UK to enact first-ever tax on digital services

Tax Hot Topics newsletterThe United Kingdom has begun the legislative process for enacting a new digital services tax (DST). The measure would capture 2% of revenues generated by search engines, social media platforms, and online marketplaces which stem from participation of UK users. It generally targets businesses that earn at least £500 million (approximately $636 million) in revenue globally from these “digital business models.” The proposed tax will likely become effective in April 2020 and is expected to raise roughly $1.9 billion over four years.

The DST is not the only proposal of its kind, but the UK is the first governing body to take concrete steps toward actually implementing the concept. In announcing the undertaking, the government cited a pressing need for international reforms to taxation of digital businesses. It posits that the specified digital business models derive significant value from the participation of UK users and a tax reflecting that value will help maintain a fair and sustainable corporate tax system. However, it indicated that international reform efforts in this vein, namely within the EU and OECD, were moving too slowly, prompting it to address the issue on its own.

Generally, the DST works by imposing a 2% tax on revenues of search engines, social media platforms, and online marketplaces which are linked to the participation of UK users. Thus the tax applies to businesses regardless of where they are located, but only to the extent that they engage in the specified activities within the UK. For instance, social media platforms and search engines would only be taxed on revenue generated by advertisements displayed to UK users. Online marketplaces would be taxed on fees and commissions received for acting as a conduit for sales of goods to UK consumers. The government was careful to note that the DST was not a tax on the actual sale of goods.

The proposal contains limitations which aim to ease the burden on smaller businesses and startups. It applies only to businesses with £500 million or more in global revenues from the three designated digital business models and exempts the first £25 million of in-scope UK revenue. It also offers a safe harbor in the form of an alternative basis for calculating liability. Businesses which elect to use this method can avoid the DST entirely if they calculate a loss under it, while those who calculate “very low” profit margins will qualify for a reduced rate. The exact nature of the alternative basis and the specific profit margin threshold and reduced rate amounts have yet to be determined.

The UK’s tax legislative process has been streamlined in recent years and all signs point to the DST being enacted next year and becoming effective in April 2020 as planned. The government issued a consultation for the proposal on Nov. 8 that will run through February 2019. A consultation is akin to the public comment period in the United States’ federal rulemaking process. The proposal will be tweaked and fleshed out in response to public feedback, but wholesale changes or outright withdrawal are unlikely. It is possible a second consultation could be issued as well. Once consultation is complete, however, the proposal will be included in the 2019-2020 Finance Bill, a single vehicle for all of the year’s tax legislation. Parliament will then have the opportunity to further refine the idea, but again, only narrow, perfecting amendments are expected before it is passed.

Despite moving forward with the DST, the UK insists that it remains committed to an international solution. It has stated it will “dis-apply” the DST if such a solution materializes before 2025, when the tax is set to undergo a formal review.

Dustin Stamper
Managing Director, Washington National Tax Office
T +1 202 861 4144

Omair Taher
Senior Associate, Washington National Tax Office
T +1 202 861 4143

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