US finds UK's digital tax discriminates against US digital companies

Out-Law News | 20 Jan 2021 | 9:42 am |

The UK's digital services tax (DST) discriminates against US digital companies, is inconsistent with the principles of international tax and burdens or restricts US commerce, the US Trade Representative's Office (USTRO) has said.

The UK's DST applies from 1 April 2020 and is charged at 2% on the UK-derived revenue of social media platforms, search engines and online marketplaces.

In June 2020, US trade representative Robert Lighthizer announced that his office was investigating digital services taxes adopted or under consideration by the UK, Spain, Italy and the EU as well as a number of other countries, with a view to deciding whether the US should take retaliatory action. The report containing the results of that investigation into the UK DST has now been published.

The report refers to statements made by three Labour party politicians mentioning taxing specific US companies such as Facebook, Google and Amazon and a statement from prime minister Boris Johnson on taxing "big digital companies" as evidence of "an intention to target US companies with special, unfavourable tax treatment".

According to the report, US companies are unfairly targeted because DST targets three categories of services where US companies are market leaders: internet search engines, social media services and online marketplaces, but does not cover digital services where UK or European firms are successful such as music streaming or online banking platforms.

The USTRO said that it has not identified any UK search engine or social media platform that would be caught by DST. It said that if the tax is applied so as to exclude 'marketplace delivery fees', it would result in the exclusion of companies such as Just Eat or Deliveroo, which the report says are "the few – if any – UK companies that might otherwise be subject to the UK DST".

"The USTR findings appear to be a little, shall we say, 'selective' in their data sets," said Eloise Walker tax expert at Pinsent Masons, the law firm behind Out-Law. "There are certainly UK head-quartered companies that are having to wrestle with the UK's DST, and the net is not woven to just catch US global giants – those giants just happen to be the biggest fish in the sea."

DST is payable by businesses whose global revenue from in-scope business activities is greater than £500 million and where more than £25m of that revenue is derived from UK users. The report points to these thresholds as further evidence that the tax was designed to target US companies because start-ups, which are more likely to be UK companies, are excluded.

In its report, the USTRO argued that DST is "unreasonable" because it is inconsistent with international tax principles because it taxes revenue rather than profit, it taxes income which is unconnected to a permanent establishment and it does not avoid double taxation. The report also pointed out that DST applies from 1 April 2020, but the Finance Act which brought it into force was passed a few months later. This is inconsistent with the principle of tax certainty and is unreasonable, the report has claimed.   

The USTRO said the tax is a "burden" because it is a tax on gross revenue and not profits. It quotes a report which said that a 2% revenue tax applied to a business with a 4.6% profit margin would result in a 43.5% effective tax rate, significantly more that the 19% corporation tax paid by UK companies.

In addition, high compliance and administrative costs for DST burdens leading US digital companies in comparison to UK competitors that are not subject to the DST, the report said.

According to the report, the fact that DST will be deductible as a normal business expense for corporation tax purposes but is not creditable against UK corporation tax increases the tax burden on US companies, while limiting or eliminating the same tax burden on UK companies.

The report also challenged the assertion that DST is an interim measure or a temporary tax by pointing out that DST neither contains an end date for collection of the tax nor does it provide for a sunset clause.

"HMRC have repeatedly said that they will review DST in due course," said Pinsent Masons' Walker. "However, they are naturally, if unfortunately, waiting to see where the OECD gets to first. If the US truly want the UK's DST and other unilateral measures gone, they can best achieve this quickly by engaging with the OECD on the issue, instead of demanding safe harbours and throwing up road blocks that pull the guts out of progressing an international agreement on the issue."

The Organisation for Economic Cooperation and Development (OECD) was asked by the G20 to come up with proposals for addressing the tax challenges of the digitalisation of the economy. It had hoped to come up with agreed proposals by the end of last year. In October 2020 it published detailed proposals for reform of the international tax system to deal with the digitisation of the economy, but announced that international agreement was not expected until the middle of 2021. 

The US government is opposed to some aspects of the OECD's proposals, which will have the effect of shifting some of the tax revenues of some of the biggest technology companies which are headquartered in the US, to market jurisdictions, particularly in Europe.

The USTRO report said that "unilateral measures, such as the UK’s DST, undermine progress in the OECD and undermine development of a multilateral approach to digital taxation".

The US has also found that Austria and Spain's DSTs are inconsistent with prevailing principles of international taxation, and burden or restricts US commerce.

US law provides that if the USTR determines that an act, policy, or practice of a foreign country is unreasonable or discriminatory and burdens or restricts US commerce, the USTR determines what retaliatory action, if any, to take. No retaliatory action has so far been announced against the UK, Austria or Spain.

In 2019 the US investigated France's introduction of a digital services tax and threatened to impose 100% tariffs on champagne and a number of French luxury goods. France agreed to suspend collection of its digital tax, in return for the US not increasing tariffs and continuing to engage with the OECD, but has since begun collecting its tax. 

"It remains to be seen what the US will do next," Walker said. "Trade wars are easier to threaten than they are to implement, and we cannot see the UK government backing down until and unless a US/UK trade deal is struck in the wider context of post-Brexit trade relations."