The UK's Digital Services Tax (DST) has been in force since 1 April this year, giving rise to potentially significant consequences for US and UK trade relations. But it has also recently been the subject of, at times misinformed, political debate around how the tax is funded. This article provides an overview of DST and aims to de-mystify the debate around digital tax.
Digital tax and the OECD
DST was born out of the UK government's frustration with its inability to tax multinational enterprises in the digital economy and make them pay their "fair share" of tax.
DST was first announced in the in the Autumn Budget 2018 as an interim response pending a global solution sought through the Organisation for Economic Co-operation and Development's (OECD) Task Force on the Digital Economy (TFDE), which was formed as a result of its Base Erosion and Profit Shifting (BEPS) Action Plan. One of its aims is find a solution for taxing the digital economy.
The BEPs and TFDE initiative – groundbreaking as it has been in many ways – has produced reports and a lot of good thinking but, as yet, limited solutions in this area. As we reported in our recent Insight, the latest report on Pillar One (taxing multinationals in countries where they have a "nexus" but no physical presence) and Pillar Two (a global minimum tax) shows progress on some issues.
But the practical difficulty is the determined opposition from the US, which has threatened retaliatory tariffs if individual countries introduce their own digital taxes. Irrespective of who wins the presidential election in November, this position is unlikely to change.
The EU has tried to bring in a Europe-wide measure but the proposed directives did not get the required approval by Member States – and the EU accepted it was better to give the OECD the chance to progress this (albeit the EU has been making noises recently about bringing forward its own proposals notwithstanding US objections).
The current state of play is that a number of countries, such as France and Italy, have joined the UK in introducing unilateral measures, although to varying degrees actual implementation has stalled, whether due to pressure of retaliatory action by the US or in hope of an OECD solution.
The UK DST applies to businesses with more than £500m in global group digital services revenues, and £25m in UK digital services revenues. Digital services revenues includes the provision of:
- a social media service;
- an internet search engine; or
- an online marketplace.
Tech platforms such as Amazon are caught because they provide an "online marketplace", which is defined as an online service that facilitates the sale of goods and services by matching third-party users. Crucially, where the platform is itself the seller, those revenues are not caught.
If a business is caught by DST then the "digital services revenues" arising in connection with any digital services activity attributable to UK users is subject to DST at 2%, although "safe harbour" rules may apply for low margin businesses. For online marketplace activities this will include commission fees, subscription fees, delivery fees, fees to access on the platform and advertising fees.
What's happening now?
The criticism at the time DST was being enacted was that the tax, as designed by the UK, was defective as it would prejudice third-party traders using the platforms. Furthermore, it argued that a solution should be found by the OECD.
Now that DST is in force in the UK, it has been reported that some platforms are looking to pass on the DST through increased fees to third-party traders in the UK.
Why is that a problem?
The fee increase has attracted significant criticism. For example, Lord Leigh, in the House of Lords, said of Amazon: “This seems to me to be absolutely outrageous. It is clear that the UK government is not taxing Amazon properly and is allowing it to avoid tax on its own sales through the marketplace. This puts regular retailers at a significant disadvantage. The digital sales tax does not achieve its objective of yielding more revenue from the likes of Amazon, as it has simply passed on to its suppliers in the marketplace, which have to absorb this tax in their margin."
There are in fact two criticisms being made here:
- the UK government is allowing platforms to avoid tax on their own sales through their marketplace; and
- certain platforms have passed on the DST in the form of increased fees.
On a platform's own sales, this outcome necessarily follows from the design of DST, which has been apparent from the earliest proposals. The proper taxing of goods and (to a lesser extent) services sold by non-resident tech companies and delivered to UK customers is completely different to the taxation of the intermediary services providing a marketplace. The marketplace activities that are being taxed under DST involve significantly less infrastructure and rely more heavily on the intangible benefit of the local market than pure retail activities.
The design of the DST contrasts with the more generic OECD approach and was a clear policy decision. In any event, the alternative solution would be impractical for the UK to achieve unilaterally, in particular, because of its network of double tax treaties.
Passing on fees
As to passing on the fees to the third-party traders, it is not correct to say that DST fails to bring in additional revenue. Plainly, platforms will be paying HMRC.
The real objection is where they pass on the cost of the tax to their customers. But looking to pass on tax rises is nothing new. DST is a turnover tax and, in the world of VAT, it is not unusual for businesses to pass on rate increases to customers where they are able to do so without impacting sales. Granted the VAT regime offers the opportunity to recover VAT, but it appears naïve to be surprised that DST is passed on where the business is able to do so.
The longer-term solution
DST was always designed as a stop gap by the UK government, which has been keen to be seen to be addressing perhaps populist campaigns against US multinationals not paying their "fair share" of tax. DST suffers from many defects: it is not going to collect much tax, it will only (currently) catch a small number of UK companies, and it is so objectionable to the US that it threatens the much needed US-UK trade deal.
The arguments that are now being raised illustrate the defects in the detailed drafting of the DST rather than anything significant about the multinationals. It is perhaps ironic that US-based tech companies have been calling for resolution at the OECD level when the US is one of the main obstacles to reform.
However, only coordinated international reform will truly resolve the tax issues thrown up by the digital economy.