On 11 July 2019, the UK government published draft legislation to establish a digital services tax (DST) in the UK. Originally announced at Budget 2018, the UK DST is a 2% tax on the revenues (not profits) of large multinational enterprises (MNEs) conducting highly digitalised business activities deriving value from UK users.
The draft legislation (and guidance) is subject to technical consultation until 5 September 2019. Assuming everything proceeds normally, the UK DST will be included in the next draft Finance Bill (which should become Finance Act 2020) and enter into force from 1 April 2020.
This article provides a technical summary of the draft legislation. It then considers how the US administration in Washington views the unilateral action of various countries, including France, to introduce a DST and how it might respond should the UK implement one. Finally, we consider what the implications for the UK DST might be following Boris Johnson becoming UK prime minister.
The UK digital services tax
Groups and revenues
The calculation of UK DST liability relies on identifying the digital services revenues of a large, global, group during an accounting period.
A group is comprised of any ultimate parent company (or any other listed, widely held, entity) and all of its subsidiaries (if any) consolidated in accordance with international accounting standards (IAS), UK generally accepted accounting practice (GAAP) or US GAAP.
The charge to UK DST follows the accounts, i.e. the regime relies on accounting principles to calculate the liability. Revenues arising to, and expenses incurred by, members of the groups, in relation to in scope digital services activities, are the amounts recognised in the income statement in the group’s GAAP compliant accounts.
Digital services activities and digital services revenues
‘Digital services revenues’ are the group’s total revenues arising in connection with any digital services activity (i.e. substantive business services provided for a commercial purpose) carried on by any group member.
A ‘digital services activity’ is:
A UK DST liability will also arise on revenues from any online advertising business (i.e. a business operated on an online platform providing or facilitating online advertising) associated with providing a digital services activity and derives a significant benefit from its connection with it. An online advertising business is not a digital services activity in its own right.
UK users and UK digital services revenues
‘UK digital services revenues’ are the proportion of a group’s total digital services revenues that are attributable to UK users.
A user is any person that uses a digital services activity. A ‘UK user’ is widely defined as (based on the available evidence) any:
In most cases, digital services revenues will be attributable to UK users to the extent they arise in connection with UK users using the digital services activity. There are two exceptions to this general rule:
Respondents to the government’s UK DST consultation expressed concern that the introduction of a DST by another country would risk double taxation on cross-border transactions. Consequently, the second exception is subject to a special rule that provides relief to the extent that a member of the group is party to a relevant cross-border transaction.
A ‘relevant cross-border transaction’ is:
In such cases, the calculation disregards 50% of the UK digital services revenues arising to the member of the group (and, under the alternative basis of charge, 50% of the relevant allowable operating expenses) in respect of the transaction. In effect, the regime halves UK DST liability on revenues attributable to such transactions.
Liability: the principal basis of charge
There is no liability to UK DST unless the worldwide group meets two financial threshold conditions in any accounting period. The two thresholds are:
The rules restrict the maximum length of any accounting period to 12 months. This means long accounting periods will be split into a 12 month period with another ending on the next accounting reference date (or after a further 12 months if earlier). Where the relevant accounting period is shorter than one year, the rules reduce the threshold amounts proportionately.
When the thresholds are met, a group’s liability to UK DST is 2% of the total amount of UK digital services revenues arising in the period in excess of £25m, i.e. there is an annual allowance for the first £25m of group-wide UK digital services revenues. As for the thresholds, the £25m exemption is pro-rated for periods of less than one year.
Where the group has a UK DST liability, each member of the group (a relevant person), wherever it is resident for tax purposes and irrespective of whether it has a taxable nexus in the UK, will be separately liable to UK DST. The relevant person’s liability will be its share of the group’s UK DST liability that reflects the proportion of the group’s total UK digital services revenues attributable to that person.
Liability: the alternative basis of charge
The legislation allows a group to claim an alternative, ‘safe harbour’, mechanism for calculating its DST liability for any accounting period. The safe harbour will only be of interest to groups with very low (or negative) UK operating margins.
However, applied in appropriate cases, a valid safe harbour claim should ensure:
A group elects to use the alternative basis of charge by making a claim in the group’s DST return for the relevant accounting period.
A valid claim eliminates the two financial threshold conditions. It can apply to group revenues arising in connection with any, or all, of the in scope digital services activities. Consequently, a group can make a maximum of three elections (one for each type of activity) in respect of any one accounting period.
