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UK's new digital services tax will be 'compliance nightmare'

Out-Law News | 07 Nov 2018 | 2:36 pm | 6 min. read

The UK's new digital services tax (DST) will be a "compliance nightmare", according to Eloise Walker , a corporate tax expert at Pinsent Masons, the law firm behind Out-Law.com.

She was commenting following the publication of a consultation document on the design of the new tax, which is intended to apply from April 2020.

The 2% tax on the UK revenues of providers of social media platforms, search engines and online marketplaces was announced in last week's budget.

"There is nothing unusual in imposing bespoke taxes for certain business sectors - but the nature of the DST is hugely contentious as it is a 'profits' tax levied not on profits but turnover. It is a gamble by the UK to introduce it to try to 'force' the international community to rewrite the current rules. The world could probably do with more consensus based politics right now," said Jason Collins, another tax expert at Pinsent Masons.

DST is designed to ensure digital businesses pay tax in the UK reflecting the value they derive from the participation of UK users. Whilst the consultation document discusses the fact that a range of digital business models involve some form of user participation, it confirms that DST will only apply to social media platforms, search engines and online marketplaces. The government considers that in these businesses participation of a user base is "a central value driver, critical to the success or failure of the business".

The legislation will operate by defining the business activities in scope of DST. Businesses will be required to assess which activities they perform are within the scope of DST and to identify revenues generated from those activities. These revenues will be subject to DST when they are linked to the participation of a UK user.

"The government clearly has certain international companies in mind but the devil will be in ensuring the definition catches the activities of those companies alone," Jason Collins said.

The consultation document gives examples of the types of social media platforms which the government thinks should be covered. These include social or online networks focusing on building social or professional communities based on shared interests, objectives or existing personal relationships. Also caught will be blogging or discussion platforms which focus on allowing users to publish information which is shared publicly with other users of the platform.

Platforms which focus on allowing users to share media content such as photos or videos and dating platforms will be caught. Platforms which focus on aggregating reviews by users will also be caught if they form the basis of the platform service of rating or assessing a given good or service.

"The definition of activities relating to provision of a search engine and an online market place are relatively narrow and much as expected. However, the definition of a social media platform is significantly wider and can extend to anything from typical social/online networks to blogging, discussion and review platforms," Walker said.

Online marketplaces will not be subject to DST on the revenues from selling their own goods online. The consultation document explains that DST will catch businesses that facilitate the formal exchange of goods, services or digital content between third-parties on a platform, such as businesses that take a commission from matching third-party buyers and sellers of physical goods. It would also catch businesses that provide a platform for third-parties to list products and services, and communicate with prospective buyers, even if subsequent transactions are concluded away from the marketplace.

The document makes it clear that DST will not catch revenues generated from the direct sale of online content such as TV or music subscription services or online newspapers, where the business either owns the content or has acquired the right to distribute content. The provision of radio and television broadcasting services should not be in scope of the DST.

The document states that DST is not intended to be a generalised tax on the collection of data or online advertising. It makes it clear that revenues that a supermarket generates from collecting information on customers via a loyalty card scheme, or revenues an industrial goods manufacturer generates from collecting data from sensors, will not be in scope of the new tax.

Where a business has activities which are caught by DST integrated with out-of-scope activities, it is proposed that businesses be required to apportion between in and out-of-scope business activities on a just and reasonable basis.

"It is unclear exactly how businesses will be expected to isolate in-scope activities where they undertake a variety of business activities. For HMRC to acknowledge that this may not always be 'straightforward' indicates the extent of the tax compliance nightmare that they are about to unleash on business," Eloise Walker said.

Only revenues linked to a UK user will be caught. For social media platforms, revenue from advertising that is targeted at UK users or involves a UK user action such as a click will be caught. If there is a subscription, payments from UK users will be caught.

For search engines UK revenue will be considered revenue from advertising that is targeted at UK users or involves a click by a UK user.

For online marketplaces, DST will catch commission fees, consideration shares or delivery fees that result from a transaction involving a UK user. If the marketplace also generates revenue through advertising, UK revenues will be revenues from advertising that is targeted at UK users or situations where a UK user has performed an action that gave rise to advertising revenue.

"The proposed approach to defining revenue from UK users is incredibly wide - unsurprisingly it will cover revenue generated from advertising that is targeted at UK users, but it will also cover revenue from in-scope activities involving a UK user action, which can be as small as a click," said Walker.

"Quantifying revenues attributable to UK users in this way is likely to be very complicated - as crazy as it seems it is now not unimaginable that from April 2020 a business will be taxed on revenues from business activities because someone in the UK has 'clicked' on a page for 10 seconds before exiting," Walker said.

The document gives some indication as to how UK users will be identified. A user will be considered to be a UK user if they are normally resident in the UK and thus primarily located in the UK when participating with the relevant business activity. Businesses will however be able to take different approaches to identifying user location, based on their activities and the way in which they generate revenue.

For difficult cases, such as where the intended destination of advertising is unclear or the user is internationally mobile, businesses will be expected to make a just and reasonable apportionment, having regard to the facts.

"The compliance nightmare that is likely to be DST is expected to be felt hardest where a business doesn’t already separate its activities into separate product lines, or where a single product line services multiple business activities including in-scope activities. The government is recommending businesses adopt a 'just and reasonable approach', which should be a clear warning that lengthy disputes with HMRC are on the cards," said Eloise Walker.

Revenue from cross border transactions where the user and the businesses are located in different countries will be caught by DST if one of the parties is in the UK - either the user or the business providing the service.

The government recognises in the consultation document that other countries may introduce a similar tax and that this could lead to double taxation. In those circumstances, the document says that the government would intend to negotiate an appropriate division of taxing rights with other countries which are also implementing a DST.

A business will only become taxable to DST if it generates more than £500 million in global annual revenues from in-scope business activities and generates more than £25m in annual revenues from in-scope business activities linked to the participation of UK users. Businesses will not have to pay tax on their first £25m of UK taxable revenues.

"Businesses which may have a relatively small proportion of revenue being generated from in-scope activities could have to devout substantial financial resources to confirm whether they have to apply the tax at all, or fall below the £25m UK revenue threshold," said Walker. "Although £25m may sounds like a high threshold, it may not be difficult to breach given that the DST will also apply to third party revenues that are generated from in scope business activities, such as revenue generated from a social media platform from online advertising, commission and subscription fees, and it will be irrelevant whether these revenues are generated in the UK or not."

The tax will include a 'safe harbour’ which will allow businesses to elect to make an alternative calculation of their DST liability which is designed to help those with very low profit margins.

The tax will be deductible against UK corporation tax, but it will not be creditable for double tax relief purposes.

The government confirmed in the document that it will continue to monitor progress in international discussions and will disapply DST "if an appropriate global solution is successfully agreed and implemented".

"For an apparently 'temporary tax' the government seems to be happy to impose a heavy compliance burden on businesses that are already struggling in the post GDPR era," Walker said.

The consultation closes on 28 February 2019.