Digital services tax a success, say officials, but it should be gone by 2025

The evidence session took place on 8 December, with witnesses:

• Jim Harra, Chief Executive and First Permanent Secretary at HMRC
• Jon Sherman, Director of Business, Assets and International directorate at HMRC
• Mike Williams, Director Business and International Tax at HM Treasury

You can read the full transcript, view written evidence from CIOT and others, and watch the session, here.

The session was opened by PAC chair Dame Meg Hillier who set out the committee’s starting point for the hearing: “Last year, the digital services tax raised about £358 million, but about 90% of that came from just five businesses. Today, we are discussing how it is working, what lessons HMRC is learning, what gaming might be going on by businesses, how it is going to work while we wait for the full international agreement to kick in, and what progress there is on that.”

Customs declaration service

Before discussing the DST Hillier asked for an update from Jim Harra on the move to a new customs declaration service (CDS). She noted that this was now in place, but the ‘trader dress rehearsal system’ had been problematic, with issues including HMRC changing some of the tariff codes.

Harra replied that the move had gone well. 240 declarants accounting for 87 all declarations had all migrated successfully by the end of November, as had a further 2,500 of the 3,000 low volume users, and 820 declarants who had not been on the old system. He said the dress rehearsal service had been used extensively. An overnight load of new tariff data had caused some problems for a day because it had not been publicised but it was not related to the dress rehearsal service itself.

Harra said he would like to be able to switch off CHIEF, the old system, currently running in parallel to the CDS, by the end of this financial year.

DST – structure and impact

Turning to the DST, Hillier asked if it was meeting government expectations. Mike Williams of HM Treasury said it was doing what the Government intended it to do, which is to act as an interim solution. The five businesses mentioned by Hillier are paying significantly more tax than before because of the DST, said Williams, but it is interim, and it is intended to be replaced in due course by a profits-based solution rather than the turnover-based tax of the DST.

Williams said that the rapid move to online shopping prompted by the pandemic had increased the profits of digital services companies, though this might have happened anyway, just more slowly. The DST had raised £358 million in its first year against a forecast of £275 million. Another reason for the take being higher than predicted might be that the OBR had applied a 20 per cent discount because it assumed there would be tax planning by those affected, said Jim Harra, but this did not appear to have happened.

Sir Geoffrey Clifton-Brown probed the panellists on the reasons for the rate and threshold of the tax. Williams acknowledged that knowledge of US opposition to the tax was a factor for the UK as for other governments) in framing the tax and setting the rate.

Also responding to Clifton-Brown the officials acknowledged that the DST creates some ‘double taxation’. Jim Harra explained: “By its nature, if they are profitable, the turnover that is being subjected to digital services tax is contributing to their profits, which are then attributed to whichever country they say has taxing rights over those profits. The reason for the digital services tax is because of the sense of unfairness that those profits are not being attributed back to the UK… So, in that sense, yes, in theory, a profitable business must be subject to tax somewhere on the profits that are generated from that turnover. On the other hand, if they are not profitable, there is a provision in the digital services tax that they can apply to sort of disapply the DST. If they demonstrate that there is no profitability for them from those activities, then we won’t tax them on their turnover.”

This, said Jon Sherman, was the alternative methodology for the tax: “It kicks in, basically, if the margin on the services that are in scope is less than 2.5%”. Has anyone used it? Yes, said Sherman. “Of the companies that have made returns under the DST, a number of them have paid and a number of them have not paid. The ones that haven’t paid will be ones where they are in a loss situation—where, as a result of the alternative methodology, there is no DST payable. In that sense, those companies will certainly have used it.”

DST – lessons

Asked what lessons the government have learned from the introduction of the DST, Mike Williams said they had always known that the best solution is to tax profits and to move profits around, rather than taxing revenue. He acknowledged this was ‘an imperfect interim solution’.

Later, Geoffrey Clifton-Brown asked whether the implementation of DST held lessons for a transition for Pillar 1 – and indeed Pillar 2 – reforms. Harra replied that a key lesson was that when you only have a small group of taxpayers you can interact with them on a one-to-one basis. It would have been ‘much more challenging’ if there had been a large population of taxpayers.

Mike Williams agreed. “This proposition that if you can get most of the money by focusing on a small number of large players then you should probably do that, if it doesn’t distort competition—you see features of that in the residential property developer tax, which is already in place, where we put in place quite a high threshold. Again, you are taking the tax from the bigger players. You also see it as a feature of the electricity generator levy… the thresholds are high enough to keep out the smaller players who would struggle but would also probably divert resources.”

You could simplify income tax if you said that only people making more than £1 million in profits would pay, mused Williams, exciting the committee somewhat. You could get cheap popularity through thresholds that are too high, he suggested. The chair suggested such matters should be left to the politicians!

