New UK Digital Services Tax Proposals Would Impact Non-UK Technology Firms

The UK Government recently proposed a 2% tax on revenues from certain digital services that derive significant value from UK users. This new tax will apply beginning on April 1, 2020.

The new Digital Services Tax (DST) will apply to UK and non-UK resident businesses

• that generate more than £500 million (~$650 million) in global revenues on a group-wide basis from the provision of a social media platform, search engine, or online marketplace (the “in-scope activities”), and
• where more than £25 million (~$33 million) of that business’s global revenues from in-scope activities is linked to the participation of UK users.

As a result, US or other non-UK businesses that have limited or no operations in the UK, but that do offer digital services to UK users, may be subject to the proposed DST.

Businesses that fall within the scope of the DST will be subject to a tax charge of 2% on their revenues over £25 million generated from in-scope activities linked to the participation of UK users. Importantly, this will be a tax on gross revenues (not profit) and, as such, costs incurred in generating the revenues will not be deductible for purposes of determining DST liability. However, there will be a safe harbor to reduce or eliminate the DST liability of businesses with very low profit margins or those making a loss (although more detail is still required as to how this safe harbor is intended to operate).

The precise scope of the activities covered by the DST and how revenue will be linked to the participation of UK users have not yet been determined, but the UK tax authority has indicated that the tax will catch revenues from the following UK user-linked activities:

A “UK user” will generally be a person who is normally resident in the UK. However, businesses that use different approaches to identify user location, such as through IP addresses (for online advertising revenues) or payment details and delivery address (for marketplaces), will be allowed to adopt these methods to identify revenues linked to UK users.

The UK tax authority anticipates that once a group meets the conditions for DST, each entity within that group will have to determine the amount of in-scope revenue it receives and then report to the UK tax authority annually and make quarterly payments in line with the UK Corporation Tax regime for large companies. However, although the proposals anticipate that businesses subject to DST will report on an entity-by-entity basis, the ultimately enacted legislation may permit group DST reporting and payment by a nominated company within the group, or even make such nomination mandatory. It is not clear at present how this will be enforced in the context of non-UK companies.

The UK Government expressly intends that the new DST will be a temporary measure pending further progress at an international level on tax reform to update tax systems more generally to reflect the value created by digital businesses, and the DST will be reviewed by the UK Government again in 2025. The OECD and the European Union are also working on new taxation schemes for digital business. At the European Union level, France and Germany have recently proposed a narrower form of a digital services tax that would apply across Europe, which targets only advertising sales revenue. If approved in March 2019, this European digital services tax would come into effect in 2021, unless the OECD makes progress on an alternative regime that would come into effect before 2021.

The DST proposal is currently undergoing a public consultation process whereby the UK Government solicits input from the public about the proposal. The process is similar to the US notice and comment period for new regulations and is expected to continue until February 28, 2019.

If you would like more detail on the proposals, the consultation document is available here. Please contact us if you would like to discuss the proposals further or if you would like us to assist in coordinating responses from you to the public consultation.