Debate: Rethinking digital services taxes

George Turner, Executive Director, TaxWatch

Claire Hooper, EY’s International Tax and Transactions Partner and Chris Sanger, UK Head of EY’s Tax Policy and Chairman of ICAEW’s Tax Policy Committee

Richard Asquith, VP, Global Indirect Tax, at software company Avalara

Complaints that tax rises targeting digital companies are unfair, cumbersome and raise little money are missing the point.

The UK’s Digital Services Tax (DST), first announced in the 2018 Budget, was designed to pressure the Organisation for Economic Co-operation and Development (OECD), and in particular the US, into agreeing a more comprehensive reform of the international tax system. The UK government said from the start that if reform was agreed, it would cancel the tax. 

Now that the OECD has failed to deliver reform in a timely fashion, the DST has to become a reality. 

The tax structures implemented by large tech companies are well known. Most rely on the complete fiction that companies tax resident in Bermuda or Ireland with no employees are more profitable than in major markets such as the UK, France and Germany. 

Any teacher, nurse or other frontline worker that has seen their quality of life eroded by austerity would not hesitate to call that a scam, and tax avoidance is almost universally hated by the public. 

The DST seeks to ensure that large, profitable digital companies end up paying more tax in the UK by taxing sales, which are much harder to move than profits. The use of turnover rather than profit is not a perfect solution and produces severe inequalities in the way different companies are treated. Facebook, with its relatively small sales but huge profit margins, will see a proportionally lesser impact on its profits via the DST than Google, for example. 

However, removing the DST, without replacing it with some other reform designed to counter tax avoidance in the digital sector, is simply not an option. 

There are now calls to expand the scope of digital taxation. The DST has no impact on online retailers who sell direct to customers. This has prompted calls for a similar tax to be put on those retailers. The purpose is to help level the playing field with high-street retailers who face higher costs and business rates. 

With the high street already in decline before COVID-19 and the government keen to get people back to the shops, some form of online sales tax would make a lot of sense from the government’s point of view. 

Given the enormous increases in profit seen by some online retailers during the lockdown, such a tax may also be a relatively easy sell politically.

The UK has pressed on with the DST, notwithstanding the OECD’s international reform project and possible implications for trade with the US. The legislation has not significantly changed from the draft published in July 2019. It is very broad in scope and may apply to groups that had not thought they would be within it. HMRC has published guidance, but this leaves areas open to subjective interpretation. 

The UK’s measure is not a general online sales tax but is targeted at value generated only by certain digital business models. It applies a 2% tax on revenues linked to UK users and not just to UK companies or permanent establishments. 

DST can be claimed as an expense in computing profits chargeable to UK corporation tax but is not creditable. It is payable annually, due nine months after the end of the period. Businesses subject to the tax are already assessing the impact, with some passing on the cost through higher fees.

New or increased activities may bring a company within scope. Groups need to register within 90 days of the end of their first DST accounting period.

As a tax on revenues, DST will disproportionately affect companies with low profit margins or losses in the year. Although there is an alternative calculation that can reduce/eliminate the charge in low/no margin situations, this is not a substitute for taxing profits. 

The government reiterated its commitment to disapply the DST once an appropriate international solution is in place. July’s G20 Finance Ministers and Central Bank Governors meeting reaffirmed the G20’s commitment to reaching a global consensus. However, the OECD Secretary General’s report to that meeting indicated divergent views on how to progress.

In the meantime, unilateral measures (and responses) continue to flourish, with the latest being the EU’s suggested digital levy from January 2023 as part of its ‘Next Generation EU’ resources to repay COVID-19 borrowing. There are notable differences between the various DSTs, both in scope and level of tax, which add to the practical challenges faced by business from a systems and process perspective.

Businesses therefore need to move to address their differing obligations in each country. The wider question is whether these DSTs will become permanent. Whatever the outcome, they are here for now and businesses need to act swiftly.

The current global corporate income tax settlement is showing its age. At more than 100 years old, it is failing to fairly tax new digital business models, but able to spook earnings out of countries’ tax nets.

Attempts to equitably reallocate digital cross-border profits via the OECD are fraying over design principles and the split of an estimated $100bn tax bounty. We are limping towards a global tax war by the end of 2020. But this does not have to be inevitable.

The OECD has hosted talks between over 130 countries on a new regime to redistribute digital earnings more objectively. These are structured around two pillars: the right to tax digital income for a country where the provider is selling but doesn’t have a physical presence; and a minimum tax rate in the country where the seller recognises their earnings. 

This would prevent profit shifting and also creates a level playing field for small companies that do not have resource to play the global tax markets.

The existing definition of the digital economy is too narrow, baiting the US into retaliation. It also opens up huge loopholes. For example, many global food chains are starting their own online self-employed driver services that would dodge the current DST construct. A better basis would be digital activities, including delivery channels and whether offshore or not.

The gross turnover tax base is regressive and does not allow for the huge scale, with tiny margins, that digital models need to be a success. This threatens to stifle this exciting sector. There must, therefore, be some allowance for the cost of delivery. 

Since there is no allowance for deductibility of DSTs incurred by businesses, they are cumulative. Scope is needed on crediting DSTs suffered to prevent taxes compounding to uneconomic levels.

There should be a move towards a more principle-based design that can withstand challenges in the long term. More appreciation is needed around what creates the value that should then be taxed.

The original aim of the OECD talks to bring about a more just and modern tax regime remains essential. The framework is in place, and there is goodwill, if no generosity, among most sides. But the parties need to urgently rethink some core arguments.

The cost of failure is an escalating tax and tariff war that will stifle a global economy hit by COVID-19.

Opinions in this feature do not necessarily reflect the views of ICAEW.