The worldwide corporate tax system has traditionally focused on the corporate entity. Where it is physically located and where it puts its employees and the tools of its business have been the primary driving factors in where it is taxed. So, if you are a US tech corporation, for example, and you had UK customers, you would not be subject to UK direct taxes unless you had a subsidiary or branch trading in the UK.
This is about to change.
The problem tax authorities around the world are facing is that the existing tax rules were never designed to cater for the digital economy. Companies in several sectors are increasingly virtual or have little or no physical presence in the countries where their users are based, and they are seen, at least in the eyes of revenue authorities, to make large profits from consumers whilst paying insufficient tax where those consumers are located.
The Organisation for Economic Cooperation and Development (OECD), which coordinates global tax policy, has been considering how to reform the international tax system and is trying to establish an agreed approach by 2020. It is, however, struggling to make headway in the face of differing views among its membership countries.
To confuse matters further the European Commission is proposing for the EU its own version of a digital tax. This is currently mired within the EU political system as different members argue about its terms.
The UK, France and Italy have all been pushing for quicker action, and the UK is going first in introducing unilateral measures. On 29 October the UK government announced that it will go ahead with plans for a UK digital services tax (DST), to be introduced in April 2020.
What is proposed?
The exact design of the tax is subject to further development, but what we know so far is that it will charge UK tax at a rate of 2% on any revenues which can be 'linked' to UK user participation, regardless of where the corporate owner of those revenues is located and irrespective of the physical presence that the corporate has in the UK.
Note that that 2% - which at first look sounds like a low rate – is applicable to revenue not profit. If you are an entity with high turnover but relatively low profit because you are cost heavy, that does not necessarily get you out of the regime.
A big problem here, both for the UK fiscal authority and for corporates, is how you link revenue to user participation. There is no clear guidance on that as yet, and many in the market have questioned how as a practical matter it is to be judged.
Who is caught?
The original proposals were widely drawn and many feared they would be inadvertently caught, especially given that few sectors these days have no online sales presence.
The final scope however applies DST to businesses engaged in only three key areas - search engines, social media platforms and online marketplaces.
It is explicitly not a tax on:
- online sales of goods, though it will hit revenues from 'intermediating' such sales;
- online advertising;
- data collection;
- financial and payment services;
- provision of online content;
- sales of software/hardware;
- television/broadcasting services.
There is scope for further exemptions to emerge as the public consultation on the proposals continues.
To be caught, a business must generate revenues from those key areas of at least £500 million globally, and the first £25m of relevant UK revenues are exempt.
This means that smaller businesses will not be caught by the tax. Rapidly growing businesses however will fall within it as soon as they pass that £500m threshold. This has triggered complaints of anti-competition in the market given that a global giant can more easily absorb the cost of DST than a smaller player trying to compete with them.
Is there a safe harbour?
There will be some sort of alternative calculation, so that those with high revenues but losses will be exempt and those with very low profit margins pay at a reduced rate. The details of this are not known yet.
Is it permanent?
DST is intended to be an 'interim measure' until the OECD comes up with an approach which enough countries worldwide can agree on.
The UK government has committed to a formal review in 2025 to check the DST is still required once further international discussions have occurred, and to dis-apply the DST if an 'appropriate international solution' is in place prior to that date.
However, given the difficulties faced by the OECD in trying to reach an international solution the DST may be with us for some time yet, and the UK government has left itself room to manoeuvre in what they do or do not consider 'appropriate'.
What does it mean for you?
Although the final details will change, absent a complete government u-turn the broad ambit is unlikely to be altered at this stage and the DST will become law on schedule with effect from 2020.
The likely impact of the rules will depend on which business you are in, and how much of it is digital.
Although examples are given of the type of income caught, they are the obvious ones given the areas targeted: revenue generated by a social media platform from targeting adverts at UK users; commissions generated by digital marketplaces for facilitating transactions between UK users; and income generated from display advertising shown to UK users when they input search terms into search engines.
It is no accident that search engines, social media platforms and online marketplaces were the key areas chosen. The UK revenue authorities have had 'established tech giants', usually taken to mean Amazon, Facebook and Google, in their crosshairs for some time and this is just the latest in a line of new rules aimed at them.
That is because the UK government thinks that their business models derive significant value from the participation of UK users which goes largely untaxed, in its view.
Obviously anyone whose core business is in these three areas will have to consider how much of their revenue is UK user-generated, whatever that comes to mean. Unfortunately, it looks like anyone else with significant revenues generated from those three areas could have to apply the rules, even if it is not their core business. It is as yet unclear exactly how the revenues from the target areas are to be split out from other income.
Eloise Walker is a corporate tax expert at Pinsent Masons, the law firm behind Out-law.com. This article was first published in digital magazine BRINK.