It’s been a busy month in the world of tax for tech companies. France and the UK are introducing digital services taxes, and serious work is underway at the OECD that may result in a shake-up of the international tax system in a manner that affects tech companies and digital businesses in particular, and sooner than people may think.
Given how fast the ground is shifting, there is a real need for companies in this sector of the economy – and possibly for a much wider group of multinationals – to start assessing, planning, and possibly even taking action. The G7 finance ministers have in the last few days agreed on the urgency of addressing the topic, and the OECD aims to deliver an international consensus solution by the end of 2020. The new tax in France meanwhile will have effect retroactively from 1 January this year, and the UK version from 1 April 2020. Both will remain in force until an international solution is implemented.
But before diving into the detail of what’s been happening, what are the issues and questions that need addressing? Below is a quick overview of some of the things we’ve been thinking about, and helping clients address.
- How should key parts of new digital services tax legislation be interpreted, for example in relation to the definition and measurement of in-scope revenue? What seems like a simple question is often tortuously difficult, legally and practically.
- How might the new taxes interact with rules for transfer pricing, or other taxes? For instance, which subsidiaries in a group should bear the cost of the new taxes? How in a large organisation should you determine whether a particular line of business has low profitability? And can you take deductions or get a credit against corporate income or tax?
- What impact might the new digital services taxes have on cash-flow and profitability, and on businesses themselves? Since the new taxes are levied on revenue, the impact on businesses with low or even modest profit margins are likely to be particularly significant. Similar points will likely be true for what comes out of the OECD proposals. And there will also be an effect on valuations for buyers and sellers in M&A deals.
- Could the proposals being considered by the OECD mean that structures and models often adopted by tech companies would become outdated? Should companies therefore already be considering new models?
- In practical terms, what work might be needed to adopt systems to capture the data needed to implement the new measures? Might wider changes need to be made to the actual infrastructure of a digital business to facilitate this? If so, what effect might this have on platform performance? How long, and what resources, might be required to effect the changes?
- Do any concerns arise from a data security and privacy standpoint? For example, what data would need to be kept and held locally to comply with record keeping requirements from a tax perspective? Does this cut-across how data is managed and kept secure within an organisation?
That’s a lot to think about. But for the layperson, what’s all the fuss about? Isn’t this just going to go away, like most things you read about in the papers? The answer to this last question is a resounding “no”. Politicians are scrambling to catch-up with the tech sector, and need to be seen doing something. And part of that is tax. Making sure a new, and often hugely profitable sector of the global economy, is seen to pay its fair share. It’s not the first sector to be hit. Banking and oil and gas have seen similar challenges, albeit in different circumstances. That tells us that changes will happen for the tech sector.
And now for the tax-minded, what are the details?
On July 11, the United Kingdom introduced draft legislation that would see a digital services tax introduced from 1 April 2020 on groups with consolidated worldwide digital services revenue exceeding £500 million, and UK digital services revenue exceeding £25 million. The tax would be imposed at a rate of 2% on all in-scope digital services revenue exceeding £25 million. “In-scope” here means revenue derived from providing a media platform, Internet search engine, or online marketplace. Companies can elect to pay the tax on an alternative basis equal to 80% of the relevant operating margin multipled by revenue (excluding the £25 million allowance). This means that companies with an affected digital business that earns low or modest profits will pay less (and not more than the operating profits earnt), and zero where not profitable. The legislation is remarkably short, with limited defined terms, given the number of new concepts it introduces. This makes it difficult to rule out interpretations which would play to HMRC’s advantage. The UK government has pledged to scrap the tax once an international agreement on taxing digital business has been implemented.
The French National Assembly meanwhile passed a bill on 4 July to impose a similar tax, but at a rate of 3% and with retrospective effect from 1 January 2019. This applies to companies with more than €750 million in digital revenues worldwide, and €25 million in France. Broadly speaking, revenues caught include turnover from online advertising, the sale of data for advertising, and fees drawn from linking users on online sales platforms. It is thought the tax will apply to about 30 companies, but only one French group. The bill does not contain an end date, although the French government will provide annual reports to the Assembly on progress made internationally to arrive at a long-term solution aimed at superseding (or pre-empting) unilateral measures.
This is not the end of the story. Other countries – Spain and Italy for instance – are introducing similar digital services taxes. Others may follow suit, even if some are opposed. Furthermore, serious efforts are underway at the OECD to formulate and deliver international consensus on a comprehensive, long-term plan for taxing the digital economy by the end of 2020. Details of the work and proposals being considered are outlined in a “Programme of Work” published by the OECD/G20’s Inclusive Framework on BEPS (which now includes over 130 countries) on 31 May, and presented to the G-20 finance ministers in early June.
The “Programme of Work” contemplates a solution founded upon two “pillars”. Pillar One would give countries where users or consumers are located greater taxing rights. Pillar Two would be a belt ‘n’ braces measure aimed at ensuring that profits are always taxed at some sort of minimum rate somewhere, somewhat in line with measures introduced by the Trump administration in the sweeping reforms implemented by its Tax Cuts and Jobs Act. The G7 finance ministers have just agreed on this, in principle. Significantly, a number of the proposals could apply across-the-board, not just to digital or tech businesses.
Before the OECD work is finished, there is also a very real possibility of significant fall-out from the unilateral taxes. The Trump administration quite predictably has launched a probe into the new French tax. And few people would be surprised were President Trump to announce retaliatory measures. Who would be affected by this?
The answers are blowing in the wind…