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The proposed UK Digital Services Tax: Government consultation document released

  • United Kingdom
  • Tax planning and consultancy
  • Technology, Media and Telecoms

08-11-2018

On 29 October 2018, the UK Chancellor announced the introduction of a Digital Services Tax (the “DST”). Very little detail about the proposed tax was provided initially. However, on 7 November 2018, the government issued a consultation document on the design and implementation of the DST, the details of which are summarised in this note.

Executive summary

From April 2020, the UK intends to apply a 2% tax on the revenues (not profits) of specific digital business models where their revenues are linked to the participation of UK users. The key features of the proposed tax are as follows:

• The DST will apply to search engines, social media platforms and online marketplaces.

• Financial and payment services, the provision of online content, sales of software/hardware and television/broadcasting services will be specifically excluded from the scope of the DST.

• The DST will only apply to businesses (whether based in the UK or not) which generate annual revenues from in-scope business models of at least £500 million globally and at least £25 million from in-scope business activities linked to the participation of UK users.

• Businesses will not have to pay tax on the first £25 million of relevant UK revenues.

• The DST will include safe harbour provisions pursuant to which businesses with very low profit margins or making a loss will pay a reduced (or zero) amount of DST.

• The DST will be deductible against UK corporation tax under existing principles.

The consultation document in more detail

The UK government remains committed to finding a long-term multilateral solution to taxing the digital economy and will continue to work at the level of the OECD and G20 to reach agreement. However, progress towards international consensus has been slow. The UK has therefore decided to take interim unilateral action and introduce a tax on the revenues of certain digital business activities in order, in the view of the UK government, to ensure that UK tax is paid that properly reflects the value derived from UK users.

The DST is intended to be a narrowly-targeted 2% tax on the UK revenues of digital businesses that are considered to derive significant value from the participation of their users. If it comes into force, the tax will apply from April 2020.

Business revenues (whether realised in a UK or non-UK entity) will only become taxable under the DST where they meet the following two conditions:

1. they are revenues that are attributable to an in-scope business activity; and

2. the revenues are linked to the participation of UK users.

Defining in-scope business activities

The consultation document explains that the following business activities will fall within the scope of the DST:

a) Provision of a social media platform: this captures platforms which benefit from and encourage the sustained engagement of a large user base, i.e. platforms which allow users to interact with each other, publish or share personal details, and join and create online communities based on shared interests or objectives. Such social media platforms generate revenue by monetising users’ engagement with the platform and with other closely integrated functions (e.g. through advertising).

b) Provision of a search engine: this is intended to apply to a narrow range of business activities and will not apply to websites with a functionality which allows users to search for other material only within that website. Rather, it is intended to apply to businesses which provide the option of viewing websites beyond the platform itself, e.g. by obtaining information or services on the internet which result from, or correspond to, keywords, web addresses or other information specified by the user. Such search engines generate revenue by monetising users’ engagement with the platform, e.g. by advertising directly against users’ search results or from advertising revenue generated on websites to which the search engine has facilitated access.

c) Provision of an online marketplace: the key element here is that in-scope marketplaces will not have legal ownership of the goods being sold on the marketplace. The definition is intended to capture platforms which allow users to advertise, list or sell goods and services to other users. Such online marketplaces generate revenue by facilitating the exchange of goods and services and through the direct or indirect monetisation of users’ engagement with the platform.

The UK government acknowledges that there will be difficulties in determining whether and to what extent certain business activities fall within the scope of the DST. The UK government also recognises that where groups undertake multiple business activities, revenues will need to be attributed between in and out of scope business activities. These issues are discussed in more detail in the consultation document.

Specifically excluded activities

As proposed, the DST is only intended to apply to specific business activities which derive significant value from user participation. It is not intended to apply to the following:

• the provision of financial or payment services;

• the sale of own goods online (either through the seller’s own website or through a marketplace);

• the provision of online content (e.g. TV or music subscriptions services, online newspapers etc.) where the business either owns the content or has acquired the right to distribute content; or

• the provision of radio and television broadcasting services.

