The UK is due to introduce a new digital services tax (DST) with effect from 1 April 2020. When announced in the Autumn 2018 Budget, DST was described as an interim action, pending global reform. Now that OECD discussions on the taxation of digital businesses appear to be moving toward an agreed consensus, does the justification for a unilateral interim measure fall away?
Are large, global, highly digitalised businesses paying less tax than they should? We examine the UK’s and the OECD’s Digital Services Tax
UK approach: tax on revenues of specified digital service businesses
The UK's DST is a 2% tax chargeable on the gross revenues of large digital services businesses which are attributable to an "in-scope activity" and are linked to UK users. It will apply to revenues earned on or after 1 April 2020.
The following activities are in-scope:
- Social medial platforms
- Internet search engines
- Online marketplaces
Businesses carrying on a mixture of in-scope activities and other activities will need to apportion revenue between the two types of activities. They will then need to identify UK users (users that are normally located in the UK) and apportion revenue from global in-scope activities to UK in-scope activities.
Revenues will only be subject to DST if (i) the global business has more than £500 million of global revenue from the activities and (ii) more than £25 million of that revenue is linked to the UK i.e. generated as a result of 'UK users'. There will be a safe harbour election if the group has low UK profit margins allowing an alternative method to calculate the tax due.
Draft DST legislation and draft guidance was published by the UK government in July 2019. The government predicts that it will raise £1.5 billion from DST over the next 4 years.
OECD approach: tax on proportion of profits of consumer facing businesses
After several years of meandering discussions, in 2019 the OECD moved forwards with two pillars of a long-term solution for the taxation of digital businesses.
Pillar 1 looks at when a taxable presence could be created in a market jurisdiction where there would not otherwise be one e.g. because there is no physical presence in that jurisdiction and considers the allocation of taxing rights to market jurisdictions and the interaction with existing transfer pricing rules.
Pillar 2 is concerned with having an overall minimum level of taxation for large digital businesses that operate globally. This minimum tax could be achieved in a number of ways including allowing jurisdictions to tax 'undertaxed' amounts and/or imposing withholding taxes on payments that would otherwise be 'undertaxed'. However, the thinking around this pillar is less developed than under pillar 1.
How would digital businesses be taxed under Pillar 1?
The OECD's proposed method of taxing digital businesses is much wider in scope than the UK's DST. The Pillar 1 proposal would apply to businesses providing automated digital services and "consumer-facing businesses" (businesses that generate revenue from supplying consumer products). This could catch large retailers, although the OECD is exploring whether a higher threshold of activity in market jurisdictions should apply to retailers. Carve-outs and financial thresholds are expected to be included.
A new nexus rule would apply when in-scope taxpayers have a "sustained and significant involvement" in the economy of a market jurisdiction. New complex profit allocation rules would allocate a proportion of the taxpayer's profits to market jurisdictions.
The OECD's goal is to arrive at a consensus solution by the end of 2020. On 31 January 2020, the OECD reported that the 137 countries involved in negotiating the measures had agreed to move ahead with the two pillar solution. However, a lot of work will be required to arrive at an agreed detailed set of rules, especially given that the United States has expressed serious concerns with Pillar 1.
UK DST versus OECD Pillar 1
The OECD proposal is broader in scope than the UK's DST. The focus on consumer-facing businesses means that measure is likely to apply to a much larger number of taxpayers than DST which only applies to taxpayers carrying on one or more of the three specified digital services.
What will the UK government do next?
DST has repeatedly been justified by the UK government as an interim measure pending global reform of international tax rules. If the OECD Pillar 1 measure is agreed by the end of 2020, should the UK go ahead with the introduction of DST just 9 months earlier?
Whilst the OECD proposal is more ambitious and far-reaching than the UK's DST, it is also much less developed than DST and is dependent upon 137 countries reaching agreement. The OECD's proposed solution involves fundamental changes to the international tax system which could well take more than one year to negotiate. Even if a detailed measure is agreed by the end of 2020, there would still need to be a further period of consultation to draft domestic legislation and guidance.
Given the uncertainty of timing of the OECD measure and the relatively large projections for DST revenue over the next few years, we think that it is likely that the UK will press ahead and introduce DST in April. This may be disappointing for taxpayers within the scope of DST who could end up having to incur significant compliance costs putting in place systems to identify in-scope revenue and apportion it to UK users, only to have to comply with a new set of rules within a couple of years.