New taxes, digital economy and our US special relationship

In 2020 a new 2% digital service tax (DST) looks set to come into force and will affect many multinational household names, taxing the proportion of their revenue derived from UK users. The new tax is set to raise hundreds of millions every year for the UK exchequer and £275 million almost immediately, in 2020/21 alone.

US threatens sanctions

But the new tax is not without its problems, even before it comes into force, and not just in the UK –consultation on it continues until September, with the DST legislation taking effect from 1 April 2020 and we are pressing ahead regardless of USA threats to impose trade sanctions on France for similar action; a 3% charge on the turnover of the largest digital companies in France.

Work is currently in progress in the USA to determine whether the French digital tax unfairly targets USA companies as part of section 301 investigation, a similar investigation that led to tariffs on Chinese imports into the US, triggering new tensions in US-China relations. These tariffs had a knock-on effect across the world, including in the UK as we noted when we had to act swiftly on steel tariffs (link to https://www.hcrlaw.com/case-studies/expert-advice-on-tariffs-customs-and-eu-steel-quotas/)– the butterfly effect in action.

The French approach has been to press on with the new tax and it seems the UK is set to do the same, apparently frustrated by the slow progress of international negotiations.

Mismatch between tax jurisdiction and economic value creation

While many people and businesses have enjoyed the explosion in growth of the digital economy, through improved services and greater inclusivity, especially for those who live in remote locations or are unable to get around easily, this has proved a problem for tax authorities.

This is primarily because the place where some profits are taxed and the place where value is created are not always the same.

For many digital businesses, value is derived from their interaction with users, yet that value from user participation is ignored when allocating profits between different countries to decide where tax is paid.

Delays prompt unilateral action

So the profits of digital activities are not paid in countries where economic value is created, some businesses taking part in the economy of a country with little if any physical presence. G20 finance ministers have expressed their concerns in the past about this and the Office of Economic Cooperation and Development (OECD) is tasked to make recommendations on emerging business models that identified three characteristics of highly digitalised businesses:

• scale without mass
• heavy reliance on intangible assets
• the importance of data.

But so far consensus has not been achieved and the OECDs final report is not anticipated until next year. This delay increased the risk that different tax jurisdictions would take uncoordinated steps, introducing new tax measures on their own to tackle the problem. And the UK has done just that.

HMRC announced in last year Budget that the new tax would come into force next April, as a tax on the value some digital businesses derive from UK users. This would be an interim measure until international tax rules improve, which is the Government’s preferred long-term solution – once an appropriate international solution is found, the tax ceases to apply.

Taxing revenue, not profits

It is proposed DST will be a 2% tax on revenue flows (not profits) from the provision to UK users of:

• social media platforms
• search engines
• online marketplaces, including the operation of any associated online advertising business.

Who will be affected?

DST will only apply to large multinationals that derive revenue from these sources, whose global revenues from these specific business activities exceed £500m and where more than £25m of those revenues derives from UK users (since DST is not payable on the first £25m of UK revenues).

Revenues will be taxed as derived from UK users if they arise as a result of a UK user using the platform and advertising revenues will be taxed as derived from UK users when adverts are intended to be viewed by UK users.

Only time will tell what effect the new DST may have on the UK-US special relationship, but if current plans go ahead, the proposals are set to shift hundreds of millions of pounds each year to the UK economy. For latest information from HM Treasury see assets.publishing.service.gov.uk

We would be glad to advise about the associated risks to business – do contact me at [email protected]