Retailers and brand owners should be mindful of recent UK tax developments that impact taxation of gross receipts and taxation of digital activities. The new income tax charge on offshore receipts from intangible property (“ORIP”) took effect from April 2019 and the Digital Services Tax (“DST”) is proposed to take effect from April 2020.

Update on ORIP

From 6 April 2019, non-UK residents in certain (generally low-tax) jurisdictions will be liable to UK income tax on their gross receipts from the exploitation of intangible property rights to the extent those receipts enable, facilitate or support UK-based sales of goods or services. The ORIP charge only applies if UK sales by the non-UK resident (and its connected persons) for a given tax year exceed £10m, but it applies whether or not the non-UK resident has any presence in the UK, and irrespective of transfer pricing adjustments.

As an example, ORIP may apply where brand owner A owns and licences its IP to retailer B, with neither party being based in the UK. If retailer B uses that IP to manufacture goods and makes direct sales to customers based in the UK, then ORIP would apply to the licence fee received by brand owner A. (UK sales include online advertising services targeted at UK persons.) The challenge is being able to trace through often complex supply chains to determine whether IP licenses which are between entirely off-shore parties are nevertheless supporting UK sales. Brand owners may well want license agreements to require licensees to report on UK sales – or not make UK sales.

There are several exemptions that are currently available and the Government has proposed additional exemptions in draft regulations released recently. For example, receipts are exempt where UK sales are by a person unconnected to the non-UK resident IP owner and the intangible does not make a “significant” contribution to the UK sales. There is also an exemption for tax transparent entities that are situated in certain jurisdictions that are 100% owned by residents in that territory, e.g. a US LLC with US members.

The ORIP charge is expected to lead to off-shore businesses restructuring to hold their IP in the UK or in full tax-treaty territories.

Update on DST

The UK has published draft legislation and guidance for its proposed DST, which is expected to come into effect from 1 April 2020. This comes as various other jurisdictions – including Austria, France and Spain – also look to introduce their own DSTs in an effort to address the perceived failure of the current international tax system to appropriately tax the value created by digitalised business models.

The UK’s DST is intended to be an interim solution pending international agreement on how to tax digitalised business models and how taxing rights are allocated. In the meantime, the proliferation of unilateral DSTs presents a significant risk of double taxation, as well as the administrative burden of applying different DST rules across various jurisdictions.

The UK’s DST will be charged on three in-scope business models: (1) search engines, (2) social media platforms, and (3) online marketplaces. Revenues from associated online advertising business will also be caught. The types of businesses falling within the three in-scope business models might seem clear but each of them, particularly online marketplaces, could catch a wider range of retail platforms than expected.

(1) Social media platforms: online platforms that offer and promote user interaction and content sharing would be in-scope and liable to DST. Comments sections on websites that are incidental to the main business on the website would not usually be captured, so this should exclude reviews of products on the websites of online retailers.

(2) Internet search engines: websites that include a search function with results from a large number of third party websites would be in-scope and liable to DST. Websites that provide a search function allowing users to locate information solely on the host website are not in-scope, as this is an ancillary activity that helps support the main business activity.

(3) Online marketplaces: if a main purpose of the marketplace is to facilitate the sale by third parties of services, goods or other property to other users, by either selling or advertising on the marketplace, then such websites would be in-scope and liable to DST. Marketplaces are in-scope even if payment arrangements must be made between users (such as paying in cash). B2B, B2C and C2C contracts are all in-scope. This business model does not capture the sales of e-commerce retailers and online sales generally. It only captures cases where the platform’s business is to act as an intermediary and match users.

Businesses will only be subject to DST at a rate of 2% on UK revenues if their aggregate revenues from the in-scope business models exceed £500m globally and the amount of such revenues linked to UK users exceeds £25m. Consequently, DST is expected to affect a relatively small number of large multinational groups. There will also be a safe harbour to ensure loss-making businesses do not have to pay DST and that businesses with low profit margins can benefit from a lower rate of DST. The safe harbour will be available through taxpayers making an election for an alternative method of calculating DST.