In our continuing series, Heather Self examines the tax issues that make the national headlines. This week, how best to tax the digital economy?
It is a truth universally acknowledged that the taxation system is in need of a new way to tax digital businesses. It is far less clear that a digital user tax, or DUT, is the right solution.
The problem is that the global tax system was designed at a time when factories manufactured physical goods. The concept of a permanent establishment (PE) sets a threshold below which local activities will not be taxed: there needs to be a fixed place of business, through which the activities of the enterprise are carried on, before a local tax liability arises. But a digital business can make significant sales, and perhaps profits, in a country without having a physical presence there at all.
There is a strong perception that major digital businesses are not paying their ‘fair share’ of tax, and the public mood is that ‘something must be done’. Politicians appear to agree.
The OECD, following on from its base erosion and profit shifting (BEPS) project, has proposed a new definition of a ‘digital PE’. However, as the current PE definition is embedded in almost all bilateral tax treaties, to change it would require global agreement. The big problem here is the US, which would be the main loser if its tech companies were to pay more tax elsewhere: why should the US play the role of a turkey voting for Thanksgiving?
More radical options, such as treating a global business as a single entity and apportioning its profits by reference to a formula (unitary tax, with formulary apportionment), or even taxing businesses by reference to where their cashflows arise (destination-based cashflow tax, or DBCFT) are likely to be even harder to agree on a global basis.
So a number of countries are starting to propose ‘interim’ solutions, which focus on taxing turnover (rather than profits) of digital businesses.
The EU suggestion is for a digital services tax (DST), which would tax the EU advertising sales of large businesses. This would impose costs on businesses such as Google and Facebook, but would not apply to the physical (or electronic) goods sold by Amazon. Levying a tax on turnover gets round the problem of needing to amend double tax treaties, but would bear more heavily on newer and less profitable businesses – so while Google could probably cope with a 3% tax, a newer competitor might struggle. It also assumes that the number of users per country can be tracked – but is a user with a laptop, a work computer and a mobile phone one user or three? And what if, for security or privacy reasons, a virtual private network (VPN) is being used, which makes it impossible to determine a user’s true location? And what about the data protection (GDPR) issues? Even if these issues could be addressed, the measure requires unanimity across the EU, and currently at least six countries are not in favour – so it seems the EU DST is unlikely to make rapid progress.
Meanwhile, it seems increasingly likely that Philip Hammond will announce a UK version of a DST in the Budget on 29 October, or at least a detailed consultation on the form it should take. The government published a position paper, Corporate tax and the digital economy, in November 2017, and updated it in March 2018. The paper focuses on the concept of ‘unrecognised user-created value’ and suggests that a tax should be levied on ‘the revenues of digital businesses deriving significant value from UK user participation’ – a digital user tax.
Like the EU’s DST, this would be a turnover tax, so would suffer from the same problems of falling more heavily on less profitable businesses, identification of users, and privacy concerns. But it would fall on a different subset of businesses, wider than mere online advertising; for example, an online platform such as Airbnb would clearly be within its scope.
The paper accepts that there will be challenges in: defining businesses that are within scope; determining the revenues of those businesses which should be taxed; the identification of user location; the problems of start-ups and loss-making businesses; and the practical difficulties of collecting tax from a business with no physical presence in the UK. It blithely assumes that these challenges can be overcome, although there is a wistful comment that it would be easier to implement a DUT on a multilateral basis.
So it seems we may well get a UK DUT from April 2020. It won’t be simple; it won’t be enough to satisfy public hunger for more to be done; and, in my view, it won’t produce a ‘fair’ result – because turnover is an arbitrary and very imperfect way to tax profits.
What could we do instead?
We could support the OECD BEPS project and seek to ensure that profits are taxed somewhere rather than nowhere, and accept that the allocation won’t be perfect. We could work hard towards longer term reform through a digital PE concept, or even DBCFT. And we could reform business rates to charge more on large physical facilities (Amazon warehouses and the like). And if we want a turnover tax, we can use VAT and compensate for any regressive impacts through other measures such as the benefits system.
But we should not assume that there is a simple solution to the problem of digital businesses not paying enough tax.
Home >Articles > Self’s assessment: What’s wrong with a digital user tax?
