The Chancellor announced a new UK digital services tax in his latest Budget. How will this impact businesses and what other international reforms in this area will businesses need to navigate through? Stella Amiss, Tax Partner, discusses with Alenka Turnsek, Tax Partner and Dave Murray, Director of Tax Policy.
Hello, I am Stella Amiss, the UK tax leader for policy, reputation, media and regulation at PwC. Welcome to the Talking Tax podcast series, where we discuss topical tax issues that would impact people and businesses.
Today, we will discuss the UK digital services tax that the UK announced in this year’s budget. Here again, we’ve seen the UK be a first mover in the international tax landscape.
We will discuss what this means for the businesses that have been targeted, and how those that weren’t specifically targeted might be impacted too. We will also look at the international reforms that may affect the landscape, and how businesses need to navigate that.
With that in mind, I am delighted to be joined by Alenka Turnsek and Dave Murray. Alenka is a tax partner, who specialises in business value chains and leads PwC’s digital tax work here in the UK. Dave is an international tax policy director, who has been closely following the ongoing international tax debates on how the system can be reformed for the digital age.
Alenka, let me come to you first. Why is the UK introducing specific digital tax rules?
Hi Stella, well this tax has been introduced to deal with concerns that there are many digitised businesses out there, who are creating value from interacting with UK users, and the government believes that the current tax system does not necessarily reflect the value that has been created, and [that value] is not being properly taxed. To put it simply, the government believes that there are some businesses, that are not really accounting for this value, and they think they need to introduce new laws to take into account the way value is being created in a digital economy.
It’s effectively like tax reform, but without a tax change program?
That’s right. I think, they are trying to deal with the macro-economic issue that it is quite difficult to effect in the international environment, and so they have tried to deal with it in micro environments all around the world, and the UK digital service tax is UK’s response to that.
Which kind of business are affected by the UK’s response?
The impact can be wider than one might think in practice. It’s impacting essentially all industries, because they all are impacted by digitising. In particular, it’s targeting social media platforms, online marketplaces, and search engines.
Are we saying that it was a targeted measure, but actually you need to stand back and see whether or not you’ve got any type of digital activity going on at all to see whether this measure will actually affect you?
It was potentially started as a targeted measure over three very specifically defined business models. But in the digital economy, if you are interacting with customers in a digitised way, you are very likely, even though you are not a tech company, to interact with them in the way that could be defined as a social platform or potentially a search engine.
So, with that in mind then, how is the tax articulated, how will it work?
At the moment two proposed tiers of tax for companies. For large companies; by large, are defined as having £500m revenues for ‘in scope’ models that we’ve just discussed. They would be taxed at 2% of the revenues generated for the ‘in scope’ activities. If you are a company of that size - past the £500m threshold) -but with very low profit margins, there is a proposed alternative way of calculating the tax due that is currently being consulted upon, so we don’t have the details for that yet. But it is likely to be lower than 2% of revenue.
So, it’s actually not a tax on profits?
No, and that’s an interesting one, it’s not a tax on profit. One of the reasons being that one of the features of the digital economy is that one of the key priorities for digital business is to keep on investing and to grow in size. So, the seizing market share tends to be more of a priority than just to make profit. So, no it is not tax on profit, which is why it is slightly at odds with the current international systems and domestic systems and how companies are currently taxed.
Okay, so when you’ve got a profit based tax, that brings in all sorts of different dynamics into the way the tax works, the way the treaties work, what do you see as being one of the key issues that we have to grapple with, with this new proposal?
One of the issues is that all of companies will be essentially taxed twice on their income here. That income will have been taxed somewhere in world, plus the UK is now saying that they want a share of tax on that digitally generated income for these particular activities in the UK, hence they are introducing a new tax.
For UK only businesses, they will literally be taxed twice in the UK on the same income. There may not be full 100% double taxation, because the new tax will be expensed in the P&L, but there will be increased tax cost for these businesses, so that is the financial impact. The other issue to be concerned with is that because the digital economy is utilising these three models more and more, I think we are expecting in the future, subject to growth, a lot of businesses to be caught, it’s not just what initially was thought would be the target segment for this particular tax.
Which would mean we’ve got more and more businesses potentially suffering double taxation or having to look at how the UK is taxing something, and whether that stuff has already been taxed elsewhere, and whether the UK rule is going to sit nicely with the way that they think their international businesses run, is that right?
That is exactly right. Hence, the HM treasury has been saying for a long time, and a very strong proponent of the needs to be a change to the international tax system, agreed at the international level, because otherwise you will see businesses paying taxes on the same profits in different countries, which is really not optimal for international trade.
