Digital Services Tax: UK consultation

The UK Government is consulting on the details of the proposed 2% digital services tax on the largest social media platform, search engine and online marketplace businesses.

Following the Chancellor’s Budget announcement, the Government has now issued its consultation on the UK’s proposed 2% digital services tax (DST). The consultation is wide-ranging across all aspects of the proposed tax and also includes some detailed insights into the reasoning behind the introduction and design of the tax. The consultation closes at the end of February 2019.

All potentially affected businesses should take the opportunity to engage with the consultation and shape the scope and administrative impact of the new tax. Simmons & Simmons will be responding to the consultation in due course and we would be happy to work with interested parties to ensure that all concerns as to the scope and impact of the tax are fully addressed.

Background

Although, in its report on Action Point 1 of the BEPS Project, the OECD concluded that the tax treatment of the digital economy should not be treated differently to the rest of the economy, a number of jurisdictions have since concluded that more work is needed to ensure fair taxation of businesses operating in the digital space. As a result, both the OECD and the European Commission have continued to work on this question.

In March 2018, the OECD published its Interim Report into the “Tax Challenges Arising from Digitalisation” noting that there was no general consensus among participating jurisdictions as to whether, and if so what, further measures to tackle taxation of digital services are needed. In response, on 21 March 2018, the EU Commission published its proposals to tackle the challenges of the digital economy, including a proposal for an interim 3% tax on gross revenue derived from certain digital services. See, “EU Commission's proposals for fair taxation of the digital economy”.

Following the 2018 Spring Statement, HM Treasury published its “Corporate tax and the digital economy: position paper update”, designed to inform the UK’s input into these ongoing international developments. See “HM Treasury's updated position paper on taxation of the digital economy”.

The UK position

At the 2018 October Budget, the Chancellor announced that the UK will impose a digital services tax at a rate of 2% on the UK revenues of digital businesses that are considered to derive significant value from the participation of their users. The tax will be narrowly-targeted and be legislated in Finance Bill 2019-20 and will apply from April 2020. The joint HMRC and HM Treasury consultation has now been published to seek feedback on the design and implementation of the new tax.

The consultation requests the views of interested parties in relation to most aspects of the tax including: the business activities in scope; the determination of taxable revenue; the alternative basis (safe harbour); and the reporting and compliance obligations.

It also includes details regarding the impact on the corporate tax calculation, the review mechanism and the interaction with the UK’s international obligations under double tax treaties (although these items are in scope of the consultation, they appear to be included primarily to set out the Government’s view on the issues).

The justification for the implementation of the DST is that in the Government’s view, for some business activities there is a mismatch between taxation under the corporate tax code and how the underlying value of the business is generated. In particular, the Government feels that social media platforms, search engines and online marketplaces all derive their value through the interaction of the users with the service. That value may be created through posting content, engaging with the service frequently enough to allow targeted advertising, or network effects where the number of users intrinsically creates value. The result of this approach is that where a business sells goods or services directly to consumer, they are excluded from the tax as their value is less dependent on user engagement. As a result some large digital businesses typically in scope of DST proposals may be exempted altogether, although HMRC do not intend to issue a detailed list of the specific exemptions from the tax.

In relation to the specific revenue streams that should be subject to the tax, the Government intends to adopt a wide-ranging approach to capturing all revenue generated by the business activities. This could include subscription revenue, fees from online advertising or the sale of customer data. The intention of this approach is to apply the tax universally to businesses undertaking similar activities regardless of how they are specifically generating revenue from those activities. The consultation also puts forward initial proposals as to how to define “users” and link revenue to the participation of a user. The consultation suggests that the use of mechanical rules in both these areas could increase taxpayer certainty.

However, the DST will only apply to businesses which generate more than £500m in global revenues from in-scope business activities and generate more than £25m in revenues from in-scope business activities linked to the participation of UK users. In addition, businesses will not have to pay the tax on the first £25m of UK in-scope revenues.

The consultation sets out an intended method for the alternative safe harbour basis for calculating the DST for businesses with very low profit margins or making losses. The suggestion is that businesses would be able to elect to use an alternative method of calculation for DST based on the following calculation: profit margin x in-scope revenues x multiplication factor (minimum of 0.8%). Whilst seeing the method is of interest, the omission of a more tightly defined profit margin measure and the specific multiplication factor to be used in the formula will prevent companies from making an initial estimate of their potential liability. It is expected that there will be significant debate regarding the specific profit margin measure to be used and HMRC have started to consider some of the implications here at a high level. Less controversial will be the deductibility of the DST as an expense in the CT calculation although the consultation has provided a number of examples in this regard.

Non-resident companies and other countries may be interested in reviewing HMRC’s views on the international aspects of the tax. In addition to the already announced review mechanism, the consultation goes into a reasonable level of depth regarding HMRC’s view of how the tax interacts with the UK’s double tax treaties. These treaties contain clauses pertaining to both non-discrimination and income taxes. HMRC consider that the global application of the DST should address the non-discrimination clauses for non-resident companies. The commentary regarding whether the DST should be considered an income tax is unsurprisingly more detailed. The consultation suggests that the DST does not fall within the definition of an income tax on the basis that the tax is on gross receipts rather than on the income (or profit) of a company. Whilst specifically acknowledging that some taxes on gross receipts have been determined to meet the definition of an income tax, HMRC believe this only applies where the tax is in lieu of a tax on income and therefore should not capture the DST.

The consultation finally provides additional details regarding the intended approach to reporting, payment, anti-avoidance and compliance. In general the intention is to mirror the existing CT Framework as far as possible. In relation to anti-avoidance the two specific measures discussed are an anti-forestalling provisions and a provision to prevent revenue being artificially re-characterised.

Comment

The introduction of the DST will clearly give rise to a number of hurdles for both businesses and HMRC to cross, in particular with regards to the scope of the tax and how it will work in practice. The Government is targeting large well known multinational tech businesses, with a significant UK presence, but there will be a number of other businesses that may be caught by the DST unexpectedly. The operational aspects of how to comply with the tax, for example, gathering detailed data about UK “clicks” and the revenue generated by each of those clicks may be easier for some businesses to track than others. Equally, how HMRC will effectively audit and enforce the tax where businesses have a significant digital presence, but limited “bricks and mortar” in the UK, will also be relevant – this is a perennial problem in the world of digital taxation but a challenge that hasn’t yet been completely overcome. The UK Government will also have to balance the need to encourage tech businesses to set up and operate in the UK, and potentially much needed investment in the UK economy from the US post-Brexit, with a drive to tax digital businesses. The level of tax being applied, and the safe harbours being afforded, suggests that this is possibly more of a political nod to the general world view that digital consumption needs to be taxed (much like cigarette and alcohol consumption), than a significant revenue generator for the Treasury. Nevertheless, businesses will have to invest some time and money to ensure that they have the systems and the expertise in place to be able to comply.

Simmons & Simmons will be submitting a response to the consultation in due course. Please contact Jo Crookshank or  Bryn Reynolds if you have any comments or concerns on the consultation - we would be happy to include these in our response to the consultation.

This document (and any information accessed through links in this document) is provided for information purposes only and does not constitute legal advice. Professional legal advice should be obtained before taking or refraining from any action as a result of the contents of this document.