UK issues position paper update on corporate tax and the digital economy

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1 14 March 2018 Global Tax Alert UK issues position paper update on corporate tax and the digital economy EY Global Tax Alert Library Access both online and pdf versions of all EY Global Tax Alerts. Copy into your web browser: Executive summary Alongside the Spring Statement 2018, delivered by the Chancellor of the Exchequer on 13 March 2018, 1 the United Kingdom (UK) Government released a number of consultations and calls for evidence, as well as an update on the Government s thinking in respect of the taxation of companies operating in the digital economy. The taxation of digital companies continues to feature highly on the fiscal agenda of many large economies, with many governments feeling that they are not receiving their fair share of tax arising from certain digital activities undertaken in their jurisdictions. Both the Organisation for Economic Co-operation and Development (OECD) and the European Commission continue to work on proposals to address the concerns, with reports on progress due in the coming weeks. In advance of these, the UK Government has produced a new position paper, following on from the previous position paper issued as part of Autumn Budget and reflecting upon points raised via stakeholder engagement to date. The new paper does not demonstrate any change in approach by the UK Government, instead giving an update on the Government s thinking, providing further details on how it considers new rules might apply and considering the challenges that might need to be addressed as both long-term and interim measures are developed. The Government notes that the paper does not set

2 2 Global Tax Alert out its final view, but it hopes its view can continue to help inform the ongoing work at the OECD, and in the European Union (EU), and to achieve a coherent, proportionate and sustainable long-term solution. Although the Government re-emphasizes its preference for multilateral cooperation in the implementation of long-term and interim measures, it remains committed to unilateral measures if sufficient progress is not made. Detailed discussion Background Where the profits of digital companies are taxed continues to feature highly on fiscal agendas, with political pressure being felt by governments to act to address the taxation of digital businesses. Following on from work undertaken by the G20/OECD as part of the Base Erosion and Profit Shifting (BEPS) Project, actions by individual territories to introduce unilateral measures and the push for action at an EU level, the UK Government set out its view on how the tax challenges posed by the digital economy could be addressed in a position paper, published at the time of Autumn Budget The Government has now updated its initial view, taking into account the responses received from a wide range of stakeholders and reflecting upon a number of key challenges that were highlighted by the previous responses. The new position paper comes in advance of the OECD and European Commission reports on taxation of the digital economy, expected in the coming weeks. There are similarities in approach between the UK position and that set out in a draft of the Commission s paper that was leaked at the end of February. However, there will be differences in views among Member States and the Commission and much negotiation to be had, but the UK hopes that it will be able to take forward changes on a multilateral basis with like-minded territories. The Government hopes to use the paper to continue to engage with businesses and other stakeholders in order to better understand and resolve some of the outstanding questions. The UK Government s view The Autumn Budget 2017 position paper set out that the Government supports the established principle that profits should be taxed where value-generating activities are undertaken and this is reinforced in the new paper. However, the Government considers that the existing framework does not take into account user-generated-value when allocating taxable profits. This remains a core view of the Government and the new paper seeks to build upon this and identify the different ways that user participation can drive value and where this concept applies most strongly. User participation The new position paper seeks to clarify what is meant by user participation, differentiating this from the role that a customer serves in a traditional business and the mere collection of customer data. In particular, the Government considers that user participation is the process by which users can create value for certain types of businesses through their engagement and active contribution. The channels currently identified by the Government include: Generation of content by users that supports a business ability to attract and retain users and generate revenue Deep engagement with the platform allowing tailoring of platform and content and collection of valuable behavioral data Development of networks through engagement and actions that create connections between users Contribution to a business brand through provision of content, goods or services and through moderation and the rating of content In the Government s view, user participation in such channels can be seen as effectively performing supply-side functions that would historically have been undertaken by the businesses themselves. The Government also notes that while traditional multi-sided and intermediation business models do exist (for example, town markets), the constraints to scale and remote operation mean that the value of users will always be limited or substantially captured in the jurisdiction where the customers are located. Relevance of user-participation value to businesses The Government acknowledges that different digital business models do not derive a common value from user participation, which leads to challenges in developing new international tax rules. The Government considers that while the link to value can be clear for online networks (such as social media, search engines and intermediation platforms) and seems least relevant for e-retailers and digital software/hardware