In essence, the alternative basis of charge:
The draft guidance published alongside the legislation includes some basic example that illustrate how to carry out the calculation in practice.
Adding the group’s UK DST liability in relation to specified digital services activities to the group’s UK DST liability in relation to its unspecified digital services activities, results in the group’s total UK DST liability. As under the principal basis of charge, each group member is separately liable to UK DST in proportion to the share of the group’s total UK digital services revenues attributable to it.
Anti-avoidance and interaction with other taxes and administration
The regime includes a targeted anti-avoidance rule (TAAR). The TAAR counteracts any DST advantage (broadly, any avoidance, reduction or deferral, or any repayment, increased repayment or accelerated repayment of DST) obtained from avoidance arrangements where:
A UK DST liability is deductible as a normal expense of business (provided it is incurred wholly and exclusively for the purposes of a trade) but it cannot be credited against a UK corporation tax (or any other tax) liability. The UK government recognises UK DST could result in double taxation, creating ‘challenging outcomes for businesses which already recognize significant taxable profit in the UK’. It has refused to introduce a credit system on the basis that it would not be ‘simple’ and could jeopardise the ‘non-discriminatory’ design of the tax.
Finally, the legislation sets out comprehensive rules covering the administration of the tax including group registration, self-assessment and the submission of returns, penalties and far-reaching powers for HMRC.
The view from Washington
The US is opposed to digital services taxes, which it views as revenue grabs targeting primarily US companies. According to press reports, the Trump administration has already threatened to walk away from discussions of a new US/UK free trade agreement (FTA) if the UK does not drop its plan to implement the UK DST.
After France enacted a digital services tax in July this year, the Office of the US Trade Representative (USTR) announced an investigation under s 301 of the Trade Act of 1974 into whether the new French tax merited retaliatory measures by the US. Such measures could include tariffs on imports from France into the US. Section 301 allows retaliatory measures to be taken (at the president’s discretion) on where a foreign country’s action is discriminatory or unreasonable and burdens or restricts US commerce.
Both Republican and Democratic leaders of the tax-writing committees in the US Congress praised the USTR’s announcement. In a joint statement, Senators Chuck Grassley and Ron Wyden, the top Republican and Democratic members of the Senate Finance Committee, said, ‘the US would not need to pursue this path (of potential retaliatory measures) if other countries would abandon these unilateral actions and focus their energies on the multilateral process that is underway at the OECD.’
The UK and France are both participating in that multilateral process as members of the Inclusive Framework on Base Erosion and Profit Shifting (‘the Inclusive Framework’), which has undertaken a programme of work, blessed by the G20 leadership, to address the tax challenges of the digitalisation of the economy.
The senators also suggested that the Treasury department consider using a different tool in response to the French DST (and other unilateral DSTs), namely s 891 of the US Internal Revenue Code. This little-known provision (that has never been used) permits the US to impose taxes on the nationals of a foreign country in response to the imposition of a discriminatory tax by that country on US nationals. It is not at all clear that the French DST (or the UK DST) would actually provide a basis for action under s 891, given that they apply to all companies that come within their scope, rather than to US companies only.
Whether or not the s 301 investigation of the French DST leads to tariffs on French goods or to other retaliatory measures, it seems clear that the US is determined to take an active approach to opposing the enactment of digital services taxes that would apply disproportionately to US companies. As the UK is likely to be in a weak bargaining position vis-à-vis the US in the wake of a UK exit from the EU later this year, it can be expected that the US will press its advantage in an effort to persuade the UK to abandon the UK DST.
London calling
The policy justification for the UK DST is that globalisation has facilitated a misalignment between the place of economic activity (i.e. value creation) and the place of taxation of profits arising from that activity. Digitalisation exacerbates the problem.
The UK government insists it supports international cooperation in tax matters and is leading the effort to find a global, consensus-based, solution to the tax challenges of digitalisation. However, signalling the UK’s willingness to act unilaterally, former Chancellor of the Exchequer Philip Hammond described progress as painfully slow. By announcing ‘a targeted, proportionate, and temporary tax’, the UK hoped to pressurise the Inclusive Framework to accelerate efforts to find a consensus.
There is debate over how targeted and proportionate it is but, if implemented, it is also far from clear the UK DST will be temporary.
The passage of the UK DST is well advanced. It has progressed in accordance with the normal Budget timetable and tax policy-making process. In normal circumstances, it would be certain that the UK DST would enter into force from 1 April 2020.
