President Trump recently dropped plans to increase tariffs on Chinese goods, after the G-20 Argentina summit. All these false alarms create volatility in the global stock markets and U.S. protectionism and unpredictability make international tax regulators keener to target U.S. tech giants.
International tax cooperation is undergoing a period of rapid transformation. The global efforts led by the G-20 and the Organization for Economic Co-operation and Development (“OECD”), aimed at addressing base erosion and profit shifting (“BEPS”) and at enhancing tax transparency, have shaken up traditional institutional and legal approaches.
It has been reported that global tax authorities continue to have U.S. companies in their sights, as it is estimated that $75 billion of capital held by big corporates is under scrutiny. Tax authorities have been using the OECD’s BEPS and the U.K.’s “Google Tax” to target the U.S. technology sector, and will soon use the new digital services tax.
The European Commission called for a long-term measure of a new taxable presence threshold of a significant digital presence (“SDP”) and an interim European-wide 3 percent digital services tax based on the gross revenues of certain large digital businesses. The SDP would act as a new permanent establishment concept and allocate profits according to traditional functional analysis techniques.
However, Ireland and Sweden have rejected this interim digital services tax, preferring to wait until the OECD achieves an international solution for taxing the digital economy (expected by 2020). Meanwhile Italy and Spain have introduced draft proposals for a digital services tax and France confirmed that it will begin taxing the tech giants from January 1, 2019 with a comprehensive digital services tax. Austria announced on December 29, 2018 that it now has plans to follow France and will impose its own digital services tax on the tech giants.
The U.K. Approach
The first prize in the unilateral race always goes to the U.K. The then U.K. Chancellor George Osborne introduced the Diverted Profits Tax in 2015 (also known as the “Google Tax”) which counters arrangements to artificially divert profits from the U.K.
The current U.K. Chancellor announced on Budget Day in October 2018 that he will introduce a temporary digital services tax (“DST”) of 2 percent from April 1, 2020 on the revenues of search engines, social media platforms and online marketplaces. It has been designed to target established tech giants with revenues of 500 million pounds ($630.5 million) or more—i.e. the Facebooks and Googles of this world.
The DST only applies to revenues from businesses linked to the participation of U.K. users (in-scope revenues). It is not a tax on online sale of goods—it will only apply to revenues earned from intermediating such sales, not from making the online sale.
The DST is a radical departure from traditional taxation methods as it will tax gross revenues (rather than profits which are split between jurisdictions). The DST could apply where, under traditional methods, no U.K. profits arise, and where businesses have no U.K. taxable presence, such as a branch or subsidiary.
A consultation on the DST was published by HM Treasury and is open to comments until February 28, 2019. The consultation covers the definition of the three in-scope businesses, identifying taxable revenues and the proposed safe harbor for unprofitable or low-margin businesses. As the DST is a temporary measure, the consultation also seeks views on the proposed review mechanism in 2025.
The DST will have the biggest impact on U.S. tech giants such as Google and Facebook. Uber, Airbnb and other business that link up users with, for example, drivers and homes may also be affected. The U.K. Chancellor’s rationale for the DST is that it will equalize the tax liabilities on non-digital companies with whom they compete.
Michael Devereux of the Oxford University Centre for Business Taxation stated in his recent blog:
“…the real reason for these proposals seems to be the lure of easy tax revenue from taxpayers that can afford to pay…. But the problem with the DST… is that their proponents claim that the tax has different purposes. That matters greatly, because the tax will be crafted to meet its perceived purposes. So it seems likely that the design of any DST will reflect the obfuscation offered by its advocates as to why it should be introduced.”
Moody’s Investors Service has said that the DST is a credit negative for the U.S. tech giants and could reduce cashflow. The DST will raise more from the tech giants but does not change the allocation rules—it just adds more tax on top. This adds to the complexity of the existing tax system.
The administration of the DST is likely to lead to increased expense as U.S. tech giants will need to introduce systems to not only track their U.K. users but also to monitor how much they are adding to their platform.
There is a risk of double taxation as businesses may pay tax on the same profits twice—through corporation tax and the DST. Although the DST is a tax-deductible operation expense subject to certain conditions, it will not be within the scope of the U.K.’s double tax treaties and consequently will not be creditable against U.K. corporation tax. The U.S. may soon look to renegotiate its treaties with the U.K.
Potential disputes are likely to arise as many regard the DST as undermining the international tax system. The U.S. and the OECD consider this to be a preemptive revenue grab by the U.K., designed to tax a small number of U.S. technology companies before an international solution on how to tax the digital economy has been reached. Now that France and Austria are introducing their own DST, the tension will escalate.
President Trump is certainly going to retaliate with some changes to the U.S. tax and regulatory landscape.
Increase in Audits and International Disputes
U.S. and international multinationals have seen an increase in tax audits and disputes with international tax authorities. The catalyst for this boom has been the increased collaboration and information sharing among countries as country-by-country reporting requirements, the Common Reporting Standard and the automatic exchange of information come into effect.
These all-pervasive tax investigations have led to an increase in resolution through negotiated settlements rather than litigation. The reasons for this are myriad—settlements are quick, cheap, and under the radar.
Also, do not underestimate the pressure experienced by these companies when under the full glare of joined-up international tax authorities intent on extracting tax and discombobulating their victims with a complex web of cross-border tax accusations.
The most common tax disputes involve transfer pricing. The issues concerning where multinationals generate profits are so complex, it is difficult to predict the chances of success if litigation is pursued.
For an isolated dispute or a fearless taxpayer, litigation may still be the preferred choice. Altera Corporation v. Commissioner 2018 WL 3542989 (9th Cir. 2018) is a transfer pricing case going through the U.S. courts. The Internal Revenue Service won and it is now on appeal. The issues are complex but if upheld, it will effectively cost the U.S. tech companies large amounts by denying deductions for equity-related compensation.
• Comment on the DST consultation by February 28, 2019.
• Large companies (especially U.S. technology companies) should strengthen their dispute resolution functions.
Fionnuala Lynch is Head of Tax with McCarthy Denning, U.K.
She may be contacted at: email@example.com