Under the skin of the UK digital services tax

Anyone with even a passing interest in tech or tax will be aware of recent hubbub around the proposed introduction of a UK digital services tax (DST).  The new tax, which will be targeted at specific highly digitised profit-making business models that generate over £500m, was announced by the Chancellor, Philip Hammond, at the recent Autumn Budget.

While the announcement provoked more reaction than any other measure included in the Budget, it won’t have come as much of a surprise. At a time when modern ways of working and doing business are rapidly evolving, the Government has been under pressure to level the playing field and address a perceived disparity in the tax treatment of bricks and mortar businesses and those operating online. As the technological world continues to grow, the lines between the digital and traditional economies are becoming increasingly blurred.

Through the DST, the Government aims to address the changing interaction between the production and consumption sides of the digital supply chain. Some business models that have been enabled by the digitalisation of the economy have transformed previously ‘passive’ customers into networked users that actively participate in and engage with the business as well as with each other. For example, customers that previously relied on traditional, direct advertising (such as via the TV or radio) to find out about products and services now also receive comments and feedback from other users that help them make a decision. Simultaneously, businesses consider users’ feedback and use it to customise, adapt and innovate new products in much shorter time than previously possible. The Government believes that all of this means business are making money in a way that isn’t accounted for by current tax laws.

The Government intends to start levying the DST from April 2020. It will be reviewed (and potentially repealed) when the OECD agrees and implements longer term tax arrangements for the digital economy or in 2025 - whichever comes sooner. Online marketplaces, search engines and social media platforms are the business platforms in the firing line.

According to a recently published consultation paper, the tax will apply to only highly digitised business models that interact most intensively with their users and those which have the greatest potential for making money from customers’ contributed content and engagement. However the definitions offered for the three targeted models could mean more businesses will be liable for the tax than initially intended, including domestic companies that are in the early stages of digitisation.

Much has been made about the a perceived risk of double taxation, with concerns that businesses may find themselves paying tax on the same profits twice over, through both corporation tax and the new DST. To partially address these concerns, the Government has proposed that DST is a tax deductible operating expense subject to certain conditions. This could still lead to an increased cost of engaging with and selling to UK users, especially for overseas businesses. There is also likely to be increased expense associated to the administration and potential disputes arising from the new tax. Meanwhile, it’s expected other territories may introduce levies and taxes on digitised businesses, potentially leading to double taxation and further financial hit for digital businesses, ultimately leading to increased costs for customers.

Most economists agree that taxing revenues distorts the economy, in terms of prices of inputs, decision making and the allocation of resources. If a number of countries introduce tax on revenues similar to the DST, this would lead to multiplied effect of levying tax on tax through intermediate processes in the global digital supply chains and ecosystems.  

The UK proposal seeks to minimise the distortive impacts of the DST by excluding loss making businesses and introducing a ‘safe harbour’ for low margin businesses although the consultation does not indicate which costs will be allowable in determining the “low margin”. Given the adverse impact of turnover taxes such as the DST, it is imperative that the long term solution which will replace the DST and similar levies is agreed as early as possible.

We must also ensure that the introduction of the DST doesn’t impact on the attractiveness of the UK as an investment and innovation hub. Adverse tax measures could reduce attractiveness of a country to foreign investors. However, in practice other factors such as political stability, skilled workforce, effectiveness of the legal system and physical and digital infrastructure also play an important role in attracting foreign investment. A key consideration will be whether the collected tax would be invested in enhancing the competitive facets of the UK.

A consultation on this hugely important development is welcome although the timeline (the deadline for responses is February 2019) does present a challenge. But at a time when future attractiveness has never been more paramount every effort should be made to ensure that no stone is left unturned. Perhaps most importantly, the issue has further underlined the pressing need to step back and review a tax system that needs fundamental reform if it is to work effectively in the world of the future.