UK leads the way with a new digital services tax

30 October 2018

A 2% Digital Services Tax is announced, on revenues linked to UK users for large digital firms such as social media platforms, search engines and online marketplaces.

Chris Denning, Corporate and International Tax Partner comments that while the new Digital Services Tax (DST) runs the risk of US retaliation, the UK may be seen as leading the way in taxing some multinationals more fairly.

The focus of DST is solely on “digital” business models so it will not impact other perceived tax avoiders such as Apple, Starbucks etc.

We have had previous legislation to tackle both digital and non-digital business models, such as diverted profits tax (DPT) which the UK also led the way in introducing and this time round there are new rules to discourage the offshore exploitation of intellectual property (IP) in low tax non-treaty territories through the imposition of UK income tax on non-resident IP owning companies. So multinational group’s routing income through tax haven territories will potentially be caught by these rules.

Coming back to DST, the question as to whether its introduction is purely politically motivated is a valid one.

The specific details of the digital services tax will follow further consultation, but we know the types of businesses it will apply to, such as search engines, social media platforms and online marketplaces who derive value from their user bases. This tallies with the government’s previously expressed views on the types of companies such a tax should apply to, and on what basis.

It is only projected however to raise £400m per year which is a tiny proportion of the UK’s total tax revenue. Like DPT it is going to be costly to manage in proportion to the revenue generated and complex in its application, with various threshold limits and exemptions applying as well as the difficulty in identifying the actual revenue generated from a UK user base that the 2% tax will apply to.

It is not a “sales tax” but being a tax on revenue there must be a risk that the “cost” is passed on to the end user. This may be of less concern where the users are commercial such as advertisers however the large marketplaces such as eBay have significant numbers of consumers who could end up footing the bill. We are already seeing in other areas such as the restriction of interest relief on residential rental property where this additional tax cost is simply being passed on to the tenant.

The government’s policy paper says that the DST legislation will include a review clause and is intended as an interim measure until the international community gets it act together so one could take the view that it’s really a half-hearted attempt to move the matter forward whilst being seen as a crackdown on the usual suspects in the meantime.

The tax is clearly aimed directly at a small number of US technology companies. When the news sinks across the pond in it could raise the possibility of retaliatory measures from the US government. Dragging the UK into an acrimonious quarrel with one of its largest trading partners is perhaps not what the Chancellor intends or would desire at this point in the UK’s history.

In addition to retaliatory measures at country level the target companies themselves will no doubt take a less than a favourable view on being singled out in what is becoming more and more an issue between governments as to where, how and what profits should be tax. The costs of multinational tax compliance are significant, so one can see as tax rates converge, larger organisations simply pushing the responsibility of determining what is taxed into the hands of the impacted revenue authorities.

There is also the impact on investment decisions by these companies who, as I have highlighted, contribute more to society and the communities in which they operate than simply the headline amount of corporation tax.

The UK’s fiscal regime is an important tool in attracting inbound investment so it is important that measures which grab headlines but that have no material impact on tax revenues and negative impact on investment decisions are avoided at a time when the UK needs to be seen as “open for business”.

The other side of the argument is that the UK will be seen as leading the way in fiscal reforms. Once the UK introduces DST it is inevitable that other territories will follow. Therefore, any non-levelling of the playing field this may create from UK’s perspective will be hopefully short lived.

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