Although the UK government has always said that an international agreement would be the best solution to ensure that digital platform businesses that generate substantial value in the UK pay their fair share of tax, the UK announced in last year's Budget that it would introduce its own interim measure, a digital services tax (DST) from April 2020.
HMRC published a consultation document on the design and implementation of the DST which closed in February 2019 and on 11 July 2019 it published a response to the consultation, draft legislation for inclusion in the Finance Bill 2019/20 and draft guidance on the DST.
What form will the DST take?
The DST is to be a targeted tax at 2% on VAT-exclusive revenues of certain digital businesses which the government considers derive significant value from UK users. The draft guidance confirms that the tax is deductible for UK corporation tax purposes (if it is so deductible on general principles) but there is no credit relief against corporation tax or any other taxes.
The residence of the taxpayer or whether it has a permanent establishment in the UK are irrelevant in applying the tax.
Which businesses are in-scope for the DST?
In-scope businesses for the DST are those which the government considers derive significant value from users, being specifically businesses which provide: social media platforms; internet search engines; and online marketplaces.
The provisions are only aimed at large businesses (incorporated or unincorporated), being those which generate:
- more than £500m in global annual revenues from in-scope business activities; and
- more than £25m in annual revenues from in-scope business activities linked to the participation of UK users. There is an annual allowance on the first £25m of revenues from in-scope activities linked to UK user participation.
Consequently, where the businesses' revenues exceed these two thresholds, its revenues derived from UK users will be subject to the DST (we discuss below what revenues will be in scope).
For all three types of in-scope businesses (social media platforms, internet search engines and online marketplaces), in-scope business activities includes carrying on any associated online advertising business.
What is a social media platform?
A social media platform is defined in the draft legislation as an online platform where:
- the main purpose, or one of the main purposes, of the platform is to promote interaction between users or between users and content supplied by other users; and
- the platform enables content to be shared.
Examples of such platforms include: social/online networks; blogging/discussion platforms; content-sharing platforms; review platforms; and dating platforms. It is not anticipated that websites which merely provide comment functionality would be in scope as social media platforms. Nor are private messaging apps covered, unless, for example, they are incidental to and part of the functionality of a wider social media business.
What is an internet search engine?
An internet search engine is not defined in the draft legislation. The draft guidance suggests that a search engine business will in principle search the whole of the internet, highlighting that internal search engines (websites that provide a search function limited to the material solely on that website, rather than providing links to third party websites), will not be in-scope.
What is an online marketplace?
An online marketplace is defined in the draft legislation as an online platform where:
- the main purpose, or one of the main purposes, of the platform is to facilitate the sale or hire by users of particular services, goods or property; and
- the platform enables users to sell or hire such things on the platform to other users or to advertise or otherwise offer to other users particular services, goods or property for sale or hire.
The measure is intended to only capture cases where the platform's business is to act as an intermediary (whether an active or passive one) and match users. A website that just advertises without facilitating sales is not covered. It is also irrelevant whether transactions are concluded on the marketplace platform itself or whether the platform simply allows users to list products and the transaction is subsequently concluded outside the platform.
Key indicators of whether there is an online marketplace include: whether third parties offer to sell on the platform; whether the platform has legal ownership for goods sold; and whether the business accounts as agent or principal.
Activities that are out of scope include financial marketplaces and the sale of own goods or services online.
What revenues are in-scope for DST?
Revenues in-scope for DST are third party revenues generated from in-scope activities. Revenues are taxable under the DST if attributable to an in-scope business activity (a DST activity) and linked to UK user participation.
A user is not defined in the draft legislation but includes anyone using the platform or DST activity and so includes both individuals and legal persons.
Revenues attributable to a DST activity include revenues from:
- Social media platform: displaying advertising to users; subscription or other access fees; charging users for content access; sale/licensing of user data; other direct fees from users;
- Internet search engines: promoting or facilitating search advertising on results; search advertising shown on third party websites; other search advertising revenues; and licensing/sale of data;
- Online marketplaces: commission fees; delivery fees; fees to access or otherwise buy/sell; advertising - for example by preferential listings, display advertising, general advertising, or subscription fees.
The general rule is that UK digital revenues are those that arise by virtue of the use of a DST activity by a UK user. These include revenues arising from UK user payments (such as subscription fees) but goes further than this and groups need to attribute revenues from DST activities between UK users and other users on a just and reasonable basis.
For advertising revenues, this involves revenues from advertising intended to be viewed by UK users. Where the user engages with the advertising (for example, by clicking through) this will be clear, but otherwise businesses will need to assess whether the advertising is intended to be viewed by UK users. Where revenues arise from both UK and non-UK users, these will need to be apportioned on a just and reasonable basis.
There will be a requirement for groups to isolate in-scope business activities. This may be difficult where such activities do not correspond to a segregated business activity.
A UK user is a user who is either an individual normally located in the UK or, for businesses, established in the UK. It is not normally required to look though entities to underlying individual customers. However, similarly to the position for VAT on electronically supplied services, HMRC will allow different approaches to determine user location depending on the nature of the business. This could include: IP address; payment details; delivery address and other customer information. The business should consider whether a reasonably informed observer would be likely to conclude that it is probable that the user is a UK user. This will be particularly relevant where businesses collect more than one source of user information which provides conflicting evidence regarding user location.
There may be situations involving online marketplaces where there is both a UK user and a non-UK user. Revenues would still be in-scope but the revenue charged will be reduced to 50% of the revenues from cross-border transactions with jurisdictions operating a similar tax to the DST.
Will there be a safe harbour?
As the tax is on revenues, it will create significant issues for low margin businesses. Therefore, the draft legislation includes an alternative charge provision or "safe harbour" which must be made against a specific category of revenue (of social media, internet search engine and online marketplace). The draft guidance confirms, therefore, that if a business has two in-scope business activities (for example an internet search engine and an online marketplace), it can choose to apply the alternative basis of charge to one, both or neither of these activities. If it does this, it must segregate the respective DST activities and apportion the £25m annual allowance between these activities.
Under the safe harbour, the DST tax rate will be based on the DST UK operating margin of the group's relevant business activities in the period. When the DST UK operating margin is nil or negative for a given activity the rate, and DST liability, will be nil for that activity.
What happens next?
Consultation on the draft legislation and guidance will run until 5 September 2019 and HMRC will publish updated guidance later in 2019, reflecting comments received and the legislation at the time of publishing in the Finance Bill.
The DST will be an interim measure which will be disapplied when an international solution is found and the government has committed to review the DST in 2025 in any event.
Osborne Clarke Comment
The design and implementation of the proposed DST has been consulted on widely and the draft legislation and draft guidance published on 11 July provides some welcome clarification of which digital business activities are in-scope. However, the scope is very wide and may affect groups that did not think they would be in scope of the new tax. As the DST applies to revenues linked to "UK users" the residence of the group or whether it has a presence in the UK is irrelevant.
There is a difficult compliance burden for groups in-scope in terms of identifying UK users and there may be significant costs in terms of updating systems to catch the necessary information. As the tax may have a limited shelf life pending a global solution, there are likely to be further costs down the line.
There are also other difficult questions for groups to grapple with if they have different streams of business activities – some of which may be in-scope of the DST and other which are not.
Only time will tell whether the DST will work in practice but with so much political pressure to address the concerns over the taxation of the digital economy, it is likely that many more countries will introduce unilateral measures if no global solution is found soon.
To read the European perspective on the taxation of digital multinational enterprises and to see which other European countries are considering, or implementing, a DST, click here.