Okay, Dave, you’ve been a little bit quiet, so we are going to bring you in now. Alenka has just opened up the prospect of the potential for disputes, so different dynamics happening on the international scale, is this the only way that UK could have addressed this problem?
Hi Stella, thanks for having me, first.
I think the UK could have updated its domestic rules to try and find some way of looking at the interaction between users and businesses to attribute some profits and levy some tax on that in the UK. The problem they would have there is two fold, the first is that there is international tax treaties that have to be respected, and unless they are going to avoid this whole treaties, the treaties would simply override what they put in the domestic law, and it would end up not being effective at all.
I think the second problem, which is probably less important, but is more of a priority, is actually trying to work out how you calculate that tax? How do you, in a system, which currently looks at where businesses locate their people, and their assets, and their management, and attribute profits on that basis, how do you find some way of attributing profits to customers and users, and have that sit aside in a coherent way and that’s really the big challenge in international tax at the moment.
We know that the UK have set out their stall, if you like. What’s happening more generally in the international landscape around taxing these type of activities?
That’s a good question. The OECD in 2012 was part of a much broader project that looked more at anti-avoidance than digital on its own. It did look at the digitalisation of the economy and how digitalisation was impacting the tax system, and what challenges that might be causing.
They concluded in 2015 that there was no specific action that was needed at that time, but there were some tensions being caused, and they were going to look again in 2020. There have been quite a few countries out there that have become quite impatient with waiting until 2020, particularly the countries that have a lot of users, a lot of potentially rich consumers, but not so many of these global giant digital companies themselves, and those countries have been pushing for international reform to be much quicker. The OECD has accelerated its review, they are currently looking to prepare a final report and some final recommendations by 2020 that all 124 members of its global inclusive framework can agree to.
That seems like a tough ask.
I think it is a tough ask. I think they are making progress, they keep saying that they are making progress. They released an interim report earlier this year, they are going to release another interim report next year. From quite a nebulous description of all the potential challenges out there that we were seeing last year and at the beginning of this year, some of the countries involved in that process have come forward, really grabbed this by the scruff of the neck, and put forward some of their own proposals, and the OECD is trying to stitch those all together into something that everyone can agree now.
Where do you think it will go? You already talked about the impatience of different territories in your response there, are we likely to see more countries like the UK introduce their own measures while they’re waiting?
Some already have. The UK is not the first European country to announce that it’s going to introduce the digital services tax, although it is the first to provide some real detail on precisely what that will cover. Because, where, say, Spain and Italy have said they are going to introduce a tax similar to this, they are waiting for EU negotiations to finalise on something that could apply across whole of the EU before they actually put that into detailed legislation. The UK is going on its own a bit compared to the rest of EU, but there is range of other measures across the world that you can look at. India went first several years ago with 6% tax on turnover from advertising, and then there is few other Eastern and Asian countries that have tried some quite innovative different solutions, some are looking at profits, some are looking at turnover, they don’t all have the same treaty concerns that the UK does, because they don’t all have the same number of treaties that the UK has, but there is a wide variety of things that are already being implemented.
If I try and put you on the spot, and I know this is going to be an unfair question, but let me ask it anyway, where do you think this is all going to pan out to over the next couple of years?
I think the OECD will manage to get some agreement on something by 2020, whether that is a coherent solution that actually solves a lot of the problems that countries are raising as problems, I think, remains to be seen. At the moment, they are looking at one proposal from Germany, which is minimum tax proposal where it essentially makes sure that you don’t get tax deductions for something unless the income is being taxed relatively high level on the other side. That doesn’t really solve any of the problems that the UK is raising, but it does satisfy Germany and potentially the US as well,. The US wants to look much more broadly and look to shift the whole system towards a destination base and that’s probably not surprising given the size of their market. So many customers in that country that are interacting with businesses, that are in the digitalising economy and in the traditional economy as well. Then of course, there is this UK long-term proposal to look at creating some kind of digital presence that only looks to attribute value to the interaction between users and companies.
Whether you can stretch those three together, I think is quite challenging. I think we will probably see some kind of anti-avoidance measure in there, like the German proposal, and then maybe something in between the UK and the US proposals. But, there is a lot of negotiation to be had there, and it will, by definition be something that’s negotiated under compromise rather than something where one country wins.
As I am listening, I am thinking that is a lot to get your head around in terms of, from the business perspective, we’ve got some actual proposals on the table, we’ve got a lot of discussions going on at the international level, we’ve got all sorts of different kind of methodologies, if you like, on the table, that’s quite confusing.
I want to layer one extra confusion on top of it, and Alenka and David I’d welcome your views. The UK has made its proposals and we are in consultation around that. We know that the EU proposals and what they might be doing, are changing almost seems like by the week at the moment. Brexit comes in to all of this. Will the UK proposals actually go ahead if the EU come to a position about what they might want to do before we are due to leave the European union?
