Is a digital services tax the way forward?
Some of the world’s largest technology companies report huge sales, but pay little or no corporation tax in countries where they do a lot of business. It seems the international tax system is not designed to deal with a digital economy in which the location of sales and profits can be a matter of debate.
Attempts are under way to arrive at an international solution to the taxation of digital services but progress has been slow. In October, the UK Chancellor Philip Hammond announced plans to introduce a digital services tax “on tech giants rather than start-ups” from April 2020.
The 2% Digital Services Tax (DST) on company sales is expected to raise more than £400m a year. It will be paid by companies with global sales of at least £500m, of which more than £25m are in the UK. The tax will apply to three types of digital technology: search engines, social media platforms and online marketplaces.
“It is only right that these global giants, with profitable businesses in the UK, pay their fair share towards supporting our public services,” the Chancellor said in his Budget speech last year.
The UK Government says that it will [continue to] work with other governments and, if there is global agreement on a tax on digital services, the UK Government says that it may use that instead of the UK DST.
“It is only right that these global giants, with profitable businesses in the UK, pay their fair share towards supporting our public services,” the Chancellor said in his Budget speech last year.
As well as raising revenue, a key aim of DST is to address public concern that a small number of tech giants are not paying the fair amount of tax in the “appropriate jurisdictions”, says Dominic Preston, Tax Partner at Grant Thornton UK.
He adds: “The fundamental issue is that our tax system has not evolved with technology companies and this new tax is looking to provoke transparency and behavioural change above anything else.”
The government is consulting on the DST until the end of February. It plans to include the tax in the 2019-20 Finance Bill.
Will it Work?
One of the main technical challenges in implementing the DST is that it would tax turnover, not profits.
“Making sales isn’t the same as making profit, particularly when you consider the high number of loss-making start-ups in the digital space,” says Chris Sanger, Global and UK Tax Policy leader at EY.
An industry body that represents more than 900 UK technology companies, techUK says the DST would be bad for investment and the UK economy. It would prefer an international tax approach.
The UK Government says that the DST is focused on a relatively small number of large tech companies, but some disagree.
The fragmented nature of much online business could make it tricky to administer the tax
“The [DST’s] proposed approach to defining the participation of UK users is very wide,” Donald Drysdale CA wrote in an article for ICAS in November. The tax will cover (on a social media platform or search engine) advertising that is targeted at UK “users”, i.e. customers, or has involved a UK user action (e.g. a click), subscription payments from UK users, and (in an online marketplace) a commission fee, share of consideration or delivery fee resulting from a transaction involving a UK user (whether buyer or seller), he wrote.
The fragmented nature of much online business could also make it tricky to administer the tax.
Rob Bamforth, a technology analyst and marketing consultant, says: “Part of the problem is that with intermediaries, both online channel aggregation and the use of separate local companies within a group, and with different locations used for servers or the company actually taking the financial transaction, it becomes very difficult, despite the digital audit trail, to see who owes what and to whom.”
A Global Digital Tax
Governments are talking about an international tax on digital businesses but progress is slow.
More than 110 member states and jurisdictions of the Organisation for Economic Co-operation and Development (OECD) hope to agree an international digital services tax by 2020.
The European Union is also talking about a digital services tax (a 3% levy on giants such as Amazon, Google and Facebook in Europe) but has yet to agree the details.
In December, France’s government said it would introduce its own digital services tax in January 2019, but details remained unclear as this article went to press.
News reports said that France’s tax would affect Apple, as well as Amazon, Google and Facebook.
The digital economy cannot be ring-fenced and attempts to do so will simply be distortive and harmful to the digitalisation of the whole economy.
“This is interesting because Apple as we all know does not sell digital services. Apple sells bits of kit i.e. phones, laptops, etc.,” says Chris Denning, Corporate and International Tax Partner at MHA MacIntyre Hudson.
“There is clearly a long way to go for the international tax community to come up with a sensible methodology to impose tax where the value is derived [from] digital business models.”
David Norfolk, an expert in government technology at Bloor Research, an IT research company, believes that in the absence of international agreement countries will develop their own temporary DSTs.
“[Should a DST] tax services provided, goods delivered or both? Will there be exclusions/special cases? Different countries might decide differently.”
Since 2015, the OECD, including the UK Government, has focused on tackling “base erosion and profit shifting” (BEPS) avoidance, changing tax rules to prevent companies from assigning profits to low-tax or no-tax jurisdictions, even though they may have no or little economic activity there. This is typically achieved through, for example, intra-company loans or inflated charges related to intellectual property, such as royalties.
According to Ali Kennedy CA, Vice President, Group Tax, at Sophos Group, applying BEPS tax-avoidance rules to the digital economy will be problematic.
She argues: “The OECD appears to support the view that the digital economy cannot be ring-fenced and attempts to do so will simply be distortive and harmful to the digitalisation of the whole economy. The UK Government position on this is less clear.”
Ali would like to see the UK Government develop tax rules for digital services in partnership with business.
Recent initiatives to reform the UK tax system, such as the move to a digital tax system (“Making Tax Digital”), have been delayed and faced major problems. Other major IT projects for government have faced similar problems.
As it is aligned to corporation tax payment and reporting requirements the DST should be more straightforward but, notes Nick Blundell, Corporate Tax Partner at RSM UK, it is still a new tax.
A Real Headache
For some global companies, identifying transactions around the world that fall within the scope of the UK’s proposed DST could be a challenge, says Nick. Also, the consultation document states that group companies could be “jointly and severally” liable for the tax.
“In certain circumstances, this could create a real headache. Imagine a small group entity with minority shareholders ending up jointly liable for a significant amount of tax arising elsewhere in the group,” Nick adds.
The measures could also create political friction between governments, he says: “There has even been talk of tariffs being imposed on the UK business in retaliation.”
Changes to the tax system tend to create unintended consequences. The proposed rules allow for the UK’s DST to apply to commission generated by online marketplaces if either the seller or the buyer (or both) is situated in the UK. If other jurisdictions introduced similar measures, however, the same commission could be liable for tax in both places, Nick says.
“Because [the DST] only taxes the largest tech companies and only apples to certain digital services … [it] risks creating an incentive to reclassify business streams for avoidance purposes,” - Alex Cobham
The government’s consultation document acknowledges this and states that in those circumstances the government would intend to negotiate an appropriate division of taxing rights with the other countries which are also implementing a DST, Nick says, adding that this may be more easily said than done.
According to other experts, however, the main problem with the DST isn’t its practicality; it’s that it’s just not tough enough on big tech companies.
“The UK proposal is a timid response at best,” says Alex Cobham, Chief Executive of Tax Justice Network, a think tank that campaigns for tax reform.
“Because [the DST] only taxes the largest tech companies and only apples to certain digital services … [it] risks creating an incentive to reclassify business streams for avoidance purposes,” he says.
Alex says that a global tax on digital services, rather than slightly different national ones, would be more effective. This approach recognises that multinationals do not maximise profit in individual subsidiaries in individual countries, but at the global group level, he says. Under such rules, the amount a digital business would be taxed would be in proportion to its sales in each country.
The UK’s planned DST may not be implemented if there is international agreement on taxing digital services by 2020. If a global consensus can’t be found, however, large tech companies (and their accountants) may have to comply with several different taxes on digital services in Europe and perhaps elsewhere. They may complain that this will deter investment, but it’s doubtful that they will get much sympathy on this score from either governments or the general public.
