‘Temporary’ Digital Services Tax risks becoming permanent, says CIOT

John Cullinane, CIOT’s Director of Public Policy, said:

“This report shines a welcome light on the Digital Services Tax three years after it came into effect.

“By some measures the tax has been a success – as the PAC points out it raised 30 per cent more than expected in its first year. However, the fact that the tax still exists – and has no immediate prospect of repeal – represents a failure.

“The Digital Services Tax was only ever intended as a stopgap – and with good reason. As we pointed out in our evidence to the committee, a revenue tax such as this is a blunt instrument that cannot accurately represent the tax on the profits generated in the UK.  It will inevitably over-tax some companies and under-tax others. It is also highly controversial internationally, especially with the United States, home of a number – perhaps a majority – of the companies affected.

“But there is little sign of a breakthrough in the OECD talks on allocation of taxation rights that all major trading partners will be able sign up to, which we are hoping will produce the agreement that will enable the UK Digital Services Tax – and its equivalents elsewhere – to be scrapped.¹

“Given the complexity of reaching agreement on allocation of taxing rights internationally and in then ratifying the treaty in a sufficient number of countries, we have to face up to the real risk that the tax could become effectively permanent.

“The PAC’s report poses some sensible questions about the problems this may create in terms of incentives and compliance – although the Digital Services Tax is a very small fraction of the overall tax bill that multinational corporations will be paying, so we should not overestimate the effort they are likely to put into reducing their bill. In any case they are likely to seek to pass on their costs to advertisers and traders.

“However, the bigger concern should be the reaction of the United States, in particular, if the OECD talks do not achieve a consensus. The US feels measures such as the Digital Services Tax unfairly target American companies and has in the past threatened retaliation against countries which adopt them.

“This report only emphasises why reaching a multilateral solution to taxing digital multinational companies is so important, and why it is important that all governments, including our own, redouble their efforts in this area, enabling us to repeal the Digital Services Tax once an appropriate global solution is in place.”

The PAC’s report also recommends that “HM Treasury and HMRC should consider what lessons can be learned from the Digital Services Tax’s introduction in terms of implementing tax systems efficiently and assessing the proportionality of its impact on taxpayers”.

John Cullinane commented:

“While we should always be ready to learn lessons, it is unclear that there are many lessons that can be learned for the introduction of future taxes from a levy which only has 18 taxpayers – and with 90 per cent of the revenue coming from just five of them.

“While the Digital Services Tax brought in more than expected in its first year that was still just a twentieth of one per cent of the tax take in that year. Corporation tax raised 150 times more and income tax 550 times more.

“All the big revenue raisers have lots of taxpayers. We think that HMRC, the Government and the PAC should focus on improving HMRC service levels, which is now essential to the collection of revenue as well as to the health and prosperity of business and individual taxpayers, and not be tempted to pursue the illusion that deficiencies in delivering the major taxes can be made good by new taxes targeting tiny numbers of taxpayers, even if they are very large taxpayers.”

Notes for editors

1. Since 2013, under the Base Erosion and Profit Shifting (BEPS) initiative, governments have been working through the Organisation for Economic Co-operation and Development (OECD) to reform international tax rules.
   
   The main BEPS process has concluded and has led to significant changes in the UK’s, and many other countries’, tax systems, to prevent multinationals (‘MNCs’) from being able to arbitrage different countries’ tax rules so that some profits effectively are not taxed at all. In the UK, for example, interest deductions have been significantly curtailed under the ‘Corporate Interest Restriction’ rules and the UK has introduced the ‘hybrid and other mismatches’ rules.
   
   The implications of digitalisation for the taxation of large companies (enabling them to operate in ways that denied many countries in which they were seen to operate effective tax rights under traditional rules) was widely seen as the main piece of unfinished business from the BEPS process. This has led to the more recent OECD-led negotiations focused on reallocating the taxing rights over the largest and most profitable multinational business groups from their home countries to the tax jurisdiction where their customers and users are located (known as Pillar One) and introducing a global minimum corporate tax rate (Pillar Two). In October 2021 more than 135 countries in the OECD/G20 Inclusive Framework on BEPS agreed to pursue this so-called ‘two-pillar solution’.
2. Although the principle of Pillar Two has been supported by the US administration (to the point that the minimum tax rate is regularly referred to as the ‘Biden proposals’), it is not at all clear that the US will support the detailed negotiated package to implement this ‘pillar’.
   
   In addition, the US could lose revenue as a result of Pillar One which would involve the transfer of significant international taxing rights from the US, where many of the largest digital business based multinationals are principally located, to other countries, such as the UK, where their users and customers are. Unilateral taxes such as the UK’s Digital Services Tax were introduced to put pressure on the US to negotiate something along the lines of Pillar One. The US views these taxes as illegitimate and has enacted retaliatory measures, which so far it has not implemented while negotiations continue. If however, as seems likely, these conclude without US acceptance, it seems inevitable that some retaliatory action will be implemented.
3. The UK’s Digital Services Tax is unusual (as compared with other countries’ similarly named unilateral taxes) in that it is specifically based, not on UK source revenues as such, but on revenues from advertising targeted at UK users, who use these companies’ digital platforms for free. The underlying argument is that these users, by adding to the numbers using the platforms and to the number and range of their interactions, add value to the platforms: that is to say, part of their value is created in the UK (and other countries where there are many users) and not just in the US where the software was developed. This seems to be an attempt to signal less of an aggressive breach with the traditional allocation of taxing rights which is based on where value is seen to be created. But  the revenues raised from advertising targeted at UK users is essentially itself an estimated number, only indirectly representative of the value created by UK users of the platforms. This means that the tax liability will inevitably reflect something of a negotiation with the very few large company taxpayers concerned.