Clifton-Brown reflected that a lot of corporation tax payers would be very pleased to have a £25 million threshold before they started paying corporation tax.

DST – purpose and future

Jonathan Djanogly asked whether the main purpose of the DST was to have people paying their fair share, or to raise revenue?

Mike Williams said that was a very good question. “There have been articles in the US tax press—they tend to always focus on the UK and France—that say, “The DSTs in those countries were introduced, and they can’t afford to give up the revenue.” But you are talking, in both cases, about half a million [he presumably meant billion] pounds of revenue a year in economies that are over £2 trillion a year. The revenue is clearly important, but I would say that getting to a fairer system is more important and more the driver.”

Geoffrey Clifton-Brown asked about the proposed retiring of the tax in April 2024. Jon Sherman explained that the government’s commitment is “that it will be retired once pillar 1 takes effect, but there is also a provision that it should be reviewed. If that has not happened by the end of 2025, I think there is a commitment to do a review.”

Pillar 1 – reallocation of taxing rights

Clifton-Brown also asked about progress on pillar 1 of the OECD Inclusive Framework – the reallocation of taxing rights.

Mike Williams told him that countries had found it easier to agree where profits should move to than which country those profits should come from. He called this ‘the essential missing piece in the jigsaw’.

In response to Lib Dem MP Sarah Olney, Williams said that it was his expectation that we will have transitioned from the DST to pillar 1 before the DST is reviewed in 2025. “That is quite a challenging timetable, but, equally, there have been challenging timetables before on pillars 1 and 2.”

Clifton-Brown asked whether the officials had seen the evidence from the Chartered Institute of Taxation, which he described as ‘quite interesting’. “They say in their evidence to us: “Pillar 1 will add a further significant compliance burden on MNEs, and we are also concerned about the resourcing burden that will be placed on HMRC as the pillars introduce a whole new level of complication around achieving tax certainty and dispute resolution.” Given that you have not even started modelling it yet, how are you preparing for this?”

Jon Sherman replied that the first filing date will be 18 months after the end of the first accounting period, so it will be the summer of 2026 when companies start filing their pillar 2 returns, “so there is a fair amount of time ahead there”. The OECD are working on a further package of administrative provisions, part of which will focus on how the process can be simplified or made more certain. The expectation is that, rather than each tax authority doing its own compliance work, “the companies in scope will be able to apply for what is called a certainty process, so they will file to their parent jurisdiction and then that jurisdiction will work with the other jurisdictions affected to agree on how the various amounts are moving around… There will be a process that will provide some kind of binding certainty for companies.”

Quoting again from CIOT’s evidence to the committee, Geoffrey Clifton-Brown asked: “Are the current expected timetables realistic, Mr Williams, or is this whole thing slipping?” Williams replied that there is ‘reason to believe that we can meet that timetable’ though he could not rule out slippage. The next milestone would be the multilateral convention, which is available for signature in the middle of 2023. However it is relatively easy for a country to sign a convention, so the question really is whether it does the domestic processes required to implement it.

Pillar 2 – global minimum corporation tax

Geoffrey Clifton-Brown also asked the officials to comment on CIOT’s doubts that pillar 2 would raise over £2 billion. Mike Williams said it was an OBR forecast, that will be a central estimate, and that there is ‘nothing in tension’ between it and the OECD’s overall numbers. “Pillar 2 targets businesses with above €750 million turnover. That is smaller than the target population of pillar 1, but they are not small businesses.”

This was followed by some inconclusive questioning around the risks of avoidance and the likelihood that any costs to business would be passed on to consumers.

There was also some discussion about how less developed countries with unsophisticated tax regimes and tax authorities would operate both pillar reforms. Williams agreed this was a key challenge. He said relatively small countries may say that there is a de minimis level that means that if your contribution to the pot will be very small, you don’t have to bother. Also, there is a proposal that the tax administration for the group as a whole (for a US-based group, the IRS; for a UK-based group, HMRC) would take the lead in doing the work to work out how much money each country should get. The OECD’s capacity building network was also mentioned.

Treatment of cryptocurrency

At the instigation of Conservative MP Flick Drummond there was some discussion about cryptocurrencies. Jon Sherman confirmed that cryptocurrency would be in scope for the DST, if you had a marketplace where the service being provided was crypto.

More broadly Jim Harra confirmed that HMRC actively monitor cryptoassets as a risk. “There are two key areas of risk there. One is whether we can manage the risk from the really big gains and get transparency, but the other is that there are probably a very large number of fairly unsophisticated people who do not normally make self-assessment returns who might make a moderate gain if they own cryptoassets, but above the annual exempt amount. We need to educate them and raise awareness, so that they are aware that they will have an obligation if they do that. We have a forum, which includes the Low Incomes Tax Reform Group, that tries to make sure that we reach not just the big, sophisticated end of the market, but also that broader end.”