1. Introduction:
Recently the UK government has announced that it will introduce a Digital Services Tax (DST) which will raise £1.5 billion over four years, in order to ensure that digital businesses pay taxes that reflect the value they drive from UK users. The proposed DST is aimed at search engines, social media platforms, and online marketplaces. The proposal is being perceived as the most concrete attempt yet by an industrialised nation to rewrite the world’s tax code for the digital era.
Big American tech firms have been criticized for reporting relatively little of their profit in local jurisdictions, opening them up to scrutiny. An international effort among rich nations to help standardize how and where to tax these digital services has been progressing slowly. The U.K. government said that it could no longer wait. As part of its annual budget, it said it was moving ahead with a plan to begin a digital tax for large tech firms by 2020.
2. Initiation of the Proposal: Main Causes:
2.1. Low reporting of UK taxes:
While Tech companies have been busy expanding in the U.K. the issue remain unsettled regarding how much tax these companies pay in Britain. The fact that digital businesses are able to generate revenues from markets in which they have limited physical presence, means that technology companies in particular are able to make substantial profits as a result of having customers in a particular location but not to pay tax on the profits in that location.
For instance, Amazon U.K. Services Ltd. in 2017 reported revenue of £1.98 billion and a profit on ordinary activities before taxation of £72.37 million, but paid only £1.7 million in U.K. taxes, according to Companies House, a register of corporate information. Facebook’s British subsidiary that year reported revenue of £1.26 billion and a profit of £62.76 million in 2017, paying £17.19 million in taxes. Google UK Ltd. for the year ended June 31, 2017, booked revenue of £1.26 billion and profit on ordinary activities of £200.55 million. It paid £47.36 million in British taxes.
Thus the UK proposal is going to specifically address the issue of under-taxation of tech giants in relation to the overall profit generated.
2.2. A Unified international proposal for DST yet to be taken:
Several international bodies, including the Organization for Economic Cooperation and Development, the G20 group of industrialized nations and European Commission, have been working on ways to crack down on corporate tax avoidance, especially by large internet and software firms. Thus the International pressure is growing for faster action to be taken with respect to digital service taxation.
Pending EC Proposal : It is predicted that the European Commission will propose a 3% tax on advertising revenues generated by digital companies; the fees raised from users and subscribers to digital music services, and the income made from selling personal data to third parties. However the EU proposal is also getting stuck in the absence of unanimous support. The EU version of the tax, which would require the unanimous support of the bloc to be passed, is being blocked by countries including the Czech Republic, which argue the cost of collecting the tax would be higher than the revenue it would generate. Apart from the internal bickering there are worries about a backlash from the US since most of the affected companies will be American.
Pending OECD Proposal: The Organisation for Economic Cooperation and Development (OECD), which coordinates global tax policy, has said that it will try to come up with an agreed approach to taxing the digital economy by 2020. The OECD report acknowledges that there is currently no consensus between OECD members as to whether action needs to be taken. It is going to review the “nexus” and “profit allocation” rules with a view to coming up with an agreed solution by 2020, with an update to the G20 in 2019.
Couldn’t afford to wait: The UK Chancellor said this multinational approach was the best option, but that negotiations in these international organizations was slow and the U.K. could not afford to wait. He said that if a better tax solution emerged from the G20 before April 2020, the U.K. would consider adopting that instead of its own policy.
As a result, the government has decided to act now and will introduce a Digital Services Tax (DST) from April 2020.
3. The Proposal: In an attempt to ensure internet giants pay their fair share the government has vowed to introduce significant changes which are as follows:
3.1. Unilateral Interim Measure:
The updated position paper by the UK Treasury made it clear that it supports reform of the international corporate tax framework to address the problem but is willing to act unilaterally on an interim basis in the absence of any unanimous consensus for an international agreement.
