Governments in numerous countries are looking at the introduction of a tax on digital services as a means of ensuring fair taxation of new business models. At the same time, the European Commission’s objective is a unilateral reform of the foundations of current tax legislation to address the same challenge.
The U.K. government has decided to introduce a digital services tax (“DST”) from April 2020. DST applies a 2 percent tax on the revenues of specific digital business models where their revenues are linked to the participation of U.K. users. The tax will apply to:
- search engines;
- social media platforms; and
- online marketplaces.
DST is not a tax on online sales of goods—as a result it will only apply to revenues earned from intermediating such sales, not from making the online sale.
The DST will apply to the revenues that are attributable to in-scope business models whenever they are linked to U.K. users. This means that, for the purposes of the DST, what matters is the location of the user, not the business. Businesses which generate revenues of at least 500 million pounds ($654 million) globally become taxable under the DST; the first 25 million pounds of relevant U.K. revenues are not taxable in UK.
The DST is intended to be narrowly targeted, proportionate and ultimately temporary, pending a comprehensive global solution reached among the EU, G-20 and Organization for Economic Co-operation and Development members.
DST will be an allowable expense for U.K. corporate tax purposes under ordinary principles. However, given the DST will not be within the scope of the U.K.’s double tax treaties, it will not be creditable against U.K. corporate tax.
The digital services falling within the scope of the DST are those in which the participation of an end user in a digital activity constitutes an essential input for the business and which enable that business to obtain revenue therefrom.
- The tax rate for DST under the proposed law in Spain is 3 percent, applicable to the gross income (excluding VAT) derived from the provision of the following digital services:
- the placing on a digital device of advertising;
- intermediation services, which allow users to find other users and to interact with them, and which may also facilitate the provision of underlying supplies of goods or services directly between users; and
- the sale of data provided by the user and generated from accessing the digital device.
- The proposed DST applies only when the user’s digital devices are present in Spain. The location of a user’s digital device is determined in accordance with its IP addresses.
- DST applies only to legal entities with an annual worldwide revenue of 750 million euros ($856 million) or more during the previous calendar year and with revenue subject to the DST of at least 3 million euros. Revenue thresholds shall be determined at a group level.
It is expected that the Spanish DST will be applicable as of 2019 as an indirect tax. Like the U.K. DST, Spain excludes the following lines of business from taxation:
- revenue derived from the online sale of goods or services made on a supplier’s website when the supplier does not act as an intermediary;
- the underlying sale of goods or services between users in the context of online intermediation services;
- online intermediation services aimed at providing users with communication or payment services; and
- certain financial services.
The Italian Budget Law 2019 (Law no.145/2018), published in the Official Gazette (G.U.) on January 1, 2019, introduces a “new” tax on digital services (the “DST”). The Ministry of Finance is required to issue an implementing decree within the following four months (i.e., by April 30, 2019) and the DST will apply as from the 60th day after its publication in the Official Gazette.
Relevant features are:
- Tax rate: 3 percent of taxable base;
- Levied on turnover—the taxable base is the amount of revenues on digital supplies (as defined below), net of value-added tax (“VAT”);
- The Italian DST will apply to revenues on the following digital services:
- advertising routed on a digital interface to its users;
- providing a multilateral digital interface allowing users to get in contact and interact, even to facilitate the supply of goods or services;
- transmitting data collected from users and generated through the use of a digital interface;
Like Spain, DST applies on digital services supplied by businesses (companies and groups) to users resident in Italy whose total amount of annual revenues worldwide is more than 750 million euros and annual revenues derived from digital services supplied in the Italian territory more than 5.5 million euros.
India introduced the Equalization Levy from April 2016 onward. The Equalization Levy has been defined as “tax leviable on consideration received or receivable for any specified service under the provisions of this chapter.” The levy would be under a separate self-contained code and is not part of the income tax law.
The Equalization Levy would be applicable at 6 percent on gross consideration payable for a “Specified Service.” “Specified Service” is defined as:
a. Online advertisement;
b. Any provision for digital advertising space or facilities/service for the purpose of online advertisement;
c. Any other service which may be notified later.
The levy will be applicable on the payments received by a nonresident service provider from an Indian resident or an Indian permanent establishment (“PE”) of a nonresident, in respect of the specified service: to be specific, tax revenue collected from businesses who provide digital services to users resident in India.
The levy would not be applicable to nonresident service providers having a PE in India, as they will be subject to a regular PE basis taxation. The levy is currently applicable only on business-to-business (“B2B”) transactions if the aggregate value of consideration in a year exceeds $1500.
As from April 1, 2018, federal states are authorized by State Agreement 106/2017 (Convênio ICMS 106/2017) to charge ICMS tax on standardized digital goods such as packaged software, games, apps and electronic files that are sold to or imported by final consumers and delivered through electronic means (e.g. software downloading, streaming and cloud computing). A special tax rate of 5 percent applies.
