INSIGHT: U.K. Digital Services Tax—What Does it Mean for Multinational Corporations?

We have seen significant change in the international tax landscape recently, but for many nations those changes do not appear to go far enough. Over 130 countries are currently working alongside the Organization for Economic Co-operation and Development (OECD) to design an international tax system that is fit for the modern, highly digitized, economy.

Those in favor of reform say that international tax rules have not kept pace with evolving business models. The current framework of international taxation is predominantly built upon the premise of “taxation by physical presence,” which is understandable given its roots over 100 years ago in a pre-digital world.

These days, however, it is possible for a business to sell its products or services internationally with no or limited presence in a country, often via digital means. The tax system today does not enable the consumer jurisdiction to tax much of the profits derived through foreign digital platforms, and that creates political tension. Whilst tech giants are the obvious challenge, there is growing global consensus that there needs to be sweeping reform of the international tax rules more generally to acknowledge, across all sectors, the digitization of the economy at large.

Recently, members of the OECD/G-20 Inclusive Framework on BEPS have agreed on a roadmap to develop a solution to the tax challenges arising from the digitization of the economy. This will focus on (a) a review of taxable nexus and profit allocation rules and (b) a global anti-base erosion/minimum tax proposal. The expectation is that agreement on a solution will be reached by the end of 2020.

However, the global efforts are proceeding too slowly for some, and whilst work is ongoing to achieve global consensus, some countries (e.g. Australia, Austria, France, Italy and the U.K., to name a few) are actively considering or have already implemented unilateral measures to tax digital companies and their activities.

The U.K.’s Digital Service Tax (DST) was first proposed in the 2018 Budget, and the legislative output from the first consultation process has recently emerged.

U.K. Digital Services Tax

Following a consultation process, the U.K. government has stayed committed to pressing forward with the introduction of a DST, notwithstanding an acceleration of thinking on a long-term multilateral solution by the OECD and concerns raised by the U.S. government in respect of similar legislation introduced in France. Draft DST legislation and guidance was published on July 11, 2019 for consultation with a view to being enacted in the next Finance Bill.

What is the DST?

The DST is a new 2% tax on the revenues of large businesses providing internet search engines, social media platforms and online marketplaces to U.K. users. It applies to businesses generating worldwide in scope revenues of more than 500 million pounds ($609 million), with at least 25 million pounds of these revenues being derived from U.K. users. A group’s first 25 million pounds of revenues derived from U.K. users will not be subject to the tax. DST should be deductible as an expense for corporation tax purposes, subject to allocation among group members in accordance with transfer pricing principles.

The DST will apply from April 1, 2020 with the government reviewing the tax in 2025. The DST is intended as a temporary “stop gap” pending work at an international level. However, it is notable that there is no “sunset clause” in the draft legislation, which was one of the recommendations made by the OECD for any country considering imposing temporary unilateral measures.

How will the DST be Charged?

The basis of charge is U.K. digital services revenues that arise in connection with digital services activities of any member of the group.

Digital Services Activity

This means the provision of a social media platform, internet search engine or an online marketplace. The provision of digital service activities by a group includes the carrying on of any associated online advertising business, being a business operated on an online platform that facilitates the placing of online advertising, and derives significant benefit from its connection with the social media platform, search engine or online marketplace.

A social media platform includes, but is not limited to, social networking sites, micro-blogging platforms, video/image sharing platforms, online dating websites, and platforms for sharing user reviews.

Businesses that stream, broadcast or publish media (e.g. film or music) are not expected to fall in scope of the definition. Likewise, online sale of own goods, the provision of online content and the provision of radio and television broadcasting services are not expected to fall within the definition.

To be in scope, an internet search engine should, in principle, search the entire internet. The underlying algorithm should continuously collect user data to improve the performance of the search engine (allowing the business the ability to monetize from user traffic and trends). It is intended that the provision of a single-site search function or an internal search engine (company intranets, for example) should not be in scope.

Broadly, an online marketplace is an online platform that facilitates the sale by users of particular things (goods, services, property) to other users. The legislation is only intended to capture cases where the platform’s business is to act as an intermediary and match users.

Business-to-consumer (B2C), business-to-business (B2B) or consumer-to-consumer (C2C) transactions and business models are covered. It is irrelevant whether transactions are concluded on the marketplace platform itself or not—the mere fact that the platform is used to list products brings the activity within charge to DST.

U.K. Digital Services Revenues

These are revenues that are attributable to U.K. users (both individuals and companies). These revenues include advertising targeted at a U.K. user or where a U.K. user is party to a transaction taking place on an online marketplace.

Draft guidance states that a U.K. user is “a user who it is reasonable to assume is either an individual normally located in the U.K. or, for businesses, established in the U.K.” In practice, making an assessment of whether there is a U.K. user is likely to involve considering different sources of information such as delivery addresses, payment details, IP addresses, intended destinations of advertising, the address of property or location of goods which are rented out.

