Out-Law / Your Daily Need-To-Know

The UK is considering whether an online sales tax (OST) should be introduced to “rebalance” the taxation of the retail sector.

The government has published a consultation document (49-page / 492KB PDF) asking for views on the implications and possible design of such a tax.

The consultation follows a 2021 review of the business rates system, which concluded that the system should be retained on the basis that there is no alternative with widespread support that would raise sufficient revenue to replace business rates. However, there are still concerns among retailers with physical retail premises that they face an unfair tax burden because they are typically subject to a higher level of business rates than their online competitors, who tend to have a business model that involves lower commercial rents and correspondingly lower rates burdens.

The OST could be used to fund reductions to business rates for ‘bricks and mortar’ retailers, according to the consultation. The government said it would not be intended to actively encourage customers to shop in-store rather than online.

Corporate tax expert Eloise Walker of Pinsent Masons said: “It is disappointing that the business rates review reached such a conclusion, but more disappointing that HM Treasury is thinking that imposing new taxes instead of fixing the problems with old taxes is the way forward”.

“Even assuming that the OST would actually result in a business rate reduction instead of a hike in taxes overall, making other taxpayers worse off in the interests of parity is an odd way to go about alleviating burdens,” she said.

Walker Eloise

Eloise Walker

Partner, Head of Corporate Tax

Although an online sales tax seems like a good idea on the surface, once you start looking at the challenges of introducing the tax in practice, it is far from a silver bullet to reduce the decline of the high street

The design of an OST would not be straightforward, and the consultation document sets out many areas of difficulty.

“Although an OST seems, on the surface, like a good idea to level the playing field caused by the burden of business rates on in-store retailers, once you start looking at the challenges of introducing the tax in practice, it is far from a silver bullet to reduce the decline of the high street,” Walker said.

One of the main challenges in designing an OST would be distinguishing between online and offline activity. An example given is whether the tax should apply to transactions conducted over the internet in any form: including, for example, in-store purchases made via an app or transactions carried out via any remote technology including telephone and mail order.

Another issue highlighted in the consultation document is whether ‘click and collect’ purchases should be covered by an OST. Some advocates of an OST have called for these sales to be exempted on the grounds that where the collection point is a physical shop, they continue to generate footfall in physical shops. However, a click and collect location could be a locker in a transport hub. An exemption for all click and collect orders could lead to delivery to a residential address being treated differently to collection from a locker on a street corner, even though these are similar transactions.

“Although business rates undoubtedly cause distortions between online and physical retailers, the problem is that they raise a huge amount of revenue, which would be difficult to source from elsewhere,” said Clara Boyd, an indirect tax expert at Pinsent Masons.

Business rates raise over £25 billion a year in England, according to the consultation document. Raising comparable amounts under the VAT system would require around a 3-4p increase to the standard rate. Around a 5p increase to the basic rate of income tax would be required to raise a similar amount.

An OST levied at 1% or 2% would not raise sufficient revenue to replace in full the estimated £7.5bn business rates levied on retailers, according to government estimates. 

Some also suggest that as business rates are often capitalised into rents, the benefits of a cut to retail business rates would flow in large part to the owner of the property, not the retailer, resulting in higher rents being paid, according to the consultation document.

OST would probably be payable by vendors. However, the government considers that it would be likely that it would be passed onto consumers. It wants to gather further evidence on the risk that specific groups could be disproportionality affected by an OST. Affected groups might include those that spend a greater proportion of their income on discretionary goods and services, those who live further from a high street or shopping centre and individuals with reduced mobility.

Proponents of an OST have largely called for a broad-based tax on all goods on the basis that business rates are paid by businesses regardless of the goods being sold including food, medicines and VAT zero-rated goods.

If the tax applies to tangible goods, the position of digital products with tangible equivalents such as books and newspapers would need to be considered. Restricting the tax to tangible products would mean that physical books purchased online might be taxed, while ebooks would not be.

Another important design consideration is whether the scope of the tax should apply to online business-to-business (B2B) transactions as well as to business-to-consumer (B2C) transactions. If the tax applies to B2B transactions, multiple layers of taxation could be created in business distribution and supply chains. These costs are likely to be passed on to the consumer, significantly increasing the price of goods, the document says.

Sales made to businesses which then re-sell those items could be excluded from an OST, but this could bring considerable administrative burdens. Similarly, if an OST only applied to sales to individuals as consumers, online sellers would need to be able to identify which of their sales were to consumers.

The consultation document draws a distinction between the proposal for an OST and the digital services tax (DST). DST is a temporary tax on revenues from certain digital services including social media, search engines and online marketplaces. In contrast the OST, if introduced, would be a permanent mechanism for funding business rate reductions for retailers.

DST is a temporary solution to the challenges posed by digitalisation to the international system for taxing the profits of multinationals and will be removed once a solution from ‘pillar one’ of the OECD agreement reached in 2021 is in place. Under pillar one multinational enterprises with global turnover above €20bn will be subject to tax on a proportion of their profits in the countries where they operate.

The OST could be levied as a percentage of revenues generated from online sales or at a flat rate on each sale, applying to both overseas and UK based sellers making sales to UK customers. The government considers that a revenue-based approach is likely to be less regressive than a flat-fee approach. No rate is suggested for the tax, although the document quotes examples of the revenue raised by a 1-2% tax.

The document suggests that a revenue threshold of £1 or 2 million of taxable sales could be set so as not to create additional administrative burdens on small businesses and overseas sellers with low levels of UK sales.

“If an OST is introduced, it could have significant implications for many businesses. Those who may be affected are encouraged to respond to the consultation so that the government hears as many views as possible on the practical implications of an OST,” Walker said.

The consultation closes on 20 May 2022.