I don’t think they would fall away in their entirety. I think, the way the EU proposals have gone through this negotiation have probably been through reducing scope. At the moment, it’s looking like they won’t be anyway near as broad as the UK’s proposals. But there will be some differences, they could catch some businesses that wouldn’t be caught by the UK proposals. If the UK remains a member of the EU, has an agreement with the EU that it will implement these directives, then it will have to make some changes, but it can of course add its own proposals on top of that. It might not need to restrict its scope, it might just need to expand it slightly. The other wrinkle that we have to remember is that these rules that the EU are proposing at the moment look like they might not come until 2021, so we don’t really know what the relationship between the UK and the EU going to be at that point.
So, yet more uncertainty on top of all of the uncertainty that we talked about so far.
With that in mind, let’s turn to what does that mean for businesses, what should businesses be doing now given this really turbulent landscape? Alenka, your thoughts on that?
First and foremost, businesses will focus on doing the business, this is why they are there, which means they have to go on with digitalisation, because except for the debates on the Brexit, which is of course huge for the UK, but parallel to that there is lot of technological developments, there is lot of AI coming in, in particular, which is changing their businesses, that’s what they have to focus on. The first phase of digitisation is around interaction with consumers. They will understand that, because their customers have changed from being a passive receiver of adverts targeted at them to converting to a network of users that collaborate with companies in developing new businesses and services. That is really what is leading them, they need to change, and need to do something at the front end. The choice that digitisation have also brought for them is to where they want to set up, how they want to interact globally.
They have been through a lot of internal changes, (looking at) how they organise themselves internally, how they interact with their users, customers, and consumers, whichever group we’ve wanted to focus on, and then how they deliver all of that, so that’s the first and foremost.
The second, is the complexity understanding where we are with all this legislation, and which country do I have to pay more taxes in. Certainly there is more resource being consumed on understanding legislation, and then processing, and then also higher cost in paying the taxes, so they have all of that to deal with.
Unfortunately there is no way around that, and for UK businesses particularly, all of these different parts of legislation from Brexit to digital taxation might actually hit about the same time.
The other thing I want to mention is slightly more macroeconomic point, is that we are not discussing in terms of the digital legislation that is coming in, is the impact of new technologies, in particular AI, that would additionally change the way that business is being done. It will also potentially change this legislation again in a year or two, once we’ve settled the initial wave. Then, of course, it will change the way they create value and the way they need to protect the value of their enterprise, which I think so far has been discussed a lot.
So, I will say to them, as they are going through all this turbulent changes, the one thing they can do, as well as making sure the business is running itself and they are compliant everywhere, is to protect the value of their enterprise through understanding where the IP is being created, where the value is being created, and take the measure in place, so they can have everything fenced out.
It sounds to me like that there is a piece around making sure that they are consulting, now we’ve got this consultation period, because it is a bit about sharing the way that businesses are developing that might not have been in the mindset of those drafting the legislation or the rules, because everything keeps changing so quickly. Then the other piece is obviously trying to understand what all of this means for your business here in the UK and more internationally.
That’s actually right. The consultation that we have from HM Treasury is running until end of February. It is a great time to engage with us and also directly with HMT to help HMT understand what this proposal will do for their business, and it’s not just today, it is not just up to February, but it’s up to the next five-year timeline, which is a very long time line in technology terms, but at least so that no provisions are put in place they will hamper the business in terms of making it successful domestically as well as internationally. So, there is certainly that component.
That make sense. Then, David, you talked quite a lot with inbound companies and the invest here in the UK, what would you think they should be doing, anything different?
I think, they should be looking to engage as well. I mean, many of them are already engaged in the international debate, and certainly I would expect large businesses to have some kind of presence in the UK and to be following this closely as well. But, I would encourage everybody at an individual and the business level to look at what services they are using, look at what activities they are performing, and think about how this proposal and the broad proposals in the international community might impact them, because now is our chance to engage. If we leave this until 2020, we are going to have so many disparate measures all around the world, no global agreement, and I don’t think that is good for anyone.
What a note to end on.
With that, let me say thank you to Alenka and Dave for joining us in the discussion.
Thank you for having me.
Thanks for having me.
Clearly, there is some turbulence ahead for international tax and a lot of challenges for businesses to get their heads around the changes that are coming. Clearly something that businesses ought to be doing, is thinking about how they get ready for those changes.
For you listening, please keep an eye out for our next podcast in the New Year and feel free to check out all of our previous episodes as well, and as always, thank you very much for listening.