With effect from 1 April 2020, the UK will start to levy a digital services tax at a rate of 2% on digital services revenues that are attributable to UK users.
The UK digital services tax (“UK DST”) is intended to apply to large businesses that earn significant revenue from in-scope digital services activities — which include social media, online marketplaces, and associated advertising.
Background
The UK DST originates from the Organisation for Economic Co-operation and Development’s (OECD) Base Erosion and Profit Shifting (BEPS) project — specifically, Action 1 (Tax Challenges Arising from Digitalization). The OECD is working to implement a long-term solution to the perceived failure of the international tax rules on profit allocation, and, if an agreement is reached, the UK DST will be repealed and replaced with the international measures. At present, the UK government plans to review the UK DST again in 2025.
The UK DST is an interim measure that will impose tax at a rate of 2% on the revenues received in connection with specified digital services activities, which will predominately impact large multinational enterprises. The UK DST is an extraterritorial tax, meaning that the enterprise subject to the UK DST does not need to be incorporated or have a permanent establishment in the UK for the tax to apply.
The development of the UK DST has been subject to much consultation, review, and draft legislation. The latest legislation for the UK DST (published in the Finance Bill 2020, along with guidance from the UK tax authority, HMRC) brought some clarification regarding the scope of the UK DST ahead of its 1 April 2020 effective date.
Who does the UK DST apply to?
The UK DST is aimed at large businesses that (on a group-wide basis) generate:
- more than £500 million in annual worldwide revenues from in-scope digital services activities; and
- more than £25 million in annual revenues from in-scope digital services activities linked to UK users.
Where a business’s revenues from in-scope digital services activities exceed these thresholds, the UK DST will apply to that business. The in-scope digital services activities are:
- social media services;
- internet search engines; or
- online marketplaces.
The in-scope digital services activities also include associated online advertising services, which derive significant benefit from association with the social media service, search engine, or online marketplace. A UK user includes individuals and legal persons that it is reasonable to assume are in the UK or are established in the UK.
Next Steps and Compliance
Businesses that are potentially affected by UK DST should undertake a review of their activities to determine whether operations fall within the specified digital services activities of the UK DST. Determining which services should be tested for compliance with the UK DST is a matter of judgment and depends on the particular facts and circumstances of the business and any wider group. The UK DST should also be considered in the context of transfer pricing rules, where transactions are made between associated members of a group. Parties should consider whether the entity that paid and/or is liable to UK DST would have borne the cost of the expense or if the expense would be factored into the transfer price.
The UK DST is payable and reportable on an annual basis. The due date of the tax is the day after nine months following the end of the accounting period. The total UK DST liability is calculated on a group‑wide basis but charged to the individual members of the group that realise the revenue that contributes to the total. A member of the group can be nominated to comply with the UK DST, otherwise the ultimate parent of the group will be responsible.
There are no specific rules for determining the deductibility of UK DST against any other tax liability. Following general UK corporation tax principles, where a UK DST liability expense is incurred wholly and exclusively for the purpose of the business’s trade, it is likely to be deductible.
For groups that have a low operating margin from providing in-scope activities to UK users, an election to calculate the UK DST under an alternative calculation can be made. Relief can also be claimed for in‑scope cross-border transactions that lead to revenue being taxed both under the UK DST and under an equivalent regime in another jurisdiction. The relief reduces the UK DST revenues by 50%.