Taxing global digital services

In this, the first of two articles, Donald Drysdale looks at Philip Hammond’s proposed digital services tax and other initiatives aimed at taxing cross-border digital transactions.

Digital services

In recent years the global economy has become increasingly digital. With technological innovation, the nature and impact of digital transactions continues to expand. As a result, the growth of cross-border digital transactions is creating new challenges for tax authorities throughout the world.

Digital products and services are now being uploaded, and made available for customers to download and use in disparate locations, without any physical product or person crossing international borders. Substantial revenues and profits can be generated from populations by companies with no local permanent establishment in a traditional sense.

There is widespread agreement throughout the developed world that tax systems need to be reformed to deal with these developments, but no consensus on exactly how this should be done.

International efforts

Many countries, including the USA, have indicated a strong preference for a coordinated global approach. Other influential organisations have supported this idea.

In 2015 the OECD published Addressing the Tax Challenges of the Digital Economy – its final report on Action 1 of the OECD/G20 base erosion and profit shifting (BEPS) project. This set out how certain business models and key features of the digital economy might exacerbate BEPS risks. It described rules for efficient collection of VAT on cross-border business-to-consumer transactions, and discussed options to deal with broader tax challenges raised by the digital economy.

A recent joint policy paper from AICPA and CIMA calls for international coordination to develop a global solution to the tax concerns raised by digital transactions and the general digitalisation of the economy.

It takes time to achieve global solutions, and some governments are unwilling to wait. In advance of international action, unilateral initiatives to tax digital activities have been implemented or proposed by several countries, including India, Israel, Italy, Saudi Arabia and Spain. Now the UK is planning to join them, albeit as a stopgap measure.

UK budget proposal

In his Budget speech on 29 October, Chancellor Philip Hammond said:

“…it’s clearly not sustainable, or fair, that digital platform businesses can generate substantial value in the UK without paying tax here in respect of that business. The UK has been leading attempts to deliver international corporate tax reform for the digital age. A new global agreement is the best long-term solution. But progress is painfully slow... So we will introduce a UK digital services tax.”

This unilateral action by the UK Government to impose a digital services tax (DST), for an interim period until an international agreement can be reached, was explained in a budget policy paper.

Subject to consultation, DST at 2% will be levied from April 2020 onwards on the revenues of search engines, social media platforms and online marketplaces where those revenues are linked to the participation of UK users. The consultation document was launched on 7 November, and my next article will explore what it says.

The UK will continue to try to reach a satisfactory international solution with its partners in the EU, G20 and OECD, and will repeal DST if and when this has been achieved. The Government has also committed to reviewing DST in 2025 to consider whether the tax is still required.

In spite of the promise of a review, there must surely be concerns that, once a new tax such as this has been implemented, politicians will be tempted to leave it in place. However, DST is expected to bring in only £1.5 billion over 4 years, so can hardly be viewed as a significant revenue-earner.

EU proposals

In the EU, two legislative proposals are being brought forward.

The EU’s preferred solution is to reform corporate tax rules so that profits are taxed where businesses have significant interaction with users through digital channels. A digital platform would be taxable in a member state if (in that state) its revenues exceed €7 million, or it has more than 100,000 users, or it creates more than 3,000 contracts for digital services with business users in a taxable year.

An alternative proposal responds to calls from several member states for an interim DST, possibly at 3%, on gross revenues from the main digital activities that currently escape tax altogether in the EU – namely online advertising, digital intermediary activities, and the sale of user-generated data. The tax would be collected by member states where users are located, but only from companies with total annual worldwide revenues of more than €750 million and EU revenues of more than €50 million.

The way ahead

Where a problem to be solved is international by nature, a piecemeal country-by-country solution may not ideally fit the bill. Hammond’s DST proposals have been described by some as a cash grab rather than a carefully-considered move towards fairer taxes.

The ‘tech giants’ such as Amazon, Google and Facebook, which are in DST’s sights, are based mainly in the USA. The US Government has spoken out forcefully against both the UK’s and the EU’s DST proposals and against similar initiatives by other countries, arguing that these unfairly target US corporations.

In the complex global economy, tax can’t be viewed in isolation. In the case of the UK, US Government sources have warned that the proposed DST might prejudice attempts to negotiate favourable US/UK trading arrangements post-Brexit.

And by the way, don’t bother searching for any draft DST legislation in the Finance (No 3) Bill 2017-19 published on 7 November. Instead, draft clauses may appear during the course of the new consultation, but it’s possible we won’t see them until this time next year.

Article supplied by Taxing Words Ltd