Tax Law Update | November.01.2018
The UK government has announced details of its proposal to bridge a perceived taxing gap in relation to certain digital service providers via a new digital services tax ('DST'). As described below, the government intends to ensure that the tax is 'narrowly-targeted, proportionate and ultimately temporary' until a more globally coordinated initiative is agreed upon.
In brief, the DST is proposed to come into force from April 2020 and will be levied at 2 per cent on revenues exceeding £25 million that are derived by social media platforms, online marketplaces and search engines from providing certain services that are 'linked' to UK users.
The proposal builds on the momentum gathering in the UK (following the UK government's position papers on the topic released in 2017 and earlier in 2018) and jumps ahead of European Union and OECD proposals for a similar tax. Positioning the UK in this vanguard could be considered optically favourable for the UK government in a pre-Brexit world, but the proposal recognises that it will be important to coordinate with (and possibly defer to) any global initiative as it emerges (by way of an example, if an international consensus solution is enacted before April 2020 the UK chancellor will consider adopting such provision in preference to the UK provision).
Under the DST, businesses will only be taxable once they generate at least £500 million globally from the three in-scope business models, and the first £25 million of relevant UK revenue will not be taxable. In addition, the legislation will contain a 'safe harbour' to allow businesses with very low profit margins to calculate their liability on an alternative basis. As such, the DST is specifically aimed towards 'established tech giants' (such as Facebook, Amazon, Netflix and Google), and the UK Office for Budget Responsibility predicts that only around 30 companies will fall within its scope. The policy behind such a targeted approach (which is only expected to generate approximately £400 million of revenue annually, a comparatively small amount) may be that these companies are considered lightly taxed under current international tax rules which do not 'adequately' attribute profits to the value those businesses create in the UK. A broader aim (aside from revenue generation for the UK treasury) may therefore be to change the behaviour of big tech companies away from any organisation or structure that leads them to be 'insufficiently taxed' in the territories in which they operate, with the hope that the market may follow its lead.
The government will seek to apply this 2 per cent tax on revenues (not profits) attributable to one of the three in-scope digital business models, where revenue is linked to participation of UK users. For example, the government would apply a 2 per cent tax (1) to revenue generated by a social media platform from targeting adverts at UK users, (2) to commissions generated by digital marketplaces for facilitating transactions between UK users, and (3) on revenue generated from display advertising shown to UK users when they input search terms into search engines. Accordingly, shifting profits between jurisdictions via transfer-pricing compliant operating agreements in order to benefit from a beneficial tax rate will not avoid the DST charge.
Much of the criticism of the DST centres on how businesses will calculate what proportion of their revenue is attributable to UK users. This is likely to entail different computations for different types of online businesses and will be impossible to do without some degree of arbitrariness. It seems likely that such businesses will at a minimum need to track their number of UK users, which is not itself straightforward given that users are internationally mobile (though companies such as Netflix must to some extent have already overcome this issue in relation to content licensing). It is also questionable, in principle, how much of the value of digital businesses should be attributed to user participation; companies may argue that much of the value of a digital business will still be derived from employee know-how and the application of unique algorithms.
In addition to the above, enforcement issues can be expected to arise when seeking to tax on an extraterritorial basis. In particular, those countries with UK users but no other UK presence will have little incentive to comply with the DST. Thought should also be given to the impact of the DST on the U.S. market, where the majority of the targeted 'tech giants' are headquartered and where its effects may be disproportionately felt.
From 1 January 2019, there will be an extension to the scope of the 'permanent establishment' ('PE') definition to prevent non-UK groups from splitting up their activities between different locations and related companies to avoid having a UK PE (by virtue of an application of the exemption for certain preparatory or auxiliary activities).
Under the current definition, certain preparatory or auxiliary activities carried on in the UK, such as the storage of goods or the collection of information for the non-resident company, are deemed not to give rise to a PE. The government is concerned that multinationals have taken advantage of this exemption by splitting their activities between related companies or locations with a view to minimising their UK tax footprint. The legislation will therefore be changed to deny the exemption from PE treatment where activities form part of a fragmented business operation, for example where:
This extension was specifically recommended by the OECD as part of the Base Erosion and Profit Shifting ('BEPS') initiative but required domestic UK implementation.
Offshore receipts in respect of intangible property
From April 2019, a new UK income tax charge will apply to amounts received in a low tax jurisdiction in respect of intangible property, to the extent that those amounts are referable to the sale of goods or services in the UK.
This will generally apply where a company is based in a low-tax jurisdiction without a tax treaty in the UK. The scope is potentially wide, as the measures will also target embedded royalties and income from the indirect exploitation of intangible property in the UK market through unrelated parties. There are to be a number of exemptions, for example (1) where the value of UK sales is less than £10 million in a given tax year; (2) where all, or substantially all, of the business activity in relation to the IP has always taken place in the relevant territory; and (3) where the tax paid in relation to the relevant income is at least 50 per cent of the UK income tax that would otherwise arise under this measure.
Whilst the proposed UK income tax charge would typically be displaced where a full double tax treaty applies, the measures also contain a targeted anti-abuse rule, effective from 29 October 2018, that will protect against arrangements designed to avoid the charge, for example through the transfer of relevant IP to a group entity in a full treaty jurisdiction.
Given the potential difficulty in imposing the charge on a non-resident IP owner, the measure will also provide for any person within the same control group during the relevant tax year to be jointly and severally liable for the UK income tax, and it will be interesting to see whether this may catch certain joint venture arrangements, a point flagged to the government in the consultation responses. More interesting, however, will be whether the proposed charge leads multinationals to onshore relevant business activities to the UK.