Once in force, it could be set to stay. There is no ‘sunset’ provision in the draft legislation. HM Treasury is merely obliged to, ‘conduct a review … and prepare a report’ before the end of 2025. The only stated metric for that review is, ‘whether [the UK DST] is meeting its policy objectives’. It is not at all certain that the review will initiate the withdrawal of the tax, even if the Inclusive Framework has reached an agreement on a consensus solution.
However, politically and economically, current circumstances are anything but normal.
Politically, Brexit dominates. Although the governing party has not changed, the UK has a new government, led by a radically different prime minister, Boris Johnson, at the head of an unrecognisable Cabinet. It also has a new, less austere, chancellor of the exchequer, Sajid Javid. The priority for the new government is to ensure the UK leaves the European Union. Prime Minister Johnson has promised to deliver Brexit, ‘do or die’, on 31 October 2019.
Economic reality is largely unchanged. The need to find new sources of tax revenue, and to ensure MNEs contribute a ‘fair share’, will remain a priority. However, economic policy is about to experience a transformation. ‘Boosterism’ under Johnson and Javid will replace the ‘austerity’ of (former PM) Theresa May and Hammond. Alongside numerous pledges to cut taxes and increase spending, the new government heralds Brexit as an opportunity to remake the UK economic model. UK policy is likely to pivot away from Europe towards a new globalism (and the US in particular). The theory is that (given time) incentivising economic growth reaps higher tax receipts. It is an argument that echoes justifications for the Tax Cuts and Jobs Act in the US in 2017.
The importance of securing a comprehensive new FTA with the US is central to the success of this strategy. Putting to one side the (im)possibility of securing Congressional approval, and irrespective of the scale of the US administration’s retaliation against the introduction of a French DST, the implementation of the UK DST will be an obstacle to a UK/US FTA.
The combined effect of the imperatives to secure Brexit (‘come what may’), reboot the UK economy and align UK interests more closely with those of the US, it is conceivable the UK DST will become a small bargaining chip in larger, trade-related, negotiations. If, during the course of this autumn:
the Johnson government could decide that implementing the UK DST for what would be a very short period, for a very small amount of revenue, at the risk of angering Washington and jeopardising progress on a UK/US FTA, is simply not worthwhile.
Very quietly, it might decide to bury the UK DST. Ashes to ashes, DST to dust.
On 11 July 2019, the UK government published draft legislation to establish a digital services tax (DST) in the UK. Originally announced at Budget 2018, the UK DST is a 2% tax on the revenues (not profits) of large multinational enterprises (MNEs) conducting highly digitalised business activities deriving value from UK users.
The draft legislation (and guidance) is subject to technical consultation until 5 September 2019. Assuming everything proceeds normally, the UK DST will be included in the next draft Finance Bill (which should become Finance Act 2020) and enter into force from 1 April 2020.
This article provides a technical summary of the draft legislation. It then considers how the US administration in Washington views the unilateral action of various countries, including France, to introduce a DST and how it might respond should the UK implement one. Finally, we consider what the implications for the UK DST might be following Boris Johnson becoming UK prime minister.
The UK digital services tax
Groups and revenues
The calculation of UK DST liability relies on identifying the digital services revenues of a large, global, group during an accounting period.
A group is comprised of any ultimate parent company (or any other listed, widely held, entity) and all of its subsidiaries (if any) consolidated in accordance with international accounting standards (IAS), UK generally accepted accounting practice (GAAP) or US GAAP.
The charge to UK DST follows the accounts, i.e. the regime relies on accounting principles to calculate the liability. Revenues arising to, and expenses incurred by, members of the groups, in relation to in scope digital services activities, are the amounts recognised in the income statement in the group’s GAAP compliant accounts.
Digital services activities and digital services revenues
‘Digital services revenues’ are the group’s total revenues arising in connection with any digital services activity (i.e. substantive business services provided for a commercial purpose) carried on by any group member.
A ‘digital services activity’ is:
A UK DST liability will also arise on revenues from any online advertising business (i.e. a business operated on an online platform providing or facilitating online advertising) associated with providing a digital services activity and derives a significant benefit from its connection with it. An online advertising business is not a digital services activity in its own right.
UK users and UK digital services revenues
‘UK digital services revenues’ are the proportion of a group’s total digital services revenues that are attributable to UK users.
A user is any person that uses a digital services activity. A ‘UK user’ is widely defined as (based on the available evidence) any:
In most cases, digital services revenues will be attributable to UK users to the extent they arise in connection with UK users using the digital services activity. There are two exceptions to this general rule:
Respondents to the government’s UK DST consultation expressed concern that the introduction of a DST by another country would risk double taxation on cross-border transactions. Consequently, the second exception is subject to a special rule that provides relief to the extent that a member of the group is party to a relevant cross-border transaction.