However the government will continue to lead efforts with its partners in the EU, G20 and OECD to reach international agreement on future reforms to the international corporate tax framework, and will dis-apply the DST when an appropriate international solution is in place. Thus the model will also include a review clause committing the government to a formal review of the tax if still in force in 2025, “to ensure it is still required following further international discussions”.
3.2. Threshold: It will only apply to firms that generate global revenues in excess of 500 million pounds ($640 million) per annum, and would only be applied to the revenue stemming from UK customers.
3.3. Applicability of DST: The DST applies a 2% tax on the revenues of specific digital business models where their revenues are linked the participation of UK users. The tax will apply to: search engines; social media platforms; and online marketplaces. That is because the government considers these business models derive significant value from the participation of their users.
3.4. A review clause – This means that the DST will be subject to formal review in 2025 to ensure it is still required following further international discussions. This underlines the government’s commitment to continue seeking a global solution to ultimately replace the DST. In addition, the government will dis-apply the DST if an appropriate international solution is in place prior to 2025.
3.5. Exemptions: Financial and payment services, the provision of online content, sales of software/hardware and television/broadcasting services will not be in scope of the DST. The government will explore with stakeholders during the consultation whether further exemptions should be made.
4. Impact of the Proposed DST:
4.1. Potential targets: Chancellor Philip Hammond said in his Budget speech that the tax would be “narrowly targeted” at “established tech giants” rather than small start-up firms in order to make “these global giants with profitable businesses in the UK pay their fair share.”
Thus the Digital Service Tax is being billed as a way for big firms to pay their fair share, or as the “Budget 2018” report advises, will “ensure that the amount of tax paid in the UK is reflective of the value they derive from their UK users.” The proposal would affect businesses generating U.K. revenue from services including search engines, social-media platforms and online marketplaces. That makes the ad-selling businesses of Google and Facebook particularly vulnerable.
4.2. Not a Sales tax: The chancellor highlighted that it wasn’t a sales tax against goods and services paid for by the users, but was an attempt to force firms to pay more in corporation taxes, something that they are keen to minimise. Thus revenues from intermediating sales are the chancellor’s target rather than the cost being just passed down to consumers.
4.3. Emphasis on Users based value creation: The Proposal re-emphasises that the digital businesses could be taxed on the concept of ‘user-generated value’. This suggests that users can create value for certain types of digital businesses through their engagement and active contribution. One example cited is a social media company that generates revenue from selling advertising on a platform populated by users’ posts and photos.
4.4. Targeting global revenue instead of profits: The U.K. digital tax — which will levy a 2 percent tax on certain business models — would target the global revenue of these tech giants and not profits, according to tax practitioners, potentially making the country a less attractive place for the companies to supply their services.
The U.K. effort underscores the complexity of such a tax. The Office for Budget Responsibility, the U.K.’s fiscal watchdog, said the Treasury’s estimate of how much tax the new levy will raise is highly uncertain.
4.5. A Front-runner in imposing digital tax: The introduction of a digital tax makes the U.K. something of a front-runner compared with other governments. The measure goes further than most tax regimes around the world. The exception is Spain, where the government of Spain proposed a similar digital-services tax this month, but that measure requires parliamentary approval.
4.6. Pressure for a speedy global solution ? The new U.K. tax puts pressure on big countries, including the U.S., to speed up the global effort. The Organization for Economic Cooperation and Development, a forum of wealthy countries, has been leading the international digital-tax talks.
4.7. Backlash from the US: Possibility of a tax trade war: The new tax could also prompt a backlash from the US, which is likely to see the move as an attack on some of its most successful industries. Critics here also said the British government’s move may result in retaliatory taxes in the U.S. They also said tech companies may simply pass the tax onto its customers.
“This proposal could disproportionately affect American companies and may ultimately wind up interfering with the U.K.’s trade commitments,” said Rufus Yerxa, president of the U.S. National Foreign Trade Council. “If enacted, this measure could also complicate the United Kingdom’s push for deeper U.S.-U.K. trade relations.”
