A position paper has been issued for taxing the digital economy. This is likely to be a game changer, particularly for social media companies and online marketplaces.
The Government has released a position paper setting out its proposals for taxing the digital economy. It is seeking views on its proposals and hopes the paper will stimulate debate ahead of the publication of the OECD’s interim report on this subject next Spring. Comments on the paper are invited by 31 January 2018.
The UK Government intends to work multilaterally to find solutions to the difficulties in taxing new digital business models but makes clear that it will take action unilaterally if consensus cannot be achieved. However, in response to some multinational groups in the digital sector currently achieving low-tax outcomes by holding IP in low tax jurisdictions with little substance, the Government plans to legislate next year to introduce a new royalty withholding tax to address this issue aimed at non UK resident vendors of goods to UK customers.
The issue of how to tax new digital business models is one that has vexed tax authorities for a number of years now and this paper comes on the back of much recent debate within the EU on the best approach to adopt. At the same time many countries outside the EU have introduced unilateral taxing measures aimed at the digital economy (such as India’s ‘equalization levy’ on online advertising revenues earned by non-resident companies in relation to Indian consumers).
Helpfully in its paper the Government sets out what parts of the digital economy are not – in its view – being taxed fully by the current international tax framework. In particular it focusses on businesses serving UK consumers where there is significant ‘user-generated value’ created in the UK, and in particular online marketplaces and social media businesses.
In the Government’s view the use of online services and platforms by users provides these companies with significant value either in terms of the data the users provide or through the network effects/economies of scale they create in the case of online marketplaces. The companies can then exploit these inputs to drive targeted advertising revenue and significant additional turnover.
While current transfer pricing models - which focus on the location of activities within a company – attempt to apportion profits based on value generation they don’t currently consider any value generated for the company by external users and so any profits in relation to this are not currently subject to tax in the jurisdiction where the users are located. In addition, digital activities are unlikely to generate a local tax footprint through the creation of permanent establishments.
The Government proposes to address this by taxing part of the revenues that these businesses generate. The main option under consideration is bringing part of the companies’ revenues (such as online advertising revenue) into tax using an apportionment metric such as average monthly users. However the Government acknowledges this is not a straightforward solution and is seeking views on the possible mechanics including the scope, nexus issues (e.g. where the advertising revenue is generated from companies in third jurisdictions), collection mechanisms and the need to avoid double taxation. On this issue the Government has made it clear that it will wait until after the publication of the OECD’s interim report before it takes action.
Interestingly the Government takes the view that a number of business models which are entirely digital (e.g. the sale of software online or the distribution of online content to users) or which rely heavily on digital platforms (e.g. the sale of physical products online) are unlikely to be within the scope of reforms to the international tax structures and implies that taxing rights should remain based on residence of the vendor. This is unexpected.
Overall the paper is strong on intent and very clear on the direction of travel. The landscape for taxing multinational businesses in the technology space is likely to change in the near future. Our concern is that the solutions adopted will vary between jurisdictions increasing the risk of double taxation for business and additional costs to consumers.
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