How will digital services tax work?

In this, the second of two articles, Donald Drysdale suggests that Britain’s proposed digital services tax may impose substantial compliance burdens.

A new tax

My previous article, Taxing global digital services, looked at Philip Hammond’s proposed digital services tax (DST) and other initiatives aimed at taxing cross-border digital transactions.

Traditionally, the profit of a multinational group should be taxed in the countries in which it creates value. However, digital innovation has altered the way cross-border business is conducted. The UK Government plans to introduce DST in April 2020 as an interim response to challenges that digital businesses create for the international corporate tax system.

DST will be designed to ensure that digital businesses pay tax in the UK that reflects the value they derive from the participation of UK users.

The consultation

On 7 November the Government published a consultation document setting out its initial proposals for DST.

The consultation will close on 28 February 2019. Before then, the ICAS International and Large Business Taxes Committee will meet to discuss a technical submission addressing some or all of the 28 specific questions posed in the consultation, plus other concerns, anomalies or compliance issues raised by members. ICAS would welcome early reactions to inform its discussions with HM Treasury and HMRC, so please email these to the ICAS tax team.

What form will DST take?

The DST legislation, to be brought forward in next year’s Finance Bill, will objectively define the business activities that derive most value from user participation and then impose the new tax on the revenues (i.e. turnover) generated from those activities. This will involve defining specific in-scope business activities as taxable business activities.

While many digital business models involve some degree of user participation in creating value for the business, DST will focus on three for which (in the Government’s view) the participation of a user base can reasonably be considered a central value driver critical to the success or failure of the business. These are: the provision of a social media platform; the provision of a search engine; and the provision of an online marketplace.

Businesses will have to assess which activities they perform are within the scope of DST, and identify revenues generated from those activities. Examples of revenues within the scope of DST could include commission, subscription fees, delivery fees or online advertising revenues earned by online marketplaces, or targeted online advertising revenues earned by search engines.

Compared to these, the definition of a social media platform is unexpectedly wide. In this instance, examples of revenues in-scope could include subscription fees or online advertising revenues earned through social/online networks, blogging/discussion platforms, content-sharing platforms, review platforms and dating platforms.

Revenues within the scope of DST may include revenues from different channels, and those realised in the UK, non-UK or multiple entities. Particular problems may arise in isolating in-scope business activities where groups undertake multiple business activities, some of them in-scope and others out-of-scope.

What will be excluded from DST?

DST will not apply to business activities which (in the Government’s view) do not derive significant benefits from user participation. These include the provision of financial or payment services, the sale of own goods online, the provision of online content, and the provision of radio and television broadcasting services. Likewise, DST will not apply to data collection or online advertising unless they are the way a business generates revenue from an in-scope activity.

The Government anticipates that there may be some difficulties in determining the boundaries between business activities which are within the scope of DST and those which are not. The consultation sets out a number of borderline examples for consideration during the consultation, before a legislative approach is chosen. Consultations will also address whether further exemptions are required.

UK focus

Revenues attributable to in-scope activities will only be liable to DST where they are linked to the participation of UK users. For this purpose, a user includes an individual, a company or any other legal person.

The proposed approach to defining the participation of UK users is very wide. For example, it will include (on a social media platform or search engine) advertising that is targeted at UK users or has involved a UK user action (e.g. a click), subscription payments from UK users, and (on an online marketplace) a commission fee, share of consideration or delivery fee resulting from a transaction involving a UK user (whether buyer or seller).

Not every case will be straightforward. For example, the intended destination of advertising may be unclear, or a mobile user may operate across borders, or a company abroad may purchase access to a social media platform on behalf of its UK employees. In such cases, businesses will be expected to make just and reasonable apportionments.

Calculating DST

Where a business generates more than £500 million in global revenues from in-scope business activities in any year from 1 April 2020 onwards, DST will be charged at 2% on revenues above £25 million attributable to in-scope business activities where these are linked to the participation of UK users. The first £25 million each year will not be taxed.

Transitional provisions will apply where an accounting period straddles 1 April 2020. Two targeted anti-avoidance rules (TAARs) are being considered.

A safe harbour will exist to allow loss-making businesses to opt out of DST and those with very low profits to pay a reduced rate of tax. However, DST is a tax on turnover, not profits, so the amount of DST payable may still be considerable even where the safe harbour applies.

DST will be an allowable expense for UK corporation tax if the usual conditions for deductibility of expenditure are met. It will fall outside the scope of the UK’s double tax treaties. Where other countries introduce a tax similar to DST, the Government hopes to negotiate an appropriate division of taxing rights on cross-border transactions.

Compliance burdens

DST as proposed seems likely to create substantial compliance difficulties for businesses within its scope. They would have to identify their in-scope business activities, then isolate the revenues flowing from these, and then calculate the amounts of these revenues attributable to UK users.

For many businesses, including some consisting of multiple entities in different countries, pre-existing processes won’t record all or perhaps any of these details. Changes will be required in their record-keeping, possibly across many business entities.

In some cases, businesses may choose to adopt an alternative approach by relying heavily on making just and reasonable apportionments, but this could lead to prolonged and complex negotiations with HMRC.

Article supplied by Taxing Words Ltd