Chancellor: UK will 'go it alone' with digital tax if no international agreement

"The best way to tax international companies is through international agreements, but the time for talking is coming to an end and the stalling has to stop. If we cannot reach agreement the UK will go it alone with a ‘Digital Services Tax’ of its own," he said.

"Unilateral measures are a bad idea and are likely to lead to uncertainty and double taxation for businesses as well as the risk of retaliatory measures from countries such as the US, where many of the tech giants are based," said Eloise Walker, a corporate tax expert at Pinsent Masons, the law firm behind Out-law.com. 

Current international tax rules allow countries to tax profits of non-resident companies which are attributable to a permanent establishment in that country. The rules, which date from the 1920s,  were not designed to cater for digital companies that may be global, virtual or have little or no physical presence in the countries where their users are based. 

A digital services tax would be an interim measure designed to shift some of the tax revenue from the countries where digital companies such as social media platforms and search engines have large numbers of users as opposed to where they book their advertising revenue.

The Organisation for Economic Cooperation and Development (OECD) is considering how the international tax system could be reformed and has said it will try to come up with an agreed approach to taxing the digital economy by 2020.

However, this may not come soon enough for a number of countries including the UK, France and Italy who are pushing for quicker action.

An updated paper published by the UK Treasury in March set out a number of options for reforming the international tax system to  tax digital businesses on the concept of 'user-generated value'. The paper suggests that social media platforms and platforms enabling users to upload self created audio or video content rely on users to interact with the platform and with each other. The platforms generate revenue from selling advertising, but very little of that revenue is taxed in the countries where the users are based.

The UK government’s position is that "active user participation" creates value for certain digital businesses, and that jurisdictions in which users are located should be entitled to tax a proportion of those businesses’ profits.

The UK's paper discusses how the international tax system could be reformed to reflect user generated value, but also suggests a revenue based tax as an interim measure. This would be a tax on the revenues of digital businesses deriving significant value from UK user participation. It would apply to those businesses wherever they are located, and irrespective of the physical presence that they have in the UK.

The European Commission has also proposed reforming international tax rules so that profits are taxed where businesses have significant interaction with users through digital channels. It proposes that a digital platform should be deemed to have a taxable 'digital presence' or a virtual permanent establishment in a member state if it has more than a specified amount of revenues and users in the state.

The Commission has proposed that until comprehensive changes can be made a 3% interim digital services tax (DST) should be applied to revenues created from activities where users play a major role in value creation such as social media platforms. Tax revenues would be collected by the member states where the users are located, and would only apply to companies with total annual worldwide revenues of €750 million and EU revenues of €50 million. The Commission's proposals would catch those selling online advertising space, digital intermediary activities, and those selling user-generated data and content. 

The European Parliament's Committee on Economic and Monetary Affairs has suggested that the Commission's proposals should be widened to include supplies of digital content such as video, audio or text through digital interfaces, and online sales of goods or services via e-commerce platforms. It has also recommended that the rate of the tax should be increased to 5% and that there should be a 'sunset clause' which would mean that DST would lapse when a permanent solution was adopted. Although it is an EU committee, the European Council is not bound to take the committee's recommendations into account.

"Getting international agreement on any new measures should not be underestimated. The US opposes any measures aimed purely at digital companies and within the EU, countries such as Ireland and the Nordic countries oppose the EU proposals as they would be likely to be net losers. If the new tax does get off the ground as a revenue raiser internationally, expect countries like China and India to follow suit – and they have many more users than the UK, so looking forward in time the Treasury could be about to shoot themselves in the foot by advocating user-based taxation," Eloise Walker said.

"Many traditional businesses which may have digital aspects to their business are concerned that they could be caught by any new revenue based tax if it is too broadly drawn. This could act as a disincentive or otherwise be a distorting influence to companies wanting to modernise their operations to take advantage of new technologies," she said.

The chancellor is due to deliver his Budget speech on 29 October.

Eloise Walker said that we will almost certainly get an update in the Budget on what the UK government is proposing.