What You Need to Know About the Digital Service Tax
From April 2020, the UK government will introduce a 2% Digital Service Tax on the revenues of search engines, social media platforms and online marketplaces which derive value from UK users.
This tax is said to be a temporary measure in lieu of a global reform that would ensure digital platform businesses pay their fair share of tax. While the UK supports an international agreement for a global Digital Service Tax, this measure is being brought in temporarily until such time that an agreement is reached.
France has already given their final approval to introduce a 3% tax on revenue generated in France by large internet firms. Both the UK and France do not believe that enough is being done to close loopholes that ensure these large firms pay tax on their revenue; so, they are taking matters into their own hands after attempts to agree a joint EU tax have failed.
Spain, Italy and Australia are also considering their own equivalent Digital Service Tax, whereas Ireland, Denmark, Sweden and Finland are opposed to the idea.
In the October 2018 budget, Chancellor Phillip Hammond announced the plans, saying: “The UK has been leading attempts to deliver international corporate tax reform for the digital age.
“A new global agreement is the best long-term solution. But progress is painfully slow. We cannot simply talk forever. So, we will now introduce a UK digital services tax.
“It is only right that these global giants, with profitable businesses in the UK, pay their fair share towards supporting our public services.”
The government forecasts that the Digital Service Tax is expected to raise £275 million in its first year and £440 million a year by 2023/24.
What is the Digital Service Tax?
The Digital Service Tax would be a targeted 2% tax on the revenues of specific digital businesses which the government considers to derive significant value from UK users. A group will be liable to DST when it provides a relevant business activity, has worldwide revenues that can be attributed to the business activities that exceed £500 million, and generates more than £25 million of these revenues from UK users.
The three online services the tax will apply to are search engines, social media platforms and online marketplaces. The DST is not a tax on online sales of goods, and it would only apply to revenues earnt from intermediating such transactions, not from the making of the purchase online.
Who Will the Digital Service Tax Effect?
Whilst the regulation has not been finalised, the government have released a draft guidance document introducing Digital Service Tax. It has been provided to assist the understanding of the application of the proposed DST and will be subjected to changes after September following a reflection on comments received. As a result, the information should be taken as a guideline and not an exhaustive list of every specific requirement and condition.
In order for it to be determined whether a company’s service is a distinct activity that would qualify them for DST or merely a component of a broader activity, it must meet two conditions: the service has to be for commercial purposes and has to provide a substantive business service.
To make this distinction, a company will need to consider the circumstances of its business model, and relevant factors may include:
- How users perceive the service.
- Where the service directly or indirectly generates revenue for the group.
- The extent to which the service contributes to the broader revenue generation of the group.
- Whether the service would be viable on a freestanding basis.
- Whether the service is an integral part of the business’ development and strategy.
Even if a given service or function does not satisfy the relevant activity condition itself, the revenues attributed to that service or function may still be taxable to the extent that they were generated in connection with a relevant activity.
The following is a more in-depth look at how the three relevant services – search engines, social media platforms and online marketplaces – are defined in the DST guide:
A search engine is not explicitly defined under the draft legislation but suggests that an internal search function that allows users to navigate information solely on that business’s website are not included under the definition. Instead, a search engine business falls under the principle of providing a search of the whole internet, and the use of an algorithm that continuously collects data to improve the performance of said search engine.
However, in cases where a website has a search function that provides results from third-party websites, and that the technology used for such a purpose comes from a third party other than the website owner, HMRC expects that it is this third party providing the search function technology that will be liable for DST and not the website owner.
Social Media Platforms
The draft legislation defines a social media platform as an online platform where:
- The primary purpose of the platform is to promote interaction between users – including interaction between users and content on the platform provided by users.
- The platform enables content to be shared with other groups of users.
- Activities that include any associate online advertising business operated by the group, where the advertising business derives significant benefit from its connection with the underlying social media platform.
The first condition refers to the purpose of the platform, and the deciding factors as to whether the platform is classified as operating as a social media platform as its primary purpose include:
- Growth and engagement of the user base.
- User-generated content as opposed to producing content.
- The ability to interact with other users being a driver in attracting new or existing users.