Self’s assessment: What’s wrong with a digital user tax?
In our continuing series, Heather Self examines the tax issues that make the national headlines. This week, how best to tax the digital economy?
It is a truth universally acknowledged that the taxation system is in need of a new way to tax digital businesses. It is far less clear that a digital user tax, or DUT, is the right solution.
The problem is that the global tax system was designed at a time when factories manufactured physical goods. The concept of a permanent establishment (PE) sets a threshold below which local activities will not be taxed: there needs to be a fixed place of business, through which the activities of the enterprise are carried on, before a local tax liability arises. But a digital business can make significant sales, and perhaps profits, in a country without having a physical presence there at all.
There is a strong perception that major digital businesses are not paying their ‘fair share’ of tax, and the public mood is that ‘something must be done’. Politicians appear to agree.
The OECD, following on from its base erosion and profit shifting (BEPS) project, has proposed a new definition of a ‘digital PE’. However, as the current PE definition is embedded in almost all bilateral tax treaties, to change it would require global agreement. The big problem here is the US, which would be the main loser if its tech companies were to pay more tax elsewhere: why should the US play the role of a turkey voting for Thanksgiving?
More radical options, such as treating a global business as a single entity and apportioning its profits by reference to a formula (unitary tax, with formulary apportionment), or even taxing businesses by reference to where their cashflows arise (destination-based cashflow tax, or DBCFT) are likely to be even harder to agree on a global basis.
So a number of countries are starting to propose ‘interim’ solutions, which focus on taxing turnover (rather than profits) of digital businesses.
The EU suggestion is for a digital services tax (DST), which would tax the EU advertising sales of large businesses. This would impose costs on businesses such as Google and Facebook, but would not apply to the physical (or electronic) goods sold by Amazon. Levying a tax on turnover gets round the problem of needing to amend double tax treaties, but would bear more heavily on newer and less profitable businesses – so while Google could probably cope with a 3% tax, a newer competitor might struggle. It also assumes that the number of users per country can be tracked – but is a user with a laptop, a work computer and a mobile phone one user or three? And what if, for security or privacy reasons, a virtual private network (VPN) is being used, which makes it impossible to determine a user’s true location? And what about the data protection (GDPR) issues? Even if these issues could be addressed, the measure requires unanimity across the EU, and currently at least six countries are not in favour – so it seems the EU DST is unlikely to make rapid progress.
Meanwhile, it seems increasingly likely that Philip Hammond will announce a UK version of a DST in the Budget on 29 October, or at least a detailed consultation on the form it should take. The government published a position paper, Corporate tax and the digital economy, in November 2017, and updated it in March 2018. The paper focuses on the concept of ‘unrecognised user-created value’ and suggests that a tax should be levied on ‘the revenues of digital businesses deriving significant value from UK user participation’ – a digital user tax.
Like the EU’s DST, this would be a turnover tax, so would suffer from the same problems of falling more heavily on less profitable businesses, identification of users, and privacy concerns. But it would fall on a different subset of businesses, wider than mere online advertising; for example, an online platform such as Airbnb would clearly be within its scope.
The paper accepts that there will be challenges in: defining businesses that are within scope; determining the revenues of those businesses which should be taxed; the identification of user location; the problems of start-ups and loss-making businesses; and the practical difficulties of collecting tax from a business with no physical presence in the UK. It blithely assumes that these challenges can be overcome, although there is a wistful comment that it would be easier to implement a DUT on a multilateral basis.
So it seems we may well get a UK DUT from April 2020. It won’t be simple; it won’t be enough to satisfy public hunger for more to be done; and, in my view, it won’t produce a ‘fair’ result – because turnover is an arbitrary and very imperfect way to tax profits.
What could we do instead?
We could support the OECD BEPS project and seek to ensure that profits are taxed somewhere rather than nowhere, and accept that the allocation won’t be perfect. We could work hard towards longer term reform through a digital PE concept, or even DBCFT. And we could reform business rates to charge more on large physical facilities (Amazon warehouses and the like). And if we want a turnover tax, we can use VAT and compensate for any regressive impacts through other measures such as the benefits system.
But we should not assume that there is a simple solution to the problem of digital businesses not paying enough tax.
