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Paul Falvey BDO LLP, U.K.
Paul Falvey is a Tax Partner at BDO LLP, U.K.
The Spring Statement confirmed the U.K. government's commitment to introducing an extension of corporation tax for digital businesses. The statement included an updated version of the consultative document on the taxation of digital companies.
The proposed form of the tax is, however, far from clear as are the means by which the technical complexities in framing a tax on the value created by digital business tax can realistically be overcome. The proposed solution to this difficulty in the short-term is to propose a temporary turnover based tax. This proposal has already been criticized.
So what are the policy reasons for an additional tax on digital business? The government has reaffirmed the principle that the profits of a business should be taxed in the countries in which value is created. However, this long established principle of international tax is challenged by businesses where additional value is created by the engagement and participation of users. The difficulty that policymakers face is that current methods of measuring value creation fail to tax this value.
While conceptually it can be seen that users create value, for example social media sites generate revenue by selling advertising on a platform populated by user content such as photographs, audio and video content, this value is not normally recognized in the accounts of the company in the country in which the users are resident. Since the users are not generally paid for their content there is no easy way to value their input. Of course from the government's perspective this does not mean that it does not exist.
The government's response to this so far is to introduce a consultation process which was updated at the Spring Statement following feedback from interested parties. The paper sets out a few ways in which this could be achieved and but it is clear from that the Chancellor is intent on addressing this perceived gap in tax policy by introducing a new tax. The technical challenge is introducing a tax that balances the conflicting pressures of maintaining global tax competitiveness with raising revenue and ensuring our international tax obligations are acknowledged.
The preferred approach is to adopt a system that is consistent with the arms-length principle but which allocates the residual taxable profit attributed to user engagement and participation on a globally agreed basis. This should be seen as an addition to the Base Erosion and Profit shifting (“BEPS”) initiative. The government's view as expressed in the consultation document is that BEPS applies to all businesses but digital businesses pose additional risks and hence require further specific attention.
One of the most obvious challenges of introducing a tax based on a global allocation of residual profit is that it will require multilateral consensus to introduce it. This is unlikely to be achieved anytime soon as it presents significant procedural challenges. The government's solution to this is to introduce a temporary turnover based tax. This suggestion has already come in for widespread criticism as it is a blunt instrument which does not properly take into account the profitability of the company or the stage of its evolution and investment cycle. For example, start-up companies make little taxable profit but, under these proposals, could be highly taxed—which could severely hamper their growth prospects. These criticisms are addressed in the paper. It is suggested that there will be a high turnover threshold set before the new tax kicks in. There is no indication of the level of the threshold but the EU has proposed a turnover threshold of 750 million euros with EU income of 50 million euros before its proposed digital tax levy kicks in.
In addition, it suggests a safe harbor mechanism that could be adopted to ensure that companies only pay the tax when they are globally profitable.
Yet the fact remains that the additional levy could affect the U.K.’s global tax competitiveness as well as increasing the risks of retaliatory measures by the U.S. treasury. However, if anyone doubts the government's commitment then they should consider the comment that, if necessary, it is prepared to introduce a tax on a unilateral basis. In practical terms, this can only mean a turnover based tax. The temporary measure of a turnover based tax has the advantages of relative simplicity and an established collection mechanism; the government suggests that it can use features of the VAT system for this purpose. It also believes that the new tax can be introduced without breaching our international obligations.
The strong likelihood therefore remains that a turnover based tax is likely to be imposed. Whether this is truly an interim measure remains to be seen. After all, income tax was introduced in the 19th century as a temporary measure and remains with us, who would bet against a turnover based digital tax having similar longevity?
Paul Falvey, Tax Partner at BDO LLP, U.K.Paul is a specialist Tax Partner at accountancy and business advisory firm, BDO. He has considerable experience of working with international businesses and regularly advises on a range of corporate transactions including acquisitions and disposals, restructuring, and international tax planning. His client base extends across technology, manufacturing and financial sectors giving him a broad range of knowledge to draw upon.
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