Physical presence used to be a salient part of international business, as any company looking to expand abroad must have had some factory, retail store, or office in that country to operate. However, since the increase of digital technologies, physical presence and the company’s place of domicile, at least by its literal definition, no longer holds such significance. Since, one could control the entirety of their global operations without ever stepping foot in that country. The digital revolution has also introduced new forms of trading involving the transaction of intangible goods through digital platforms. This arrangement may only become more prevalent in the future, with the global digital economy growing to a staggering US$11.5 trillion dollars in 2018.
Despite this paradigm shift, however, corporate taxation has remained archaic as many governments still tax companies based on their physical presence and tangible goods rather than their digital footprint. Clearly, this framework is very problematic in the new age of business, and in light of this, the OECD, alongside other organisations, have pushed for a multilateral tax reform for the very purpose of targeting the digital economy. However, years of stagnant talks have left many countries with little choice but to impose their own Digital Services Tax (DST), most of whom are within the European Union (France, Poland, Spain and the recently departed United Kingdom). What are the conditions of the UK’s Digital Services Tax, and is it really effective in solving the loopholes that Big Tech had used previously to reduce tax liability?
General Description of the Measure
In the UK, the Digital Services Tax was first announced in the 2018 Budget Report, which was then followed with a consultation and a Draft Legislation in the following year. The new measure which is currently in effect (which started in 1 April 2020) levies a “...2% tax on the revenues of search engines, social media services and online marketplaces which derive value from UK users.” For the purposes of the DST, an individual would be considered to be a UK user if they are normally located or established in the UK. Since the measure is directed at Big Tech companies rather than small and medium-sized enterprises (SMEs), companies would only be subject to the tax if the Group’s global revenues from digital activities exceed £500 million with more than £25 million derived from UK users.
This £500 million pounds is calculated at the group level, but the tax itself is actually charged on the individual entities which generate the revenue. Additionally, the companies’ revenues would still be counted to the “thresholds even if they are recognised in entities which do not have a UK taxable presence for corporation tax purposes”. A rather clever move by the legislatures, as this prevents any reduction of tax liability through corporate restructuring.
Allowances and Exceptions to DST
The 2% DST would not apply to the first £25 million pounds of revenue generated from UK users. Additionally, if an online marketplace transaction involves more than one user, and that other user is located in a country with a comparable DST, the tax revenue charged on that particular transaction would be reduced by 50%. Furthermore, and quite importantly, the DST would not be included in the UK's double tax treaties (agreements with other countries to avoid double taxation) as it can be deductible (but not creditable) from corporate tax. Also, financial service providers are excluded from the definition of an “online-marketplace”.
Search Engines, Social Media Services, Online Marketplaces
The Big Tech companies of Google, Facebook and Amazon would be subject to the DST as i) their global revenues exceed the £500 million pound threshold ii) more than £25 million is derived from UK users and iii) they clearly generate revenues through one of the three business activities as defined: search engines, social media services & online marketplaces.
However, would the tax apply for other companies which fall within the grey area in respect to their business activities? According to the legislation, the revenue generated from these activities would only be subject to the tax if they are substantive to the principal function of the business. Following this principle, an online newspaper which has social media features (a comment section) would not fall within the scope of the measure since that activity is not substantive to the principal function of journalism. On the contrary, any activity which is incidental or ancillary to an in-scope activity could be taxed; i.e product listing fees are ancillary to the in-scope activity of an online marketplace, so it would be taxed.
Implications
Previously, the overdependence on a company’s physical presence created many loopholes within the system. It enabled corporations to reduce their tax liabilities through corporate restructuring and offshore incorporation. However, with the current shakeup,, these shrewd tactics should theoretically be made obsolete. After all, under the new law, if a certain revenue is derived from a UK user, no matter how the corporation is structured and where the company shifts its revenue to, it does not change the fact that the revenue was indeed generated from a UK user, and therefore is subject to the DST. This should then also correct the misalignment between where profits are taxed and the place where value is created.
Unfortunately, these assumptions are far from the truth as many companies are simply shifting the tax burden onto the customer and their suppliers, with a complete lack of indiscretion. Apple has already announced last month that they would be charging UK customers an additional 2% VAT on the existing 20% for all App Store purchases, stating that it was “...specifically designed to offset a new digital services tax introduced by [the] UK government.” As expected, Amazon is coping with the DST in a similar fashion, but instead displacing the cost onto their sellers by increasing their fees by 2%. Google along with other Big Tech companies are looking to do the same with its advertisers. If this continues, it seems likely that the £275m that the government expects to raise from this tax would be coming out of the pockets of their own citizens.
The Future and Beyond
While this new legislation was not the earth shattering solution that we had hoped for, it seems to be a step in the right direction in the ever-increasing scrutiny of tech firms and the digital economy. We should not be too harsh, as any law, particularly those which attempt to shake up century long dispositions, would require constant refinement, sustained patience and, above all, unwavering faith. Although much remains uncertain as to the form and substance of this digital services tax in the future, what is certain is that it is here to stay.
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