A ‘relevant cross-border transaction’ is:
In such cases, the calculation disregards 50% of the UK digital services revenues arising to the member of the group (and, under the alternative basis of charge, 50% of the relevant allowable operating expenses) in respect of the transaction. In effect, the regime halves UK DST liability on revenues attributable to such transactions.
Liability: the principal basis of charge
There is no liability to UK DST unless the worldwide group meets two financial threshold conditions in any accounting period. The two thresholds are:
The rules restrict the maximum length of any accounting period to 12 months. This means long accounting periods will be split into a 12 month period with another ending on the next accounting reference date (or after a further 12 months if earlier). Where the relevant accounting period is shorter than one year, the rules reduce the threshold amounts proportionately.
When the thresholds are met, a group’s liability to UK DST is 2% of the total amount of UK digital services revenues arising in the period in excess of £25m, i.e. there is an annual allowance for the first £25m of group-wide UK digital services revenues. As for the thresholds, the £25m exemption is pro-rated for periods of less than one year.
Where the group has a UK DST liability, each member of the group (a relevant person), wherever it is resident for tax purposes and irrespective of whether it has a taxable nexus in the UK, will be separately liable to UK DST. The relevant person’s liability will be its share of the group’s UK DST liability that reflects the proportion of the group’s total UK digital services revenues attributable to that person.
Liability: the alternative basis of charge
The legislation allows a group to claim an alternative, ‘safe harbour’, mechanism for calculating its DST liability for any accounting period. The safe harbour will only be of interest to groups with very low (or negative) UK operating margins.
However, applied in appropriate cases, a valid safe harbour claim should ensure:
A group elects to use the alternative basis of charge by making a claim in the group’s DST return for the relevant accounting period.
A valid claim eliminates the two financial threshold conditions. It can apply to group revenues arising in connection with any, or all, of the in scope digital services activities. Consequently, a group can make a maximum of three elections (one for each type of activity) in respect of any one accounting period.
In essence, the alternative basis of charge:
The draft guidance published alongside the legislation includes some basic example that illustrate how to carry out the calculation in practice.
Adding the group’s UK DST liability in relation to specified digital services activities to the group’s UK DST liability in relation to its unspecified digital services activities, results in the group’s total UK DST liability. As under the principal basis of charge, each group member is separately liable to UK DST in proportion to the share of the group’s total UK digital services revenues attributable to it.
Anti-avoidance and interaction with other taxes and administration
The regime includes a targeted anti-avoidance rule (TAAR). The TAAR counteracts any DST advantage (broadly, any avoidance, reduction or deferral, or any repayment, increased repayment or accelerated repayment of DST) obtained from avoidance arrangements where:
A UK DST liability is deductible as a normal expense of business (provided it is incurred wholly and exclusively for the purposes of a trade) but it cannot be credited against a UK corporation tax (or any other tax) liability. The UK government recognises UK DST could result in double taxation, creating ‘challenging outcomes for businesses which already recognize significant taxable profit in the UK’. It has refused to introduce a credit system on the basis that it would not be ‘simple’ and could jeopardise the ‘non-discriminatory’ design of the tax.
Finally, the legislation sets out comprehensive rules covering the administration of the tax including group registration, self-assessment and the submission of returns, penalties and far-reaching powers for HMRC.
The view from Washington
The US is opposed to digital services taxes, which it views as revenue grabs targeting primarily US companies. According to press reports, the Trump administration has already threatened to walk away from discussions of a new US/UK free trade agreement (FTA) if the UK does not drop its plan to implement the UK DST.
After France enacted a digital services tax in July this year, the Office of the US Trade Representative (USTR) announced an investigation under s 301 of the Trade Act of 1974 into whether the new French tax merited retaliatory measures by the US. Such measures could include tariffs on imports from France into the US. Section 301 allows retaliatory measures to be taken (at the president’s discretion) on where a foreign country’s action is discriminatory or unreasonable and burdens or restricts US commerce.
Both Republican and Democratic leaders of the tax-writing committees in the US Congress praised the USTR’s announcement. In a joint statement, Senators Chuck Grassley and Ron Wyden, the top Republican and Democratic members of the Senate Finance Committee, said, ‘the US would not need to pursue this path (of potential retaliatory measures) if other countries would abandon these unilateral actions and focus their energies on the multilateral process that is underway at the OECD.’
