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Digital services tax becomes UK law

Matt Stringer Matt Stringer

The Finance Act 2020 became law on 22 July, 2020. This Act retrospectively introduced the UK’s Digital Services Tax (DST), which is to apply from 1 April, 2020.

DST is a new unilateral tax introduced by the UK to tackle the perceived tax challenges of the digital economy. The government has said it remains committed to a long-term solution to the tax challenges arising from digitalisation, but believes that more immediate action is required in the short term at a unilateral level to tackle these challenges.

What are the highlights?

There have been few changes since draft legislation was released in this area. The headlines of the new tax are as follows:

  • DST is levied at 2% on gross revenues of specific digital activities, where these revenues are linked to the participation of UK users
  • The three business models that are ‘in scope’ are: search engines, social media platforms and online marketplaces
  • DST is not intended to penalise the UK user, or be a tax on online business in the broader sense, but applies to revenues earned from the intermediation of sales where UK users have driven the value allowing for those sales to take place
  • Financial and payment services businesses are noted as specifically ‘out of scope’, while other businesses providing online content, software/hardware sales, television and broadcasting services must infer their exemption from the definitions of the in-scope business models
  • A ‘double’ threshold is in place to ensure DST only affects the largest digital businesses, while only groups with global revenues from in-scope business models of more than £500 million fall within scope, and the first £25 million of relevant UK revenues are exempt
  • Safe harbours are in place so that loss-making businesses are not subject to DST, and low-profit-margin businesses will be charged a reduced rate
  • DST is intended to be temporary, until international consensus is reached; and there is a commitment to review its necessity in 2025

The devil is in the detail

The final legislation is broadly consistent with the above principles, in terms of the targeted business models, the rate and the double threshold to target only the largest multinationals.

  • ‘In scope’ business models specifically include the carrying on of any associated online advertising business, which derives significant benefit from its connection with a social media platform, search engine or online marketplace, which seems to be a targeted effort to ensure that online advertising activities are within the scope of the measures
  • UK digital services revenues include any revenue earned by a group that is connected to the relevant business activities – regardless of how the business actually monetises its platform
  • A UK user is briefly defined as a party or one party in a multi-party transaction who it is reasonable to assume is normally in the UK, with an exception where the second jurisdiction involved in the transaction also applies a tax “similar” to DST, in which case 50% of the revenues will be included
  • An alternative basis of calculation has been included where a formulaic approach to ensure those with low profit margins are not adversely impacted, including an 80% operating margin cap, as per the suggestion in the original consultation document
  • All revenues of the group will be aggregated for the purposes of calculating any potential exposure, with the group’s ultimate parent or another elected party then responsible for reporting and remittance, while DST is payable nine months and one day after the end of the accounting period and will be reported and payable on an annual basis

What do I do next?

If your business is large enough to be potentially within the scope of DST, now is the time to understand the final law and accompanying guidance provided to answer key questions, such as:

  • Does my business model, in whole or in part, fall within one of the ‘in scope’ models?
  • How do I track my ‘users’, and apportion these between UK and non-UK users for the purpose of tracking digital services revenues?

I would encourage taxpayers and HMRC to begin an open dialogue about how to calculate any exposure. I would also urge the UK government to remain an integral part of the OECD level discussions on the tax challenges of the digital economy, with a view to ensuring the Digital Services Tax is a short-term measure.

The sunset clause contained in the law recommends a review of DST by 2025, which for those looking for a multinational solution to these challenges is too far into the distance.

US sensitivities

Voices from US government have spoken out against unilateral DST measures in many jurisdictions, including the UK, arguing that such taxes unfairly target US tech companies. While agreement was reached between the USA and France on a tapered-back introduction of DST, the UK has not watered down its approach.

As the UK attempts to secure a post-Brexit trade deal with the USA, the existence of DST is likely to remain a barrier.

For more information on the Digital Services Tax, contact Matt Stringer