Globalization and the dominance of international tech giants, largely based in the US, have posed a challenge to tax authorities around the world, where there is a misalignment between the place where profits are taxed and the place where the value is created. Countries outside of the US have long argued that digital platforms should face a unique tax on their services in-country, as there is value derived from users participating with their services online.
The OECD has been working on a complex and complete international tax agreement to tackle this issue, one that would include approximately 140 tax jurisdictions, but has faced a number of delays to its implementation. As a result a number of individual countries have pushed ahead with their own plans in the interim.
One of those countries is the UK, which launched its own Digital Services Tax back in 2020, which is a tax on turnover, not profits, for business groups whose revenues from in-scope activities are more than £500 million and where more than £25 million is derived from UK users.
This is untested territory and this week we got a first bit of insight into how such a novel tax regime has played out for the UK tax authorities. The influential Public Accounts Committee in the UK has assessed HMRC’s approach to taxing digital services providers, where it has found that - at least initially - the “blunt instrument” scheme has been more successful than anticipated.
The Digital Services Tax is only meant as an interim measure while the OECD seeks to get agreement and implement its own international measures, but with those up in the air, questions are being raised about the UK extending the current regime.
The Public Accounts Committee found that between 2020-21 HMRC collected revenues of £358 million, which is 30% higher than was projected. It found that different businesses paid both more and less than expected, with positive and negative impacts from the COVID-19 pandemic creating significant variation against expectations.
We don’t have the exact details, but fourteen businesses paid more than expected, while fifteen paid less than expected or nothing. However, the report released today adds that HMRC is still identifying additional potential payers, so the final £358 million figure may well increase.
However, because these figures reflect the first year of the tax regime, which occurred during the pandemic, it’s difficult to know what a ‘normal’ year’s revenues would look like. It was initially predicted that the tax would bring in approximately £3 billion of revenues by 2025.
Interestingly the tax has only cost HMRC £6.3 million so far to implement, less than budgeted - although there will be ongoing compliance costs. But the small population of payers means that HMRC has been able to build a relationship with each tax paying business and has been able to learn about the population of digital businesses more generally.
The OECD challenge
As noted above, the OECD is working on its own measures to establish an international agreement for multinational corporations, which will cover companies that go beyond those with digital platforms. The timetable for implementation of the OECD reforms has already slipped since the OECD announced agreement on the framework for its ‘two-pillar solution’ in October 2021.
Pillar one aims to ensure a fairer distribution of profits and taxing rights among countries with respect to the largest and most profitable multinational enterprises. Pillar two introduces a global minimum corporate tax rate set at 15%, which will apply to companies with revenue above EUR 750 million. The UK had said that it would drop its Digital Services Tax once Pillar one was introduced.
The OECD’s current timetable for a multilateral convention signed by 140 tax jurisdictions is in mid-2023, leading to implementation of Pillar One in 2024. However, as the Public Accounts Committee highlights:
This looks challenging and the ability to get key players on board is crucial. HMRC has not yet produced an estimate of revenue to the UK from Pillar One, telling us that too much is still uncertain about the new arrangements. HMRC says that the Office of Budget Responsibility’s estimate for annual revenues of £2 billion through Pillar Two is in line with high-level estimates from OECD.
It adds that there is a “significant risk” that the Digital Services Tax may require extension beyond its intended lifespan, and that this could prompt changes in taxpayer behavior. It notes:
Should the OECD reforms be delayed beyond 2024, the Government is required by law to review the operation of the Digital Services Tax in 2025. We assume that the tax would continue in some form if possible but there is a question about its long-term sustainability. While there may be no evidence of active tax avoidance or evasion by businesses to date, this may change if the life of the Digital Services Tax is extended.
Businesses such as those within the scope of the tax traditionally employ significant resources to ensure that their exposure to tax is minimized, and they may consider that the Digital Services Tax is more worthy of such attention if it is extended. Methods for ensuring compliance are untested and could require cooperation between countries.
This is an interesting insight into how such a tax could lead to increased revenues for tax authorities. The scheme seems to be working well, with low costs attached and strong relationships between the companies and the authorities. However, there is still concern about how this will work over the longer term as these organizations face more tax burdens internationally - not to mention how the US responds, given it wants to protect its thriving tech giants. The OECD has a tough job on its hands getting 140 tax regions to sign up to its complex, comprehensive plans - and then compliance will become the next issue. However, what’s clear is that the current tax regime isn’t fit for the modern world of business and new solutions need to be tried and tested.