The taxpayer is the owner of the website or electronic platform by means of which the transaction is made, and the tax is collected by the state in which the buyer is located. States may transfer the responsibility of collecting the tax to the financial intermediate (e.g., credit card administrator) or to the final consumer in case the taxpayer is not registered in that state.
In import transactions, the collection of the tax must be made by the credit or debit card administrator or the financial company that is a foreign exchange intermediate.
There is dispute between states and municipalities concerning the taxation of digital transactions. A tax on services, “ISS” is levied by municipalities on the provision of services, while ICMS is levied by states on the sale of goods. These two taxes are mutually exclusive (they cannot be levied on the same transaction), and digital transactions cannot be easily qualified as service or sale of goods according to Brazilian legislation and case law. Currently, municipalities are also authorized to levy ISS on the provision of digital services of around 5 percent.
South Korea amended its VAT law to tax services provided by nonresidents electronically at 10 percent, effective July 1, 2015. The registration requirement applies to a foreign service provider which provides electronic services directly to its Korean customers without or through a PE in Korea. There is no threshold limit defined under VAT law in South Korea.
Foreign providers of electronic services must register with the South Korean tax authorities through the simplified business registration system.
Electronic service means the supply of:
- game, audio, video files, electronic documents or software, or similar items that are processed by optical or electronic means and produced or modified in the form of codes, letters, audio, and video, and any similar items; and
- the upgrade of such electronic service.
Japan introduced specific rules to tax cross-border digital services since October 1, 2015. The notion of digital services covers most content and services provided through an electronic network, e.g., e-books, online newspapers, music, videos and software provided via the internet, online advertising, online language courses, etc. The place of supply of digital services is where the recipient belongs, having regard to its address.
For services to businesses, the place of supply is where the recipient has its head office, main office, or in certain circumstances an establishment situated in another country that purchases the services for the purpose of its activities in that country.
A distinction is made between B2B and business-to-consumer (“B2C”) supplies, based on the nature of the service, as well as the terms and conditions of the contract. The classification of the supply as B2B or B2C impacts on the treatment applicable to cross-border digital services to customers.
- B2B digital services: a reverse-charge mechanism applies, whereby the recipient may be required to declare and pay the consumption tax on the purchase. The foreign business providing B2B digital services must inform the customer beforehand that the reverse charge mechanism may be applicable.
- B2C digital services: the supplier is required to charge consumption tax, file returns and pay the tax to the state unless it can benefit from the exemption for small businesses.
For the European Commission, the digital service tax is only an interim solution to ensure fair taxation of digital businesses and to prevent member states from drawing up their own legislation that may disrupt the internal market. Spain and Italy have already started down this path. The European Commission’s ultimate objective is a unilateral reform of the foundations of current tax legislation through the introduction of a taxable “significant digital presence.”
The DST shares a number of features with a VAT, by applying “destination” principles to determining the tax base, and in potentially allowing taxpayers to leverage information already collected from their customers (in a VAT context) for determining their location.
What appears to be contemplated is the idea of a nonresident taxpayer accounting for the tax by registering and paying in each jurisdiction in which they are liable for the tax. Keeping in view the principal purpose of electronic commerce tax, some key planning recommendations for business are:
- DST in the EU is based on “destination” principles and in the nature of a VAT. It is levied on the location of the user accessing digital services. A business would need to develop a process and record information of users accessing digital services to discharge their tax liabilities.
- Even though DST is in the nature of a VAT or indirect tax, input used in providing the services may not be available as credit under the present regulations. Business should assess the cost of input services which will become sunk cost, unless there is clarity in the regulation to reclaim credits.
- The Equalization Levy introduced in India is under corporate tax law, which is an independent code and regulation. The Equalization Levy is not creditable against corporate tax nor covered under tax treaties. Businesses will need to expense off equalization tax in the books. The business should assess the impact on cash flow, considering equalization is levied on the location of users.
- Brazil has developed a unique system of taxing digital services by bringing them under the ICMS tax. No credit of input services used to provide digital services is permissible under Brazilian law. At present, the proposal to tax digital services is on hold, but sooner or later rules will be announced. Businesses should prepare themselves to implement it and assess the cash flow impact of ICMS cost and ISS cost on digital services. It may be possible to reclaim corporate deduction on ICMS and ISS taxes in Brazil by the business as an expense, unless corporate tax law restricts deduction.
- There are reporting obligations in each jurisdiction—monthly or quarterly. Businesses must develop processes and IT systems to meet the reporting requirements.
Rajeev Agarwal is Head of Global Tax with Qatar Navigation QPSC. He may be contacted at: firstname.lastname@example.org.
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