Having failed to reach an EU-wide unanimous consensus on an earlier EU Commission proposal for a DST Directive, certain EU countries, including Austria, the Czech Republic, France, Italy, Spain and the United Kingdom, decided to go it alone and introduce DSTs unilaterally into their own national tax systems. These decisions were driven primarily by a perception that larger multinationals, many of which have highly digitalised operations, are not paying their “fair share” of taxes globally. In addition, a growing consensus has emerged in recent months that “market jurisdictions” should have the right to tax, because those markets—namely, the countries where the users and consumers are based—ultimately create value for online businesses.
The Organisation for Economic Co-operation and Development (OECD) takes a neutral view on the use of DSTs by its members, in that it neither recommends nor discourages them. Member countries that do decide to adopt a DST should
- Comply with international obligations
- Ensure the DST is temporary and narrowly targeted
- Minimise over-taxation, cost, complexity, and compliance burdens
- Ensure the DST has a minimal adverse impact on small businesses.
The French DST is already in force. The Italian DST is in draft form, with the government intending for it to enter into force in January 2020, while other DST regimes, including that of the United Kingdom, are expected to come into force some time during 2020. None of these national rules seem to have complied with the OECD guidelines, and there are several practical challenges for businesses that are common across all three regimes.
Identifying Taxable Revenues and Services
In France, each company belonging to a group that derives gross revenues from digital services exceeding €750 million on a worldwide basis, and €25 million in France, is subject to French DST at a rate of 3 per cent. French DST is assessed at the company level only, based on gross revenues derived from digital services deemed to be provided in France during the previous calendar year. This is calculated as the gross revenues derived from taxable digital services, multiplied by the proportion of French users over the total number of users of the taxable digital services.
As it currently stands, the Italian DST would apply to Italian resident and non-resident companies that, at the individual or group level, earned during a calendar year a total amount of worldwide revenues of over €750 million, and an amount of revenues derived from digital services provided in Italy of over €5.5 million.
Only groups with annual worldwide revenues above £500 million and UK revenues above £25 million would be affected by the UK DST, with the first £25 million of UK revenues being exempt. The UK DST would be calculated on a group-wide basis and apportioned pro rata to each group member. Groups with low operating margins may opt for a “safe harbour” alternative DST calculation, based on the group’s operating margin.
Identifying Taxable Services
The taxable services that fall within the scope of the French, Italian, and UK DSTs are broadly similar and include
- The provision of a social media platform
- Search engines
- Any online marketplace
- Online advertising business, including those that use or sell individual users’ data
It is noteworthy that digital platforms for the provision of payment services, communication services, crowdfunding services, or digital content, as well as self-operated digital platforms for the direct sale of goods and services, are specifically beyond the scope of the French and UK DST.
The issues that arise are also broadly similar. There are likely to be conflicts regarding dual-purpose platforms, i.e., those that include both taxable and exempt digital services. The fact that the lists are not exhaustive and that the DSTs will apply to all revenues received in connection with a relevant DST activity means that affected businesses will need to analyse the nature of the revenue streams and the activities from which they are generated, and each case will turn on its own facts. This will entail a substantial administrative burden for affected businesses, as well as a lack of certainty over potential DST filing obligations.
Both France and Italy consider the location of users to be based on the location of the electronic device when the user accesses the digital services. The United Kingdom intends to determine that someone is a UK user if, it is reasonable to assume, they are normally located or established in the United Kingdom.
France and Italy will use IP addresses, wi-fi connections, GPS data, etc., plus reference to that user’s personal data and place of residence; while the UK plans to extrapolate user location from data such as delivery addresses, payment details, IP addresses, contractual evidence, or the address of properties for rent or location of goods for sale.
There are many problems with these approaches. At the most basic level, different data sources can provide conflicting evidence of a user’s location, and IP addresses can be easily manipulated. Businesses will therefore need to come to a reasonable, evidence-based conclusion on the likelihood of that user’s location, further adding to their administrative burden and broadening the scope to make a mistake. The use of personal data and place of residence are also likely to trigger data protection issues under the EU General Data Protection Regulations.
Potential Double Taxation and Reimbursements
There is a risk of double taxation if another jurisdiction imposes a DST on the same revenues, for example as a result of inconsistencies between one set of national rules and those of another jurisdiction regarding user location or taxing rights. DST is however generally deductible for corporate income tax purposes.
France’s President Macron stated at the 2019 G7 that any excess of French DST over the new international DST being brokered by the OECD would be refunded. He did not, unfortunately, give much detail as to how and under what limitations this refund will take place.
The Italian draft DST provisions do not include any specific rule on this aspect and, although they seem to propose a sunset clause according to which the Italian DST is automatically repealed when the new OECD-agreed corporate income tax enters into force, there does not appear to be scope for a retroactive reimbursement of the difference (if any) between the Italian DST and such future corporate income tax.
The draft UK DST rules disregard 50 per cent of UK revenues from cross-border transactions between a buyer and a seller through an online marketplace where the non-UK party is in another DST jurisdiction. But this does not fully resolve the issue of potential double taxation if the other jurisdiction imposes a DST on the same revenues, for example due to inconsistencies between the UK national rules and those of the other DST jurisdiction regarding user location and/ or taxing rights.
The UK DST will also not be creditable against either corporation tax, income tax under the Offshore Receipts in respect of Intangible Property regime, or diverted profits tax; although it should generally be deductible for corporation tax purposes as a trading expense. Unlike France or Italy, neither the draft legislation nor HMRC guidance mentions the possibility of a retroactive reimbursement of the UK DST once the OECD’s long-term solution for a revised corporate income tax has been agreed and implemented by member countries.
The US Response
The US legislature takes a hostile view of DST proposals generally, as evidenced by a recent investigation into whether the French DST discriminates against US businesses. This could lead to retaliatory US tariffs being imposed on imports from France and punitive US tax charges on French companies doing business in the United States.
Other DSTs, including those of the United Kingdom and Italy, can probably expect similar responses from the United States. UK Prime Minister Boris Johnson has indicated his support in principle for a UK DST or a similarly targeted tax. He has also indicated that the structure of this tax would be on the table in any trade negotiations with the United States, and the future of the current draft Finance Bill hinges on the result of the UK general election in December, so there is currently very little certainty as to whether UK DST will take effect at all.
For now, the best course of action for affected businesses is to assume that all DSTs will take effect as planned and prepare accordingly, notwithstanding any current legislative or political uncertainty.