Tim Power and George Barnes, of Her Majesty’s Treasury (HMT) Department recently presented to partners and MD’s from KPMG’s SVO and SF offices on its proposed digital services tax (DST).
The DST will be a direct 2% tax on the revenues derived from UK’s users’ creation of value for digital services businesses. The UK Government considers that UK users create value for digital businesses through participation and engagement, which in their view is not currently captured by the international taxing framework. To address this gap, the DST is designed to tax the UK revenue associated with social media networks, search engines, and on-line marketplaces in which there is UK user participation.
While certain businesses and activities may immediately spring to mind when considering the scope of the DST, HMT acknowledged that there will be boundary issues that both businesses and HMT will need to consider. HMT noted that businesses such as those engaged in financial or payment services are intended to be outside the scope of the DST. However, the proposed rules are widely drawn and it will be important to see what businesses are definitively excluded. HMT was also asked whether the legislation could contain an exemption list that clearly identified other business that may be out of “scope” (e.g., online gaming). HMT was not inclined to adopt this suggestion; voicing concern that this may create more ambiguity for businesses.
All told HMT expects the DST to apply to a relatively small number of business. Mr. Power stated that HMT, which does not have access to taxpayer specific information, does not have the exact number of affected companies. However, based on publicly available information, it is reasonable to expect the number to be in excess of 30 subject to the conclusion of the consultation and drafting of the legislation.
Also discussed was the challenge of identifying in-scope UK revenues. For some businesses determining their in-scope revenue may be clear. But HMT acknowledged that businesses with multiple business activities that are not segmented into product lines or with business that do not track in-scope revenue streams for management reporting purposes, may face challenges in quantifying in-scope revenues. Importantly, Mr. Power distinguished the UK approach as focusing on “users” and not “advertising”, which France and Germany proposed to the European Union. In HMT’s view, while an advertising focused tax may be easier to administer, HMT considers user participation to be a key value driver for digital businesses and that this is addressed via an appropriately targeted DST. Accordingly, the revenue stemming from in-scope activities regardless of whether ad revenue, subscription revenue, or the like, will be subject to the DST. Mr. Power noted that the legislation will have an anti-abuse clause to prevent companies from changing the character of their revenues such as an eCommerce site moving from commission-based to buy/sell model solely to avoid DST without changing to the substance of a real buy-sell model (i.e., flash title).
The proposed UK’s DST will be effective for fiscal years beginning on or after April 1, 2020, and will apply to businesses that generate greater than £500M in global revenues from in-scope activities, and derive more than £25M in revenues from in-scope business activities linked to the participation of UK users. The first £25M of the UK revenues will be exempt from the DST. The thresholds and allowance will apply on a group-wide basis, not on a per business activity or per company basis. A safe harbor for businesses with very low profit margins allows for an alternative calculation.
When asked about the DST’s compatibility with the UK’s treaty obligations, the HMT responded that due consideration had been given to that topic, with the conclusion that the DST is compliant with treaty obligations. HMT also considered whether the DST could be creditable against any UK corporate tax liability, but concluded that such a credit may be seen as discriminatory under EU law. Several participants wondered whether this concern would continue after Brexit. Mr. Power declined to speculate.
The HMT also highlighted, that as drafted, they consider that the DST does not discriminate based on a residency of the business, as it applies to all in-scope activities in the UK.
Mr. Powers and Mr. Barnes noted that the DST was intended as interim tax until a multilateral solution that was acceptable to the UK was adopted. HMT is including a review clause, which differs from sunset clauses sometimes found in US legislation, so the UK can more closely review and monitor the international discussions on this issue.
For more information, please contact Theresa Kolish at 415-963-5100.