Corporate tax and the digital economy – HM Treasury position paper

Tue 12 Dec 2017

What’s the issue?

HM Treasury issued a position paper on corporate tax and the digital economy on 22 November. It highlights deficiencies in the international tax framework , where value is generated by digital means from the presence of users in a territory, rather than any actual physical presence of the business itself. Two such business models where the value is generated as a result of having users in the UK are:

• Social media platforms, which generate advertising revenues through directing adverts at UK users of free online platforms, as well as the collection and onward sale of data collected about its users;
• Online marketplaces which earn commission for bringing together buyers and sellers, which therefore relies on users of the marketplace.

The UK government is keen to ensure that, going forwards, UK corporation tax receipts are commensurate with the value generated by such digital businesses.

Proposed approaches

The Government has proposed a three pronged approach:

• Long term: multilateral reform of international tax framework, enabling countries to tax the profits of foreign companies that derive value from an active user base, even where there is no permanent establishment;
• Interim: whilst the preferred option is a multilateral reform, the government is considering models for taxing the revenues that digital businesses generate from the provision of digital services to the UK market. This could include introducing a revenue based tax depending on revenue generated with a UK ‘nexus’.  The key issue here would be identifying which revenues the UK would have a right to tax in the types of businesses concerned. The introduction of the diverted profits tax showed that the UK is not averse to taking unilateral action where it feels necessary, and this stance is repeated in this paper.
• Short term: as announced in Autumn Budget 2017, the introduction from April 2019 of a withholding tax on royalties paid by the digital business, where that royalty is paid to a low or no tax jurisdiction. The UK proposes to apply this even where there is no UK taxable presence.  It will be interesting to see how this will operate in practice. On 1 December 2017 HMRC and HM Treasury issued a consultation on this short term measure.

Considerations posed by the position paper

The position paper posed a number of questions:

To what extent can digital businesses be ring fenced?

The UK does not think tax issues caused by centralisation of multinational activities is an issue unique to digital businesses, though it considers they are exacerbated by dematerialised digital groups.

What businesses would fall within the scope of an interim solution?

The paper suggests this would be businesses for whom the participation of users and the relationship between the business and the users is critical to the business model’s success and directly links to generation of revenue. For example:

• Online services or online user generated contribution websites with a user base from which revenue is generated through advertising;
• Online market places generating a commission (for example market places for buyers and sellers and those which match users’ common interests).

The Government does not believe retailer websites where self-developed or acquired goods are sold are within scope.

To what extent could restructuring in response to BEPS and possible US tax reform change the analysis?

While the UK Government recognises digitalisation of business may have led to greater transparency, it does not consider the BEPS measures nor US tax reform have significantly reduced the challenges in the international tax system.

How does this interact with the roles of the UK as a global digital hub?

Any revenue based tax would need to properly cater for start-up businesses which may initially be operating at a loss.

The Government wants the UK to be the best place to start and grow a digital business.  However it will seek to ensure digital businesses do not gain an unfair advantage from the international tax framework.  It is also important to ensure the UK remains a competitive place to do business.

What steps have been taken to address some of the challenges posed by digitalisation for the VAT system?

The paper notes some of the measures announced on 22 November to prevent VAT fraud through the use of online platforms and its continuing research into the use of the split payment model (for example where tax or VAT payments may be made automatically through the electronic payment system).  It also notes that the provision of a free services (such as a search engine) in return for data constitutes a value for value barter transaction where it could be argued VAT should be applied.

Comments on the UK position as outlined in this paper are invited by 31 January 2018. For a discussion of international tax matters affecting digital businesses, please get in touch with a member of the Mazars international tax team.