The UK and France are both participating in that multilateral process as members of the Inclusive Framework on Base Erosion and Profit Shifting (‘the Inclusive Framework’), which has undertaken a programme of work, blessed by the G20 leadership, to address the tax challenges of the digitalisation of the economy.
The senators also suggested that the Treasury department consider using a different tool in response to the French DST (and other unilateral DSTs), namely s 891 of the US Internal Revenue Code. This little-known provision (that has never been used) permits the US to impose taxes on the nationals of a foreign country in response to the imposition of a discriminatory tax by that country on US nationals. It is not at all clear that the French DST (or the UK DST) would actually provide a basis for action under s 891, given that they apply to all companies that come within their scope, rather than to US companies only.
Whether or not the s 301 investigation of the French DST leads to tariffs on French goods or to other retaliatory measures, it seems clear that the US is determined to take an active approach to opposing the enactment of digital services taxes that would apply disproportionately to US companies. As the UK is likely to be in a weak bargaining position vis-à-vis the US in the wake of a UK exit from the EU later this year, it can be expected that the US will press its advantage in an effort to persuade the UK to abandon the UK DST.
London calling
The policy justification for the UK DST is that globalisation has facilitated a misalignment between the place of economic activity (i.e. value creation) and the place of taxation of profits arising from that activity. Digitalisation exacerbates the problem.
The UK government insists it supports international cooperation in tax matters and is leading the effort to find a global, consensus-based, solution to the tax challenges of digitalisation. However, signalling the UK’s willingness to act unilaterally, former Chancellor of the Exchequer Philip Hammond described progress as painfully slow. By announcing ‘a targeted, proportionate, and temporary tax’, the UK hoped to pressurise the Inclusive Framework to accelerate efforts to find a consensus.
There is debate over how targeted and proportionate it is but, if implemented, it is also far from clear the UK DST will be temporary.
The passage of the UK DST is well advanced. It has progressed in accordance with the normal Budget timetable and tax policy-making process. In normal circumstances, it would be certain that the UK DST would enter into force from 1 April 2020.
Once in force, it could be set to stay. There is no ‘sunset’ provision in the draft legislation. HM Treasury is merely obliged to, ‘conduct a review … and prepare a report’ before the end of 2025. The only stated metric for that review is, ‘whether [the UK DST] is meeting its policy objectives’. It is not at all certain that the review will initiate the withdrawal of the tax, even if the Inclusive Framework has reached an agreement on a consensus solution.
However, politically and economically, current circumstances are anything but normal.
Politically, Brexit dominates. Although the governing party has not changed, the UK has a new government, led by a radically different prime minister, Boris Johnson, at the head of an unrecognisable Cabinet. It also has a new, less austere, chancellor of the exchequer, Sajid Javid. The priority for the new government is to ensure the UK leaves the European Union. Prime Minister Johnson has promised to deliver Brexit, ‘do or die’, on 31 October 2019.
Economic reality is largely unchanged. The need to find new sources of tax revenue, and to ensure MNEs contribute a ‘fair share’, will remain a priority. However, economic policy is about to experience a transformation. ‘Boosterism’ under Johnson and Javid will replace the ‘austerity’ of (former PM) Theresa May and Hammond. Alongside numerous pledges to cut taxes and increase spending, the new government heralds Brexit as an opportunity to remake the UK economic model. UK policy is likely to pivot away from Europe towards a new globalism (and the US in particular). The theory is that (given time) incentivising economic growth reaps higher tax receipts. It is an argument that echoes justifications for the Tax Cuts and Jobs Act in the US in 2017.
The importance of securing a comprehensive new FTA with the US is central to the success of this strategy. Putting to one side the (im)possibility of securing Congressional approval, and irrespective of the scale of the US administration’s retaliation against the introduction of a French DST, the implementation of the UK DST will be an obstacle to a UK/US FTA.
The combined effect of the imperatives to secure Brexit (‘come what may’), reboot the UK economy and align UK interests more closely with those of the US, it is conceivable the UK DST will become a small bargaining chip in larger, trade-related, negotiations. If, during the course of this autumn:
the Johnson government could decide that implementing the UK DST for what would be a very short period, for a very small amount of revenue, at the risk of angering Washington and jeopardising progress on a UK/US FTA, is simply not worthwhile.
Very quietly, it might decide to bury the UK DST. Ashes to ashes, DST to dust.
