The UK has published draft legislation and draft guidance for its proposed digital services tax (DST), to be introduced with effect from 1 April 2020.

The UK’s DST runs counter to the usual international tax nexus rules by taxing digital business based upon value created by UK users rather than taxing based upon physical presence (residence or a permanent establishment) in the UK. It is intended to be an interim solution pending international agreement on how to tax digitalised business models and how to allocate taxing rights. In the background the OECD is working towards finding a new global solution to the tax problems posed by the digitalisation of the economy by the end of 2020. It is a challenging timetable. The UK is not the only country to take unilateral action pending the OECD solution: France has already enacted a DST and other countries (e.g. Austria and Spain) are considering similar taxes.

What is the UK proposing?

The UK’s DST will be charged at a rate of 2% on UK revenues deriving from three in-scope business models: internet search engines, social media platforms and online marketplaces. Revenues from associated online advertising business will also be caught.

DST is aimed at the largest multinationals, but there is a safe harbour for loss making or low profit activities

Groups will only be subject to DST if their revenues from these in-scope business models exceed £500m globally and the amount of such revenues linked to UK users exceeds £25m. The £25m acts as an allowance for each accounting period. Consequently, DST is expected to affect a small number of large multinational groups. Businesses with in-scope activities that are loss making or have a low profit margin can elect for an alternative method of calculating DST. If the election is made, loss making in-scope activities will not be subject to DST and low profit activities will be subject to a lower DST charge. This safe harbour should be beneficial for businesses with an in-scope business model with a profit margin below 2.5%. It can be applied on an in-scope activity by activity basis, so a business could elect for the alternative calculation for one in-scope business model but not another.

DST is targeted at in-scope businesses

The three in-scope business models are internet search engines, social media platforms and online marketplaces. Each of them, particularly online marketplaces, could catch a wider range of platforms than expected. Whilst “internet search engines” will take its ordinary meaning, “social media platform” and “online marketplace” are specifically defined in the draft legislation.

A social media platform is any online platform with a main purpose of promoting interaction between users and enables users to share content. This will include social networking sites, micro-blogging platforms, video or image sharing platforms, online dating websites, and platforms that exist primarily to provide user review. Private email is not expected to be caught.

An online marketplace is an online platform with a main purpose of facilitating the sale by users of services, goods or other property and which enables users to sell, or advertise for sale, such things to other users. HM Treasury’s response to the DST consultation states that “the essence of a marketplace is connecting sets of unrelated third parties, where the marketplace does not bear significant risk in the development and sale of the product”. Accordingly, gig economy platforms are expected to fall within the definition of an online marketplace, but it is not intended to catch online sales of e-commerce retailers. Most financial services are expected to be out of scope, but for clarity the draft legislation includes a specific exemption for certain financial services providers. In contrast, there is no specific exemption for streaming, broadcasting or publishing media, although they are not expected to be an online marketplace if they develop or acquire content to display to customers.

It taxes UK revenues from in-scope businesses

DST is applied to revenues derived from in-scope businesses that are attributable to UK users. We look at these concepts below.

“Revenue” is defined as revenue recognised in the income statement (or profit and loss) for a period assuming the accounts are drawn up using applicable accounting standards (i.e. IAS, UK GAAP, US GAAP). No surprises here, but how do you define a UK user?

A UK user is a user who it is reasonable to assume is either an individual who is normally in the UK or a business established in the UK. So within the definition there is an acknowledgement that tracking down whether a user operating remotely has a UK connection cannot be an exact science. Instead there is a pragmatic reasonable assumption test, which is based upon the evidence available. For instance businesses are not expected to ‘look through’ to the ultimate user when entering into B2B transactions to identify the location of the underlying individual consumer. However, businesses within scope will need to use a system to be able to track UK users.

Revenue will then be attributed to UK users in certain situations. For instance, the revenue could arise “in connection” with a UK user. Online advertising revenue is within scope if advertising is intended to be viewed by UK users. For online marketplaces where there is a UK user, all revenues from the transaction will be within scope. Revenue from an online marketplace transaction relating to UK land will also be subject to the charge.

DST will be calculated and reported at group level. A group will be required to register for DST if the £500m and £25m revenue thresholds are exceeded. However, DST will arise on the individual entities in the group that receive the underlying revenues that are chargeable. DST will be payable nine months and one day after end of the relevant accounting period of the group.

DST should normally be deductible against UK taxable profits when calculating UK corporation tax, but will not be creditable against UK taxes.

Potential issues

There are a range of potential issues for in-scope businesses. For example:

Breadth of application

Each of the in scope activities, particularly online marketplaces, could catch a wider range of platforms than expected.

Does the business’s financial reporting enable it to split out “in scope” revenues?

Businesses are allowed to make a “just and reasonable apportionment” where revenue is derived from both in scope and out of scope activities, but how easy will it be for businesses to substantiate a proposed split if their financial reporting does not mirror in-scope revenues?

Tracing the UK user Although the business can rely upon available evidence to identify UK users, it may need to build a system (or adapt an existing system) to identify those users.

Breaching the threshold Businesses currently below the threshold should be aware that they could become subject to DST if they are acquired (in whole or in part).

How will the UK DST interact with other jurisdictions’ DSTs (e.g. Austria, France, and Spain) and to what extent will there be double taxation? The UK Government is conscious of the risk of double taxation but the only relief currently proposed is a limited (50%) double tax relief available for transactions on online marketplaces with a non-UK user located in a jurisdiction that has a DST and the revenues are subject to foreign DST. However, this relief is partial and the administrative burden of applying different DST rules across various jurisdictions could be considerable.

Now that we have greater clarity from the draft legislation and guidance, those groups that conduct activities that could be in-scope should identify in-scope activities and assess connected revenues to see whether they are above the £500m global and £25m UK thresholds.

Affected groups will need to consider whether they should make the election for the alternative method of calculating DST if they are loss-making or have low profit margins. They should also assess their existing systems to see whether they are up to the job of identifying chargeable revenue.

This is a possibility. The United States Trade Representative’s has initiated an investigation into France’s new DST under section 301 of the Trade Act of 1974. The French DST is a 3% tax on revenues generated from providing certain digital services to, or aimed at, French users. It too has high revenue thresholds – EUR750m globally and EUR25m in France. The US Trade Representative, Robert Lighthizer, on announcing the investigation, said that the US is “very concerned” that the French DST “unfairly targets American companies”. The thresholds mean that only the largest companies, often US headed multinationals, will be caught. Following this announcement France has gone ahead and enacted its DST. US reaction to the French DST makes it more likely that the US will take a similar approach to the UK’s DST.

We are speculating even further here, but with a new UK Prime Minister pledging a “no ifs, no buts” Brexit by 31 October 2019, will it make a difference whether the UK comes out of the EU with no transitional arrangement between the UK and the EU (a hard Brexit)? If there is a hard Brexit would Boris Johnson then be keen, very keen, to do a trade deal with the US, and what difference would that make (if at all) to DST, which was announced by the previous Prime Minister’s Chancellor?