Image credit: REUTERS/Phil Noble
It was no doubt intended to be a political win, with the UK portrayed as the brave pioneer striking out against the might of the multinationals. In fact, the proposals are relatively limited in their scope, applying only to businesses whose global revenue is at least £500m and expressly contemplating safe harbour protections.
A cynic might conclude this was political posturing rather than a serious tax policy intended to yield significant revenue. Further, the proposals are unlikely to please the US, where most of the targeted taxpayers are based. The UK’s global popularity is already somewhat diminished; it might have been better not to provoke a key ally at this point, particularly one as volatile as the Donald Trump administration.
The government persists with its political rhetoric about being open to business, but to whom? The UK may have shown the guts, but whether it meets glory is not yet clear, and any immediate political victory may ultimately prove to be pyrrhic.
(For Practical Law commentary on this measure, see Legal update, Autumn 2018 Budget: key business measures: Digital Services Tax.)
Read the reaction to the Autumn 2018 Budget from industry leading tax practitioners:
Sandy Bhogal, Gibson Dunn
The Chancellor Philip Hammond had the rise of Labour, Brexit and technology companies on his mind during this Budget. The great giveaway that some had predicted did not quite come to fruition, but there were sufficient amounts handed out to different government departments to ensure Hammond made it back on to some people’s Christmas card lists. And whilst he was doing what politicians do—i.e. blaming others for things that have gone wrong—HM Treasury were publishing the technical details which us tax folk live for.
My initial reaction to the proposed Digital Services Tax (DST) is twofold. The Chancellor clearly does not believe that an international consensus solution will happen anytime soon, judging by the fact that it is being labelled as a temporary measure, but will not be reviewed until 2025. However, at least he has been sensible enough to consult on the detail and wait until 2020 before introducing it. I also assume the government has taken state aid advice on this proposal. Secondly, I can only assume that US President Donald Trump’s administration will consider this as deliberately targeting certain US multinationals, especially given the high thresholds that will be built into the legislation. HM Treasury will need to prepare for what the reaction will be from across the Atlantic. It is also worth noting that DPT, intangibles income and permanent establishments are also within the scope of the announced changes, which all points to a more coordinated strategy for dealing with digital businesses.
Real estate also continues to be flavor of the day for raising tax revenue. The legislation for non-resident gains in real estate and details of how it impacts funds will be published on 7 November, but it is interesting that there will be no 25 percent threshold for fund investors, whereas non-fund investors may benefit. It will be interesting to see if this asymmetry is maintained long term, or if a more holistic approach will be considered in the future.
Paul Concannon, Addleshaw Goddard LLP
Two headline-grabbing announcements were the introduction of the Digital Services Tax and changes to the entrepreneurs’ relief rules. Some sort of DST had been heavily trailed and was generally widely anticipated, and many will agree with the Chancellor’s comments that the tax system has failed to keep up with the structure of modern digital businesses. It is also good news that, if you take the announcement at face value, the government is intending something quite specific and targeted—but how plausible is it that this is what we will get? The target of the new tax feels like it will be easier to describe in general terms than to legislate for with precision, and there is considerable recent history of expansive legislation that is inadequately narrowed by specific exemptions and guidance. No doubt many advisers will be readying their red pens for the arrival of the promised consultation document.
In contrast to DST, the changes to the personal company test for entrepreneurs’ relief feel pretty unfair—or at least the timing does. The personal company test worked on the basis of fairly clear and simple bright-line requirements—it does not feel like ’abuse’ to implement structures that fall within those requirements. The government is well within its rights to take the view that those are the wrong requirements, but to make an immediate change on the grounds of abuse without any warning seems disproportionate. It is hard to believe that government has only recently discovered that these rules might not do all that they had hoped, or that changes could not have been delayed at least a bit. A lot of shareholders will be looking at their equity packages again.
Reform of the intangibles degrouping rules, which have been anomalous for some time, is much more welcome. So too is the promise of reform to stamp duty consideration rules—especially if it means not having to explain the contingency principle to another overseas client. Finally, the Chancellor couldn’t resist the prospect of squeezing yet more SDLT out of the market; this time from overseas buyers. One wonders how much extra revenue there really is here— possibly just one for the galleries?
Adam Craggs, RPC
As widely anticipated, the government has announced the introduction, from April 2020, of a 2 percent Digital Services Tax to address perceived tax avoidance by large global digital companies, such as Google, Amazon and Facebook, that receive substantial amounts from advertising expenditure on their online platforms in the UK and derive significant value from the participation of their users. It is expected to raise around £400m per year.
The introduction of this tax is politically safe as it is unlikely to upset the average voter who perceives the tech giants as not paying their ‘fair share’ of tax. However, with Brexit looming and the UK requiring fresh international investment, it is debateable whether now is the right time to introduce this tax. Additionally, given the dominance of the US amongst worldwide technology giants, the Trump administration may not welcome the UK government’s introduction of this tax at a time when new trade deals are of particular importance.
