This guide was last updated in November 2018.
Some countries want an increased share of tax on the profits generated from users based in their countries. The Organisation for Economic Cooperation and Development (OECD) is considering global solutions to the problem, the European Commission has put forward proposals which include a digital services tax as an interim solution. Individual countries, including the UK, are taking or threatening unilateral action.
Current international tax rules allow countries to tax profits of non-resident companies which are attributable to a permanent establishment in that country. Transfer pricing rules seek to ensure that a multinational group's profits are divided between the group companies in accordance with each company's contribution to the profits generated.
The concept of permanent establishment currently requires some form of fixed base in a country. The rules, which date from the 1920s, were not designed to cater for digital companies which may be global and have little or no physical presence in the countries where their users are based.
For example, technology companies with digital platforms such as search engines and social media platforms can make substantial profits through the sale of advertising. Adverts may be targeted at users of the platform in a particular country, yet the technology company may have no substantial physical presence there.
In recent years considerable media attention has focused on the fact that US owned technology companies have made large profits from interactions with individuals resident in the UK and other EU countries but have paid low levels of tax in those countries, or indeed anywhere. The European Commission has tried to use the EU State aid rules to attack some of these structures.
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.
It published an interim report on the tax challenges arising form digitalisation in March 2018. This set out the issues but did not contain any recommendations because there is no consensus between OECD member countries about what should be done or, indeed whether any action is required at all.
The OECD's task force on the digital economy met in July 2018 to consider the main options.
Amongst the countries that want change, there are three main approaches. These are:
- focus on data and user participation – this is the approach favoured by the UK and would involve taxing digital company profits in line with the number of users in that country. It would mean that the tax rules would only need to change for highly digitalised businesses such as search engines and social media platforms.
- broader approach to allocation of taxing rights – this is the approach favoured by the US and would mean changes to the tax system which would not just affect highly digitalised businesses. It would involve the jurisdictions where services are marketed being taken into account in the allocation of taxing rights.
- minimum tax concept – this is the approach suggested by the German and French foreign ministers at an Ecofin meeting in Vienna in September 2018. It would not be specific to highly digitalized businesses and would involve the establishment of a minimum tax rate. This could be similar to the global intangible low taxed income (GILTI) rules in the US 2017 tax reforms.
According to an OECD webcast in October 2018, the OECD hopes to be able to have a sense of direction by January 2019 and to be able to present some suggestions to the G20 Finance Ministers meeting in Japan in June 2019.
The European Commission has 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 – in a similar way to the VAT mini one stop shop (MOSS).
It is proposed that DST would only apply to companies with total annual worldwide revenues of more than €750 million and EU revenues of more than €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.
Some EU countries have voiced their opposition to the Commission's proposals. These include Ireland, Luxembourg and the Nordic countries.
In the 2018 budget, the UK government announced that it will introduce a Digital Services Tax (DST) from April 2020.
DST will apply a 2% tax on the revenues of search engines, social media platforms and online marketplaces where their revenues are linked the participation of UK users. It will not be a tax on online sales of goods and will only apply to revenues earnt from intermediating such sales, not from making the online sale. It will also only catch the revenues from online advertising or the collection of data where the business is providing a search engine, social media platform or online marketplace.
To be caught by DST businesses will need to generate revenues from in-scope business models of at least £500m globally. The first £25m of relevant UK revenues will also not taxable. This is designed to exclude small businesses from then scope of the tax.
The UK government says that there will be provisions in the rules which will mean that those making losses will not have to pay DST and those with very low profit margins will pay a reduced rate of tax.
DST will be subject to formal review in 2025 to ensure it is still required following further international discussions and the UK government says the tax will be disapplied if an appropriate international solution is in place before that time.
The UK government says it will be consulting on the design of the tax and it intends to include the necessarily legislation in Finance Bill 2020.
The announcement follows the publication by the UK government of two 'position papers' the latest being an updated paper published by the UK Treasury in March 2018.
The March 2018 paper set out the UK government’s position 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 has already introduced diverted profits tax (DPT) aimed at multinationals operating in the UK which have structures which avoid UK tax. Although in practice it has much wider application.
The UK government also announced in the 2018 budget that it intends to apply a UK income tax charge to amounts received in a low tax jurisdiction in respect of intangible property, to the extent that those amounts are referable to the sale of goods or services in the UK. The measure will apply to income receivable from both related and unrelated parties and will apply from 6 April 2019..
The measure targets multinational groups that generate significant income from intangible property through UK sales, and have made arrangements such that the income is received in offshore jurisdictions where it is taxed at no or low effective rates
It will generally apply to entities that are located in jurisdictions with whom the UK does not have a full tax treaty. There will be an exclusion for income where the tax payable by the foreign entity is at least 50% of the UK income tax charge that would otherwise arise under this measure. There will also be a £10 million de minimis UK sales threshold.
Other countries have proposed or have introduced unilateral measures in relation to the taxation of the digital economy. Some examples are:
- Australia has introduced a tax similar to the UK's diverted profits tax.
- India has introduced an equalisation levy whereby a percentage of any payment made to a non-resident in respect of online advertising is withheld by the Indian taxpayer.
- Italy has introduced a tax on digital transactions which catches electronic services supplied to businesses and will require a 3% withholding by the Italian customer. It is not yet in force.