UK proposes stop-gap measures to tax digital companies

The EU and the UK have threatened unilateral action on tax reforms for the digital economy ahead of the OECD’s 2018 interim report on the issue. Proposals so far indicate a paradigm shift towards taxing the functional areas of the digital economy.

28 November 2017

While the OECD awaits the completion of an interim report by the task force on the digital economy, European countries have begun to propose their own stop-gaps.

In a position paper published on November 22 alongside the Autumn Budget, the UK Treasury outlined short-term measures that would seek to tax digital businesses on profits derived from value created in the UK with or without a permanent establishment (PE).

The proposal to tax user-generated value does not so much affect traditional online retailers but those without a taxable physical presence of the user-base.

The conversation on what to tax, or value creation, is beginning to be dominated by larger consumer markets, such as the UK, calling for a move from taxing businesses on their location of assets and risks to where services are marketed and create value through user data. 

The only consensus so far is that the current model of taxation is no longer fit-for-purpose for a digital economy and that time is of the essence as public pressure mounts.

“The UK will work with other countries to consider how such a tax could be targeted, designed and co-ordinated to minimise business burdens and distortion. However, the government stands ready to take unilateral action in the absence of sufficient progress on multilateral solutions,” the report stated.

Nevertheless, the document repeatedly stressed the need for multilateral efforts together with the OECD.

The OECD’s Task Force on the Digital Economy is expected to present an interim report to the G20 in spring 2018 following its completion in April. 

Pascal Saint-Amans, director of the OECD’s Centre for Tax Policy and Administration, at a public consultation in San Francisco in early November warned against unilateral moves by countries, pointing to the proposed equalisation tax by several European finance ministers this summer. 

UK and US implications

Eloise Walker, partner at Pinsent Masons in London, said the position on digital taxation was probably the most radical of Budget proposals.

“Public opinion seems to be that multinationals should be paying tax here if their revenue is derived from UK customers. The Treasury must be frustrated that previous solutions like the diverted profits tax have not impacted significantly on digital businesses,” Walker told TP Week.

“The Treasury’s solution is neat for the UK in that it would impact on US tech multinationals operating in the UK, but should not affect UK businesses which are selling goods online to customers outside the UK,” she explained.

As a potential impact on cross-border taxation for businesses that fall into this category, Walker said, “The particular structures the US tech giants have adopted are designed with the US tax system in mind – to avoid repatriating to the US profits generated outside the US. UK tech start-ups will be more concerned if other countries adopt unilateral solutions which mean that they suffer double taxation.”

The paper narrows the definition of business falling within the scope of a digital tax, applying it to businesses that generate value via their user base through advertising revenue or through commissions on user-to-user transactions.

Walker said the paper suggested that the arm’s-length principle should be amended to allocate profits to user-generated value.

“The arm’s-length principle looks at the price that is paid for the services that are supplied by each group company – so if the IP is held outside the UK it looks at whether the price paid for the use of the IP is an arm’s-length price; it therefore only looks at what the group is doing in the UK through employees, premises etc. and not at how many customers are UK-based and what those customers are doing,” she said.

Tax policy adviser for Microsoft Bill Sample, speaking at a roundtable on global tax policy issues hosted by the International Tax and Investment Center in London in November, said business model evolution continued at a fast pace.

“The digital economy is a bigger income tax issue today because nobody made any money from it in the 90s,” he said. He added that the focus was no longer on taxing a remote seller but on “taxing at a higher margin”.

As non-infrastructure aspects of a functional digital economy, such as services and e-commerce activity, are growing, Sample mooted the idea that “transfer pricing changes are changing income allocation back to the functional areas”.

EU position

Earlier in November, Margrethe Vestager in a speech in Paris pointed out that domestic digital businesses pay less than half the effective tax rate of their offline equivalents.

“The results of that [EC] consultation will help us work with our partners in the OECD, to find solutions that will work all over the world. And if there’s no international answer to this issue by spring next year, we’ll produce our own proposal for new EU rules to make sure digital companies are taxed fairly,” Vestager said.

The EC department on Taxation and Customs is wrapping up a consultation on fair taxation of the digital economy on January 3 2018.

So far, the EC has outlined several business models in the digital economy that could be considered for different taxation angles without necessarily having a PE in all or any of the jurisdictions they are active in. The grouping offers a foray into narrowing down definitions for digital businesses and considering how business in the digital sector differ from each other. The different business models are:

  • Online retail (Amazon, Alibaba)
  • Social media (Facebook, Xing, Qzone)
  • Subscription (Netflix, Spotify, iQiyi)
  • Collaborative platforms (Airbnb, Blablacar, Did Chuxing)

The above article was published on on November 28 2017 and has been republished with the approval of the Publisher.