The United Kingdom is going it alone with a proposal for a digital services tax (DST), with the aim of increasing the tax tech giants such as Facebook and Google pay in the UK. The DST was confirmed by the Chancellor Philip Hammond in his Budget at the end of October.
However, experts warn that international tax reform is what’s really needed, not only for tech companies, but for taxation as a whole, to address public and political anger over the relatively small amount of tax major companies pay.
Hammond has criticised the pace of international discussions on taxing digital firms, calling it ‘painfully slow’. In the Budget the Chancellor described the challenge digital platforms – such as online marketplaces – pose for the UK’s tax system, and announced the DST as a ‘narrowly-targeted tax on the UK-generated revenues of specific digital platform business models’.
A consultation on the proposed tax was published on 7 November; feedback is due by 28 February 2019 and the DST will enter force in April 2020.
‘There’s political and public anger, rightly or wrongly, about the tax that some of these companies pay,’ says Jessica Kemp, a partner at law firm Travers Smith.
“The preferred long-term solution is to reform current corporate tax rules in order to cover the new business models used by tech companies
Co-Chair, IBA Taxes Committee and partner, Macchi di Cellere Gangemi
The DST will tax a company’s gross revenues at two per cent and apply to profitable companies that generate at least £500m a year in global revenues and at least £25m in annual revenues from activities linked to participation of UK users.
Kemp notes that the DST’s objective is different to that of the diverted profits tax, which took effect in the UK in 2015 and is often labelled the ‘Google tax’. ‘The diverted profits tax was implemented not with the intention of collecting money, but of changing behaviours,’ says Kemp, who says the DST is, in contrast, ‘a straight revenue raiser.’
The Chancellor was keen to point out that the DST won’t target tech startups; it won’t apply to the first £25 million of a business’ UK taxable revenues.
However, Andrew Rink, a corporate tax lawyer at Bird & Bird, says that because the DST is levied on revenue, it ‘could unfairly disadvantage companies that are still raising money through equity finance, potentially damaging the UK’s reputation as the best place to start a technology business or to invest.’
Some tech firms are also concerned about the impact on innovation. Francesco Capitta, Co-Chair of the IBA Taxes Committee and a partner at the law firm Macchi di Cellere Gangemi, explains however that digital service taxes are typically aimed at avoiding the erosion of taxes in the countries that implement them. ‘The underlying assumption is that tech companies do not pay their fair share of taxes in the countries where the customers are based because they do not have a physical presence in such countries,’ he says. ‘Under such perspective, digital services taxes are aimed at eliminating a distortion that favours tech companies versus old economy companies. Eliminating a distortion as such should not affect innovation.’
The reaction from the United States will be closely watched. On 31 October the US House of Representatives Ways and Means Committee Chairman Kevin Brady criticised the proposed DST as a ‘blatant revenue grab’ which ‘singles out’ an industry where US companies dominate.
The tech firms likely to be affected by the DST pay tax in the US. While the UK government does not believe the DST is covered by double taxation treaties, Kemp thinks these US firms will strongly argue the opposite. ‘At a pure legal level, the US can’t stop the UK taxing how it wants to,’ says Kemp. However, ‘The US can apply political pressure, especially when the UK is looking for a trade deal.’
The EU meanwhile has drafted a proposal for an interim, EU-wide tax at three per cent on firms’ digital revenues, and another proposal for a more permanent solution aimed at establishing a corporate taxation regime to apply where companies have significant digital presence. ‘Like the UK, the EU hopes its interim measure will prompt quicker international action, but critics worry it could lead to retaliation,’ notes Laurence Clot, a partner at Bird & Bird in France.
‘Policy makers are currently struggling to find solutions which can ensure fair and effective taxation’, says Capitta. ‘In any case, the introduction of a web or digital tax is seen as an interim measure that is not intended to be a long-term solution. The preferred long-term solution is to reform current corporate tax rules in order to cover the new business models used by tech companies.’
At a global level, the Organisation for Economic Co-operation and Development is looking at digital taxation. In 2018 over 110 countries and jurisdictions pledged to review two key concepts of the international tax system, following a mandate from the G20 Finance Ministers to study the consequences of digitalisation for taxation.
The UK government has taken what Kemp describes as an ‘unusual’ step by including a compulsory review, scheduled for 2025, in the DST proposal, which means that parliament must look at the DST again at that point in the future. Depending on what happens both in the EU and globally, the UK might ultimately adjust the DST.