Jo Crookshank, Simmons & Simmons
The Chancellor’s announcement that Britain will act unilaterally in introducing a Digital Services Tax in April 2020 in the absence of international agreement on effective taxation of digital businesses, was not a total surprise. The government will, however, have to balance taxation targeted at the tech sector with the UK’s broader economic interests. The tech sector is one of the fastest growing sectors within the UK economy and the Chancellor is clearly cognizant of this, as he was keen to highlight that the tax will be highly-targeted and will not penalise the UK homegrown tech sector. Equally important for the public, the tax will not be passed on to consumers as a sales tax. The Chancellor predicts that this will generate over £400m in additional tax for public services. The tax is clearly aimed at US headquartered tech businesses, which have in the past threatened to withdraw UK investment if a targeted Digital Services Tax is introduced. In the longer term, if multilateral reform of the international corporate tax framework is achieved prior to 2025, then the government will disapply the DST. However, this will create uncertainty for affected businesses in the interim.
Erika Jupe, Osborne Clarke LLP
The introduction of a Digital Services Tax was well trailed, but in introducing it only for the largest MNEs from 2020, the Chancellor has hedged his bets on ’going it alone’. By limiting the measure to the tech giants, he hopes to limit any adverse impact on UK tech companies. By deferring the introduction of the tax, he still has the ability to adopt any international consensus rules if they can be agreed in time. He is aware that a Digital Services Tax developed with proper consultation with other countries is more likely to protect growing innovation in the UK and avoid damaging retaliatory measures from other countries.
Alex Jupp, Skadden, Arps, Slate, Meagher & Flom (UK) LLP
On a positive note, some of the elements of Budget 2018 suggest that responses to consultation might on occasion bear fruit.
A long-overdue revision to the intangible fixed assets regime should hopefully allow certain goodwill back into tax amortisation and finally align degrouping rules for intangibles with those for capital assets.
The narrowing in scope of the new Digital Services Tax is also an improvement: significant concern and opposition had been voiced in connection with the first two attempts and the hardest edges of some of the most egregious elements now appear to have been softened.
However, the unilateral introduction of DST cannot be a welcome development. DST is targeted at certain industry sectors and appears intended to capture only the bigger players; some might even see it as a selective and protectionist measure. At best, DST may be a political placeholder which is ultimately to be given up and which adds a handy few billion to help balance the books in the meantime. On the other hand, it risks adding to a perception of Britain not being all that open for business, drawing similar significant criticism from US policy makers to that levelled recently at the European equivalent, and leaving the UK with an obvious pressure point in future trade negotiations.
The change in direction from extending withholding taxes on royalties to direct assessment of gross intangible receipts (GIR) derived from UK sales may prove to be equally controversial and the calculation of how much can be linked to the UK and taxed as GIR (or under DST) will be a source of much disagreement.
Multinationals will be justified in continuing to be concerned that HMRC is ever further from feeling confident that traditional transfer pricing tools do a good enough job for them.
Laurence Kiddle, Thomson Reuters Tax & Accounting
My Amazon homepage this morning offered me the chance to buy all kinds of Halloween costumes, from vampires and witches to ‘voodoo dudes’ and even an inflatable Donald Trump. Tomorrow, perhaps, there will be the opportunity to buy your very own Philip Hammond ‘Spreadsheet Phil’ dress-up: guaranteed to scare executives at the big tech companies.
The Chancellor’s Digital Services Tax was widely trailed and the amounts involved—estimated Government revenues of £440m—are not hugely material to the UK’s tax take. At a rate of 2 percent it may not be hugely material to the tech firms either (they must be making profits to pay it at all; and must also generate at least £500m of annual revenues). But it sets the direction of travel, not just for the UK but for an international effort to extract tax revenue from the tech giants.
Hammond said that progress towards a multilateral consensus on how the digital economy should be taxed has been ‘painfully slow’. But tax authorities have recently proved themselves reasonably adept at working cross-border. Increasing amounts of information are being shared under FATCA and the Common Reporting Standards, not to mention the OECD push to country-by-country reporting under the Base Erosion and Profit Shifting (BEPS) framework. It is just about possible that the Digital Services Tax regime, due to start in April 2020, could be superseded before it kicks in—although the commitment to a review in 2025 suggests that this is unlikely.
So, to return to the (rather tenuous) Halloween theme, perhaps Monday’s budget signals a change to the government’s game of ‘trick or treat’ with the likes of Amazon and Google. The UK has long been keen to attract investment from the tech giants. Today we see the skeleton of a new, more confrontational regime emerging. And, of course, the largest tech firms are American (perhaps the blow-up Donald Trump costume is relevant after all). It will be interesting to see the transatlantic reaction.