For businesses with mixed revenues i.e. that are attributable to the digital services activity and to another activity, draft legislation allows for an apportionment on a just and reasonable basis.

What Recent Changes Arose from the Consultation?

The U.K. government published a consultation on November 7, 2018 into the introduction of a DST. Many of the core features proposed in that consultation remain unchanged, demonstrating that the U.K. government has a fairly clear and unshakeable policy intent. However, a few changes in approach have emerged, including:

• A partial relief from the DST where one of the users in relation to that transaction is located in a country which also has a DST that applies to marketplace transactions. In respect of online marketplaces, where one of the parties is a U.K. user, all of the digital services revenues will be treated as derived from U.K. users. However, in determining the charge to DST, the revenue can be reduced to 50% of the revenues when the counterparty is located in a country that operates a similar tax. Taxpayers are required to make a specific claim in their DST returns to avail themselves of this reduction. Whilst welcome, this will not provide full relief from double taxation and many businesses could be subject to corporation tax and DST in the U.K. (as DST is only deductible from profit for corporation tax purposes in the U.K.), as well as other similar taxes around the world on the same revenue stream;
• An intention to make the DST reportable and payable on an annual basis, rather than in quarterly installment payments as was previously proposed;
• An exemption from the online marketplace definition for financial and payment services providers;
• Clarification through draft guidance that the rules are unlikely to apply to core telecommunications networks or private communications platforms like email or messaging activities unless they are highly integrated with a wider social media platform. U.K. property-related activities that fall within the definition of an online marketplace are specifically included.
• Confirmation that the government will be moving forward with its previously stated preference to use a U.K. profit margin in the safe harbor calculation. This will be of value to those businesses where the relevant digital services activity has a very low (typically 2.5% or lower) U.K. operating margin. In case of a negative margin, there will be no DST liability.
• Confirmation that the DST will be calculated and reported at the group level, and the group will be able to nominate a company to undertake the reporting. Where no nomination is made, the ultimate parent of the group will be responsible. The DST liability and expense will remain with the entities that generate the underlying revenues subject to DST for expense deductibility purposes.

What Should Businesses be Doing?

Businesses should be reviewing the DST proposals in detail, considering the impact on their current and future state operating models and assessing the resultant impact on the pricing of their products and services.

In particular businesses should be:

• reviewing their revenue streams to confirm whether and to what extent business activities are within the charge to DST and what part of the group revenues are attributable to U.K. users;
• assessing whether they have the right infrastructure in place (IT and accounting systems, policies and procedures, across the group) to support the collection of data needed to identify, apportion, capture and monitor, in-scope activities and associated revenues;
• considering whether any reconfiguration of the business operating model is required as a result of the DST;
• planning for future DST compliance obligations including accounts reporting requirements (although the first DST return and payment will not be due until 2021).

Concluding Remarks

Whilst the U.K. government still believes that the long-term solution to the tax challenges arising from digitalization lies in reforming the international tax rules, it considers interim, unilateral measures such as the DST are justified in the short term.

The DST will increase the administrative and compliance burden on affected taxpayers, and there are inherent challenges of a revenue-based tax that cannot be fully mitigated through design, including, but not limited to, risk of double taxation. Boundary issues arising from the attempt of the U.K. DST to ring-fence certain business models are also likely to present significant challenges for modern, highly integrated businesses.

These design challenges have led to concern among many in the international community regarding the proliferation of unilateral DSTs. The U.S., for example, has been a vocal voice against the implementation of DSTs in Europe, and has commenced an investigation into the French government’s introduction of a similar measure in a move that could ultimately see the imposition of retaliatory tariffs. It seems likely the U.S. could take a similar view of the U.K. DST, given the thresholds and scope mean that it could predominantly affect U.S. tech giants. The potential impact on U.K.–U.S. trade negotiations in a post-Brexit environment remains to be seen.

It also remains to be seen whether the U.K. moving forward with its DST will encourage other governments that have been actively considering similar proposals to move forward (including Austria, Italy, Spain, Mexico, New Zealand) with similar taxes which could add further complexity to an already complex fiscal environment.

Planning Points

• Whilst the DST is applicable only to certain large technology businesses, all international businesses should continue to monitor developments in relation to the taxation of the digital economy, as many countries are actively considering measures with lower thresholds and broader scope.
• Impacted businesses should consider responding on both the draft legislation and draft guidance by September 5, 2019 to ensure the tax is workable in practice.
• Affected businesses should be actively reviewing whether they have the systems in place to collect the required data, and if not, taking the required steps now.

Ross Robertson is an International Tax Partner and Arjun Bhatia is International Tax Director with BDO LLP

The authors may be contacted at: ross.robertson@bdo.co.uk; arjun.bhatia@bdo.co.uk

This column does not necessarily reflect the opinion of The Bureau of National Affairs, Inc. or its owners.