Treasury rolls out detailed plans for 2% digital services tax
The Treasury is going ahead with plans for a 2% tax on large online multinationals from 2020, including social media and search engine companies, to raise over £600m by 2022
7 Nov 2018
The digital services tax is described as a 2% tax on the UK revenues of digital businesses that are considered to derive ‘significant value’ from the participation of their users. It is not a tax on online sales and is not intended to be a general tax on all businesses that collect data, provide online services or generate revenue from online advertising.
At present, businesses will only be taxable if they generate more than £500m in global annual revenue from business activities conducted online, or generates more than £25m in revenue from business activities linked ‘to the participation of UK users’. This means that most UK-based digital businesses will be exempt, as around 30 companies will be captured by this tax.
The thresholds mean that small businesses are not in scope of the tax. It is expected that, in the 2020-21 period following the enactment of the law, the revenue gained will be £275m, rising to £370m in 2021-22 and £400m in 2022-23.
This tax, according to the consultation, will include a ‘safe harbour’ that will permit businesses ‘to elect to make an alternative calculation of the digital services tax liability’ in cases of companies with very low profit margins.
This safe harbour ‘would help ensure that the profit margin reflects the performance of the business within the UK, and hence more accurately reflects the value created by UK users’. The tax will also be deductible against UK corporation tax but will not be creditable.
The consultation seeks to clarify a number of points, one of the most significant being user participation, or ‘the process by which users create value for certain types of digital business through their engagement and participation’.
Content generation of this kind, and the depth of engagement by users, are key drivers of profit for online companies such as social media companies and determining how this interaction generated profit is of key importance to the effectiveness of the digital services tax.
Three ways are proposed for determining value from this interaction, including imposing a tax on the channels by which users create value for an online business based on a case-by-case assessment; objectively defining the business activities that derive most value from user participation and taxing the revenue generated; and defining the most common revenue streams by sub-section and taxing any business in relation to such revenues. Of these, the government strongly favour the second option, which requires ‘defining specific in-scope business activities in legislation’.
Businesses not included within the scope of the digital services tax include companies that offer ‘the provision of financial or payment services’, such as banks and building societies. The online websites of retailers would also be exempt in cases where a company sells their own goods online, as in this case users ‘are not considered a central value driver’. The government is considering that this category would include companies that provide hardware, software and cloud computing services.
Newspapers, publications and TV or music subscription services would also be exempt in cases ‘where the business either owns the content or has acquired the right to distribute content’ as this is the same effective principle behind the online sale of goods.
However, the consultation paper notes that ‘there are online games that share similar features to social media and online marketplace business models’ and further consideration is needed of borderline cases. This is designed to close a potential loophole under which social media giants could claim ownership of user-generated content.
The government is also considering introducing two anti-avoidance rules around the tax. The first would seek to prevent forestalling to prevent companies accelerating revenue recognition before 1 April 2020 to avoid the impact of the tax. The second would prevent companies ‘artificially re-characterising revenue streams so that they fall outside the relevant business activity’.
It is anticipated that some non-resident businesses, including companies without a UK permanent establishment, would be liable to the tax. The government would expect companies to comply voluntarily with the tax as they would with other UK tax obligations, but foresees the possible necessity of new penalties to encourage compliance. With regards to cross-border transactions, the Treasury is seeking additional input on what measures could be included in the tax.
On the definition of a user, particularly in cases of being based in the UK, ‘the meaning of user will include an individual, a company or any other legal person that participates with an in-scope business activity’ and a user will be considered a UK user ‘if they are normally resident in the UK and thus primarily located in the UK when participating with the relevant business activity’.
This would be determinable by either the IP address of the user, in the case of a search engine engagement, or payment details and delivery address when using an online marketplace.
Payments are intended to mirror the corporation tax structure, with businesses making tax payments quarterly ‘according to the same payment schedule as very large corporate quarterly instalment payments’. Credit and debit interest will also operate in the same as the corporate tax framework for over- and underpayments of instalments, and late and repayment interest may also be sought.
Eloise Walker, partner at Pinsent Masons, said: 'It is a gamble by the UK to introduce to try to force the international community to rewrite the current rules. The world could probably do with more consensus-based politics right now.'
'This is a very complex set of proposals that will impose a huge compliance burden on businesses that feel they are drowning in compliance costs. Many businesses will have to do a lot of expensive work just to establish that this tax does not apply to them – so the burden of the tax is not just on the businesses that will have to pay it.'
'It is unclear exactly how businesses will be expected to isolate in-scope activities where they undertake a variety of business activities. For HMRC to acknowledge that this may not always be “straightforward” indicates the extent of the tax compliance nightmare that they are about to unleash on business. If this tax is introduced then lengthy disputes with HMRC are on the cards.'
'The proposed approach will also cover revenue from in-scope activities involving a UK user action, which can be as small as a click. Quantifying revenues attributable to UK users in this way is likely to be very complicated – as crazy as it seems it is now not unimaginable that from April 2020 a business will be taxed on revenues from business activities because someone in the UK has “clicked” on a page for 10 seconds before exiting.'
'There is nothing unusual in imposing bespoke taxes for certain business sectors – but the nature of the tax is hugely contentious as it is a profits tax levied not on profits but turnover.'
Th consultation on the digital services tax closes on 28 February 2018.
Report by James Bunney