Global digital businesses have been in the headlines for several years now. There continues to be widespread public concern at the very low amounts of U.K. corporation tax they pay. The public perception is that our tax system is unfair if it allows multinational companies, with their many evident and widespread customers in the U.K., to pay so little U.K. tax on their profits.
The U.K. government has recently published an updated position paper on “Corporate Tax and the Digital Economy” with some ideas on how the government might seek to tackle the perceived unfairness in the system and increase its tax revenues from these global digital giants.
Our U.K. tax system, in line with all countries involved in the Organization for Economic Cooperation and Development (“OECD”), taxes profits. The international tax rules currently look to business functions and the control of assets and risks in determining the countries in which a business should be taxed. The OECD tax system does not currently consider the value that “users” contribute to businesses in this allocation of profits between territories.
The position paper sets out in some detail why “user participation” should also be taken into account when determining how business value is created and where profits should be taxed. It notes that the participation and engagement of users is an important aspect of value creation for certain digital business models, and is likely to be reflected through several channels, such as the provision of content or as a contribution to certain intangibles such as brand.
The paper sets out some different ways to approach how to value “user participation.” For example, an online retailer will derive less of its value from its users, because the design and quality of the product will remain of key importance, so it should continue to attribute value to where the design functions are carried out. In contrast a website where users provide and share content and as a result introduce new subscribers or provide access to new customers and services will derive more value from its customers and so value will be created wherever they are located.
The government's preferred solution to this challenge is reform of the international corporate tax framework to reflect the value of user participation through the OECD. The U.K. has been an enthusiastic supporter of previous initiatives by the OECD to tackle perceived multinational tax avoidance, and an early adopter of the agreed principles into our U.K. domestic tax law. So you would expect this to be the preferred route. The disadvantage of this route is the time it is likely to take to reach any international consensus on the changes required.
The slow pace of internationally-agreed change may mean the U.K. chooses to consider interim measures such as revenue-based taxes. The new legislation to extend royalty withholding taxes to catch certain payments for the use of intellectual property, which are made to connected non-U.K. companies, could be viewed as an example of this sort of measure. Draft legislation is expected on this next year with changes from April 1, 2019.
While a revenue-based tax may seem like a short term solution to tackle perceived tax avoidance by multinationals and the unfairness in the system, it will be difficult to come to agreement and measure what income should be taxed. It will also be important to protect start-up and growth businesses, on which much of our U.K. economic prosperity depends. Add to this the impact of Brexit, and the need for the U.K. to maintain good relations with our international trade partners to secure good trading arrangements in our post-EU phase, and it is unlikely that the U.K. would want to pursue any significant unilateral changes in the short term.
Jane Mackay is Head of Tax at national audit, tax and advisory firm, Crowe Clark Whitehill.
She may be contacted at: firstname.lastname@example.org
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