- Whether the business expends resources to understand how users interact with the platform and how to increase engagement.
- Whether the user is likely to use the platform in the absence of other users.
The second refers to content sharing. This is a broad concept and will only be met if the platform provides the capability to share content with multiple users – to distinguish it from private messaging software.
Some examples of the types of platform that could be covered by this definition of social media platform include:
- Social networking sites
- Video or image sharing platforms
- Online dating websites
- User review websites
The last condition refers to a business displaying advertising on websites and applications that may generate revenue through auctioning advertising space on third-party or related websites under their control. They will need to determine whether their business facilitates the display of online advertising and derives significant benefit from its connection with the underlying activity.
An online marketplace is defined as an online platform where:
- The primary purpose of the platform is to facilitate the sale of particular goods or services to users.
- The platform enables users to sell particular things on the platform to other users, or to advertise or, otherwise, offer other users particular things for sale.
These conditions are met if:
- The business activity is conducted through an online platform.
- The platform allows third parties to sell or advertise services, goods or other property to users – regardless of whether the platform facilities B2C, B2B or C2C or if the transactions are conducted on the marketplace platform or concluded outside the platform.
- The primary purpose, or one of the main purposes, of the platform is to facilitate the sale of services, goods or other property between users.
What is a UK User?
A UK user is defined as a user who it can reasonably be assumed is an individual or a business that is established in the UK. So, if someone using a marketplace service provides a UK address or UK payment details, it can reasonably assume that that person is usually located in the UK, and therefore a UK user.
HMRC will allow different approaches to determine user location, such as IP address, payment details, delivery address or other customer information. The business should conclude whether an outsider would make the reasonable conclusion that the user is most likely in the UK.
How Will the Tax Work?
The tax will be applied to revenues that are linked to the participation of UK users from search engines, social media platforms and online marketplaces. Businesses will only be taxed on the revenues derived from these services to the extent they are performing one of the three listed business models. The link to UK users means that it is the location of the user, not the business, which matters.
For example, a search engine that generates revenue from displaying advertising against the results of key search terms inputted by UK users would have the 2% tax applied to those revenues. A 2% tax would also apply to the revenue of a social media platform that generates revenue from targeting adverts at UK users. And a marketplace that generates commission by facilitating a transaction between UK users would have a 2% tax applied to those revenues.
Are There Any Exemptions?
The DST applies to companies with a global revenue of more than £500 million from in-scope business activities and UK revenues of more than £25 million from in-scope activities linked to the participation of UK users. There is an annual allowance on the first £25 million of revenues from in-scope activities linked to UK users. As a result, small businesses will not be in the scope of the tax.
There will also be a safe harbour to benefit businesses with very low-profit margins. These businesses can calculate their liability on an alternative basis, so the outcome is that losses under this calculation will not have to pay the DST and those with very low-profit margins will pay a reduced rate of tax. So, if a business has two in-scope business activities, such as a search engine and an online marketplace, it could choose to apply the alternative basis of charge to one, both or neither of these.
What are the Next Steps?
In the coming weeks, the government will be consulting on the final legislation for DST, exploring the key questions and challenges. HMRC will publish updated guidance later in 2019, reflecting comments received. It will then be legislated for the 2019/20 Finance Bill and will apply from April 2020.
The DST is set for a formal review in 2025, in line with the government’s commitment to continue to seek a global solution to ultimately replace DST. The government has also said it will dis-apply DST if an appropriate international solution is in place before this.
While this new Digital Service Tax may not affect your company, you may have clients who could fall under the in-scope business activities in the UK to qualify for being eligible to be taxed. At Gorilla Accounting, we are a technology-driven accountancy firm that provides accounting for contractors and freelancers operating through a Limited Company.
We provide you with your very own accountant who is always on hand to answer any questions you might have about your finances. You can even use our contractor tax calculator to find out how much your take-home pay could be per year based on your daily rate; we’ll help you maximise what you take home monthly. With our all-inclusive package that includes unlimited support and 24/7 access to our FreeAgent accounting software, Gorilla Accounting can help you regardless of your accounting requirements.