations. Failure to comply can result in fines, interest charges, or restrictions on operating within the country.

Penalties for non-compliance vary by jurisdiction but can be substantial. In Spain, companies that fail to file DST returns on time face fines of up to 1% of undeclared revenue, with additional penalties for repeated offenses. In Turkey, non-payment of the DST can lead to tax audits and potential bans on digital advertising services, limiting a company’s ability to generate revenue. Some governments have also explored withholding mechanisms, where payment processors or financial institutions deduct DST amounts before remitting funds to digital service providers. This approach shifts enforcement responsibility to intermediaries, reducing the risk of tax avoidance but adding complexity to cross-border transactions.