4.8. Detrimental impact on technology innovation: Significant concerns have been raised by business that without careful and narrow scoping, a [digital services tax] could have a detrimental impact on technology innovation taking place within larger businesses. This could take the form of a penal tax which could drive away genuine innovations within tech giants.
4.9. Increased competitiveness for small tech giants: But the proposal is likely to be welcomed by smaller businesses in the UK and Britain’s retail sector, which has struggled to compete with large online marketplaces. Paul Martin, UK head of retail at KPMG, said: “The digital services tax . . . holds the greatest potential to rewrite how the retail game is played. Online marketplaces have often been able to rise above the problems faced by traditional legacy players or independents.” Lawrence Jones, chief executive of the British IT company UKFast, added: “It’s way beyond time for action on the pitiful amount of tax paid by the likes of Facebook, Amazon and Google, so I congratulate the chancellor on taking this first step. If all UK businesses took advantage of the tax rules that apply to offshore businesses, the country would collapse.”
4.10. Effects of a Unilateral approach: An Isolationist Stance?
The Unilateral approach can be perceived as an isolationist stance taken by UK without coordinating efforts with the its key global partners, which is the US and EU in this case.
On the other hand the approach is not entirely unilateral in the sense that that it will be “narrowly-targeted, proportionate and ultimately temporary”. Even the rates seems to be less harsh than the ones proposed by other EU member states. For instance it applies a 2% rate on revenues of specific digital business models, rather than the generalised 3% rate proposed by other EU member states. Thus it can be said that the approach is not daring in the sense that it still is dependent on the global consensus.
4.11. Modest Revenue generation: These moderations soften the blow, so that the anticipated revenue is only £275 million in FY21, rising to £440 million by FY24. Compare that with the recent Spanish proposal, based on the EU’s formula, which promises over €1 billion per year.
4.12. Possibilities of double taxation :Opponents of digital taxes, which include lobbyists for multinationals, say a patchwork of new rules that vary by country will hurt smaller firms. They say the initiatives could lead to double taxation of corporate profit that will stifle international trade and discourage investment.
4.14. Deductible against corporate tax?:
The consultation document anticipates that the DST will be an allowable expense where the revenues subject to the DST are realised in a UK-resident company (subject to UK corporation tax) whose trade is that of an in-scope business activity. However, whether an allowable expense is achieved will depend on the facts and circumstances of each taxpayer, in particular the nature of the activities carried on in the UK. A non-resident company (outside the scope of UK corporation tax) cannot get a tax deduction for the DST expense recognised in their accounts, even if a UK-resident group company pays the DST on its behalf (as the DST would have been incurred for the purposes of another group member’s trade).
4.13. Future Implementation Challenges:
The UK version will be no less complex and uncertain in its application. There are numerous unsettled technical issues and uncertainties to resolve through further consultation and deliberation.
It is still unclear regarding the implementation of these interim proposals. One might also wonder just how ‘interim’ these proposals will be in practice and what criteria HMRC will apply to determine if the OECD’s version – if it ever gets off the ground – is an ‘appropriate international solution.
5. Next steps
The government will be issuing a consultation on the design of the DST in the coming weeks. It intends to use this consultation to explore the key questions and challenges concerning the application of the DST, ensure it operates as intended and that it does not place unreasonable burdens on businesses. The DST will then be legislated for in the 2019/2020 Finance Bill, and apply from April 2020.
Thus the proposals need to be sustainable and not watered down in the coming years, in order to demonstrate that interim unilateral tax rules towards digital taxation can be the solution in the absence of international measure.
References:
2https://www.out-law.com/en/articles/2018/october/budget-2018-uk-digital-services-tax-introduced/
4https://www.ft.com/content/a8c36a90-dba5-11e8-9f04-38d397e6661c
5https://www.wsj.com/articles/u-k-to-roll-out-developed-worlds-first-digital-tax-1540831931
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