User participation

As discussed in the consultation document, the DST is focussed on business models for which the participation of a user base can reasonably be considered a central value driver, often critical to the success or failure of the business. User participation in the business models summarised above plays a role beyond merely creating demand for a product: users of such business models contribute to the business offering and help to develop and improve that offering through their participation.

The UK government intends to define a user broadly, to include an individual, a company or any other legal person that participates in an in-scope business activity. Critically, for the purposes of the DST, a user must be a UK user. This means that the user will be normally resident in the UK and thus primarily located in the UK when participating in the relevant business activity.

The consultation document acknowledges that there could be challenging cases where it may be more difficult to determine a user’s location. By way of example, reference is made to cases involving users who are mobile across borders, e.g. a user who travels for work while participating in a social media platform. Cases such as these are acknowledged to potentially require further consideration.

De minimis thresholds

To become taxable under the DST, a business would need to meet the following conditions:

1. generate more than £500 million per annum in global revenues from in-scope business activities; and

2. generate more than £25 million per annum in revenues from in-scope business activities linked to the participation of UK users.

Businesses that meet these thresholds would not have to pay tax on the first £25 million of their UK revenues. The thresholds and allowance will apply on a group-wide basis, not on a per business activity or per company basis. It is worth noting that the DST is not intended to be limited to activities undertaken by corporates and will therefore apply to both incorporated and unincorporated businesses.

Low profit margin businesses

To ensure that the DST is levied proportionately, the government has proposed safe harbour provisions for businesses which are either loss-making or have very low profit margins. Such businesses will be able to elect to make an alternative calculation of their DST liability according to a UK and business activity-specific profit margin formula which is intended to produce a reduced (or zero rate) DST charge.

UK corporatation tax deductibility

The consultation document anticipates that the DST will be an allowable expense where the revenues subject to the DST are realised in a UK-resident company (subject to UK corporation tax) whose trade is that of an in-scope business activity. However, whether an allowable expense is achieved will depend on the facts and circumstances of each taxpayer, in particular the nature of the activities carried on in the UK. A non-resident company (outside the scope of UK corporation tax) cannot get a tax deduction for the DST expense recognised in their accounts, even if a UK-resident group company pays the DST on its behalf (as the DST would have been incurred for the purposes of another group member’s trade).

Interaction with international obligations

The UK government is confident that the proposed DST is consistent with the UK’s international obligations and is compatible with double tax treaty principles on the basis that the DST is not discriminatory and does not fall within the definition of an income tax for tax treaty purposes. It does not therefore anticipate that any successful treaty challenges or overrides could be applied to the DST.

Review clause and global reform

The UK government maintains that the long-term solution to the challenge of taxing the digital economy is global reform. It therefore intends for the DST to be a temporary tax, to be replaced by a global solution, once international consensus has been reached. The UK government has also suggested (assuming that the DST is introduced as planned in 2020) that a review clause should be included in the implementing legislation to assess the application of the DST in 2025.

Reporting, payment and compliance

There are a number of sections in the consultation document which set out in detail the reporting and payment obligations under the proposed DST. Key points to note are as follows:

• The reporting and compliance framework for the DST will be aligned with the existing UK corporation tax framework (i.e. the DST will be reported annually).

• Businesses will make DST payments quarterly.

• Businesses will be able to nominate a single company in their group to act on their behalf in respect of their DST liabilities and obligations.

• All entities in a group will be jointly and severally liable for payment of a group member’s DST liability.

What next?

The UK government’s consultation on the proposed DST presents an opportunity for taxpayers and other interested parties to provide comments and feedback on the proposed DST and potentially shape its development or change is scope. The consultation will remain open until 28 February 2019 and business potentially affected by the DST are strongly encouraged to engage in the consultation process and seek to address challenging issues at this developmental stage.

The consultation document can be access through this link here.

Eversheds Sutherland frequently engages in legislative consultation process, both on our own account and together with clients. If you would like to discuss any aspect of the DST proposals or the consultation process, please contact Ben Jones.

For more information contact

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