3 Global Tax Alert 3 providers, further investigation is required on the relevance of user participation to digital content providers. While these share some characteristics with e-retailers, the Government considers that there is the ability to develop a more sustained relationship with the users. There is also a need to consider the variation of businesses within a given category (for example, where the value might depend upon the platform s sophistication), where the distinction between different categories of business might be blurred and how the rapid pace of change in the digital sector may alter the relevance of user-participation for newer businesses. Long-term reform In the Government s view, the existing international tax framework could be amended to deal with businesses in the digital economy by giving recognition to value created by user participation and considering this when allocating profits. It considers that jurisdictions should be given the right to tax their proportionate share of the profits generated by a business from user participation. It considers this might be done be giving jurisdictions in which active users are located the right to tax a percentage share of the residual profit realized by principal companies in the group, i.e., a share of profits after an arm s-length return has been given for routine functions. This would require changes to the framework, which the Government suggests could be delivered through the OECD s Model Tax Convention as follows: Recognize user participation as an important value driver Set out a method for determining that value Identify the companies within a group that users should be linked to that should be taxed (which might not necessarily be the company with the residual profits) Give jurisdictions the right to tax such companies, even where no traditional permanent establishment exists Set out a method for determining the proportion of the user-created profits that should be allocated to a territory There remain areas that would need to be considered in more detail, such as what might happen where users are linked to companies which do not contain the residual profits of the business, or where there may be multiple companies taking a share of the residual profit. The administrative burdens where multiple companies are deemed to have a permanent establishment in a jurisdiction would also need to be considered, although the Government considers that this could be mitigated by giving groups the option to have one such company responsible for paying tax on behalf of the others. Interim measures As set out in its previous position paper, the Government considers that an interim solution may be necessary. It envisages that such a measure would be in the form of a revenue-based tax, though recognizes that this would need to be carefully targeted and include measures to prevent adverse impacts on start-ups, growth companies and those making losses. Approaches could include: Defining the characteristics through which users create value and then taxing businesses where such characteristics are most relevant, e.g., generation of content, deep engagement with platform, among others Define the categories of business which derive most value from user participation, e.g., social media platforms, search engines and online marketplaces Define revenue streams commonly generated from user participation in such businesses, such as online advertising revenues Recognizing the different merits and challenges, the Government suggests a combination of these approaches, together with a de minimis threshold, might be appropriate. It also suggests that a safe harbor mechanism could be used to protect businesses making losses and/or low margins. The Government s preference would see compliance sitting with the businesses generating the revenues, even where no physical UK presence exists, though a one stop shop approach, similar to value added tax, could be used to reduce the burden. It acknowledges that administration and collection are areas where multilateral adoption would offer benefits. Key milestones coming up The tax challenges of the digital economy are due to be discussed at the next G20 meeting of finance ministers, to be held in Buenos Aires, Argentina, on March The discussions are to be based upon an outline of the

4 4 Global Tax Alert OECD s upcoming interim report. The European Commission and the finance ministers of France, Germany, Italy, Spain and the UK set out their high-level views in a letter to the G20 Chair on 1 March. In particular, they consider that new global rules on territorial nexus and the allocation of profits should be pursued, although this should not prevent countries being allowed to adopt an interim solution, preferably on a coordinated basis. Both the European Commission and OECD are due to publish their reports in the coming weeks, with the timetable for the OECD s report rumored to have been accelerated. The leaked version of the Commission s paper suggests that they are considering many of the same issues as the UK, although we understand the paper has been subject to much negotiation since the leaked draft and the final version may differ somewhat. Meanwhile, the OECD is considering the views of many countries, not all of whom support a change, and accordingly its report is expected to consider the benefits and issues of different proposals and the challenges of interim measures. Nevertheless, there seems scope for agreement among a core group of countries on an approach, even if not full consensus. Absent that, there are likely to be continued implementation of unilateral measures. Implications While not an official consultation paper, the UK Government wishes to continue to engage with businesses and other stakeholders to discuss the position set out in the paper. It is clear that the UK is keen to remain at the forefront of the debate on the taxation of digital businesses and possible actions for international reform, helping shape the ongoing work of the OECD and the European Commission. However, the increasingly vocal support for interim measures based upon a tax on gross revenues, both from individual countries and from the leaked draft of the European Commission report, suggests a high likelihood that such measures will be introduced in the near future by at least some countries, potentially on an uncoordinated basis. While there is still considerable detail to be thought through, businesses should consider the potential impact of the UK s proposals and what it might mean for their operating models in light of the additional clarity provided. We can assist businesses who may wish to provide comments on the new position paper to help shape the Government s views through better information and understanding of the impacts and help businesses monitor developments in other countries in which they operate. Endotes 1. See EY Global Tax Alert, UK issues Spring Statement and associated documents, dated 14 March See EY Global Tax Alert, UK 2017 Autumn Budget: Key business tax announcements, dated 22 November 2017.

5 Global Tax Alert 5 For additional information with respect to this Alert, please contact the following: Ernst & Young LLP (United Kingdom), London Claire Hooper chooper@uk.ey.com Edward Cawdron ecawdron@uk.ey.com Ernst & Young LLP, UK Tax Desk, New York James A. Taylor james.taylor1@ey.com

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