Wendy Nicholls, Grant Thornton UK LLP
The UK Government has put both feet forward in a bid to end (and win) the game of cat and mouse being played between tax authorities and internet giants.
Hammond’s announcement of a new 2 percent Digital Services Tax moves the UK ahead of international bodies like the OECD, although it does follow the actions of some other countries such as Italy and Spain. The UK has argued that ‘user generated value’ from so-called prosumers interacting with digital sites should be recognised and taxed in the relevant market. It was again emphasised that the tech giants are the key target here, not small businesses, in an effort to ensure that digital innovation in the UK is not quashed.
Note that this is a turnover tax—a big shift from all the international tax standards, whereby corporate taxes are based on profits.
The UK has rightly prided itself on being at the forefront of international efforts by the OECD and G20 to tackle Base Erosion and Profit Shifting (BEPS). However, rather than going it alone, we believe now is the very time for the UK to be working alongside other countries in a concerted way, and we are encouraged to hear that the Chancellor will look to adopt a consensus solution from the OECD/G20 should one materialise, when they report again on the digitalisation of the economy in 2019.
The measure is set to impact businesses with over £500m in global revenues from the provision of search engines, social media platforms and online marketplaces, and over £25m in the UK, with exemptions for low margin and loss-making entities—this exemption being a notable difference to the EU’s current proposals. The Chancellor is keen to emphasise that it is not an online sales tax, and hopes that it falls on providers and not on consumers. The measure is due to be implemented in April 2020 and is forecast to raise £400m per year, but with only £5m set to be raised in the first year.
The UK has to tread a fine line between being seen to be tough on multinationals and showing it is open for business, particularly as we prepare for a post-Brexit economy. One of the reasons that innovative businesses are attracted here is the combination of a stable tax regime and an even-handed approach. It will be interesting to see how this measure develops as further details unfold.
Dominic Robertson, Slaughter and May
This was a busy budget. There were no major revenue-raising measures. The only proposal raising more than £500m annually was a toughening up of IR35 enforcement—but this was balanced by a broad range of smaller scale tax changes. Hopefully this is the only budget where the Chancellor needs to introduce both a raft of EU-mandated changes (including changes to taxing regulatory capital) and changes to protect against a hard Brexit (including an entirely new carbon emissions tax as a no-deal backstop).
For technology companies, the new Digital Services Tax has taken all the headlines, though in practice it will apply only to a handful of high-profile businesses. In contrast, the new income tax charge on offshore IP income (which replaced an earlier proposal for royalty withholding tax) has attracted much less attention, though it will apply to far more US tech companies.
It seems to me this tax is dealing with yesterday’s problem, when US businesses could roll up IP profits tax-free until they were eventually distributed back to the US. Since the end of 2017, American companies’ IP income is subject to (broadly) the same US tax rate whether the IP is held in the US or offshore. However, IP held in the US would be protected from the new tax, whereas IP held offshore would be subject to 20 percent UK tax. As the two structures are now taxed in broadly the same way in the US, what’s the case for taxing them very differently in the UK?
(And, extraordinarily, a literal reading of the TAAR for these rules would mean that you couldn’t fix the issue by moving the IP to the UK, and subjecting the profits to UK corporation tax. That should surely be fixed, at least in guidance.)
Vimal Tilakapala, Allen & Overy LLP
This was a difficult budget for the Chancellor to deliver with Brexit so close and so uncertain, and a number of spending pledges having already been made by No.10. As a result, there has been much concern over recent weeks about which taxpayers would be required to fund these commitments. The Digital Services Tax is the big funding announcement and has already generated a lot of interest from our clients in the tech sector; it is therefore disappointing that for all the press headlines and public focus, there is little detail available at this stage on the new tax. The detailed proposals are keenly awaited. We are all still a little scarred by the last time a politically motivated tax was brought in hastily in this area and we hope that lessons have been learnt from the diverted profits tax debacle.
The other major announcement was on the overhaul of the regulatory capital securities regulations and the introduction of new provisions for hybrid capital securities. The preservation of interest relief for regulatory capital is a relief for banks and insurers. This is a complex area and it is pleasing to see that HMRC has clearly put a lot of work into ensuring that the measures will work properly and not cause unnecessary disruption for financial institutions which have limited control over the rules imposed by regulators.
The extension of the new regime to corporates is generally a very welcome development and one which may stimulate new types of borrowing. For anyone tracking developments in this area and the recent changes made by the Dutch tax authorities to their regulatory capital regime, it is clear that the changes are to see off possible EC state aid arguments. This is of course remains unsaid.
Read more on the Autumn 2018 Budget
Further analysis on the key areas:
- Finance and Financial Services
- Property, Energy and Environment
- IP, Media and R&D
- Employment
- Other business measures
