This article first appeared in Tax Journal on April 24, 2020.
With effect from April 1, 2020, the UK now has a digital services tax
(DST), joining France and Italy which already have in place broadly
similar taxes. The UK DST is charged at 2 per cent on revenues made by
large businesses that provide a social media service, search engine
or online marketplace to UK-based users. While the legislation
has not changed significantly since the draft issued in July 2019,
the guidance has been comprehensively reworked and expanded,
offering significantly more examples on how, in HMRC’s view, the
DST should be applied by businesses.
As we are all forced into confinement by the coronavirus
pandemic, the ability of digital businesses to keep us
connected, entertained and provisioned has seen a sharp spike
in their usage. The government’s implementation of its digital
services tax (DST) could therefore perhaps be considered
fortuitous timing. Commentators in the early part of the
year queried whether the government might postpone the
DST to see what progress the OECD makes on reaching an
international consensus. It did not hold off though, and the
DST is now to come into force on royal assent of the Finance
Bill 2019/20 and with effect from 1 April 2020. Accordingly,
businesses with online revenues must assess the changes made
in the revised legislation and HMRC’s guidance in its Digital
Services Tax Manual, as well as their obligations and exposure
under the new tax.
The DST is a 2% tax on the VAT-exclusive revenues derived
from UK users and is to be imposed on large businesses
that provide a social media service, search engine or online
marketplace. For this purpose, a business is large if (judged on
a consolidated group-wide basis) it has in-scope annual global
revenues of more than £500m and more than £25m of those
are attributable to UK sales. The first £25m of revenue derived
from UK sales is excluded from the tax.
For low margin or loss making businesses, there is an alternative basis of calculation, whereby the DST rate will be
based on the UK operating margin of the group’s relevant
activities. This means that where the group’s UK operating
margin is nil or negative, no UK DST liability should arise.
The tax has to be paid within nine months of the end of
the relevant accounting period, and the DST return submitted
within one year. The first tax payments could be due in early
An “online service”
The key question for businesses is whether their revenues
are in-scope. In this respect, the tax only applies to “online
services”. What constitutes an “online service” is not defined,
but the revised guidance contains some detailed discussions
on whether activities are sufficiently separate to be considered
a ‘service’ in their own right or if they are part of or ancillary
to a wider business function (which may lead to discussions
reminiscent of some VAT cases). This is an important gateway
test for businesses: are their online activities sufficiently
distinct to be considered an “online service”? If so, are the
“online services” within the three in-scope categories.
Social media service
The definition of “social media service” has changed from
that in the draft legislation published last July. The first limb
(main purpose of promoting user interactions) remains, but
the second limb (sharing of user-generated content) has been
narrowed. The sharing of user-generated content must now be
“a significant feature of the service”. This additional condition
is welcome, as it means businesses will not be in-scope just
because users share content on their platform even if, for
example, that content is not significant because it merely
relates to commenting on content provided by the business.
One concern which was raised with respect to the DST was
whether online games would be in-scope, given the significant
growth in e-sports and the revenue generated from such
activities. The revised guidance provides a lengthy discussion
on this but does not provide the sweeping exemption the
industry was perhaps looking for. Rather, the guidance notes
that a case by case approach will be needed to determine
whether user-generated content is a significant part of the
game. Any in-game messaging and user-generated items
would be considered user-generated content, although playing
the game itself will not be.
Internet search engines
There remains no statutory definition of an “internet search
engine”, meaning that it will take its ordinary understanding if
a court ever has to construe it. The legislation does, however,
now exclude search engines which search a single (or closely
related) website. The search engines that are in-scope are
those where their core business involves the operation of a
search engine. The guidance notes that these engines will in
principle search the whole of the internet. The guidance also
notes that where a website has a “search box” that uses third
party technology to display results from external websites, the
third party technology provider typically would be considered
to be performing an in-scope activity, rather than the website
An online marketplace is in-scope where the marketplace
has a main purpose to facilitate the sale (or hire) of goods or
services offered by users, and the marketplace enables users
to sell or advertise. (The use of the “main purpose” test may
lead to some debate, given the difficulty that there has been
historically in the use of this test.)
The legislative test has been amended to make it clearer
that it includes marketplaces which bring users together,
even if the sale occurs away from the platform. Another
of the concerns with the draft legislation and guidance
was particular uncertainty around the scope of “online
marketplace”. In response to this, HMRC’s guidance on the
definition has been substantially expanded and now sets out
a list of factors that it considers to be relevant in determining
whether there is an online marketplace. These include
competition between sellers, the existence of a recognisable
place or portal, and features that allow customers to search for
products or services. This guidance, along with the plethora
of new examples, is a big step forward in giving online
businesses comfort around how they will be treated under this
aspect of the regime.
The government’s response to the 2018 consultation on the
DST acknowledged that there were a number of reasons for
excluding financial platforms, including that there are strict
rules and limitations on how these platforms interact with
users, they often bear significant costs and risks, and they
are often very localised. In dealing with these concerns, the
draft legislation sought to define the exclusion very narrowly.
Following further consultation, the legislation in the Finance
Bill has now been significantly expanded, as follows:
- The requirement that the provider of an online
marketplace must be a regulated entity has been removed.
- The exclusion now expressly includes the trading of
commodities and forex, as well as financial instruments.
- “Trading” has now been expanded to include the creation
of assets which means that peer to peer lenders (which
facilitate the origination of new financial instruments for
users of the platform) should be within the exemption.
The expanded exemption will therefore come as a huge
relief to the financial sector. It is worth flagging though that
while the DSTs in France, Italy and the draft DST in Spain
also contain exclusions for financial marketplaces, these are
substantially narrower in scope. This then is an area where
international businesses will need to be wary, and it highlights
the difficulties with jurisdictions imposing unilateral solutions
to the taxation of digital businesses.
Which revenues are in-scope?
Revenues in-scope for DST are third party revenues generated
from the three in-scope ‘online service’ activities listed above.
Revenues are taxable under the DST if attributable to an inscope business activity and linked to UK user participation.
In addition, revenues from an activity that is ancillary
to any in-scope business activity will be included as
digital service revenues (so, for example, where an online
marketplace charges payment handling fees, these would
be in-scope where they relate to sales on the marketplace).
Businesses with in-scope activities will also need to consider
whether they have an associated online advertising service as
this will also be in-scope to the extent the advertising service
obtains a significant benefit from the digital service.
The amount of digital services revenues are determined
from the consolidated financial statements of the business
prepared in accordance with the appropriate accounting
framework. This had led to concern for some businesses
(such as investment funds) which are not required to prepare
consolidated accounts. To address this, the legislation has
been amended to provide that digital services revenues
are those revenues which would have been recognised in
the consolidated group accounts if no exemption from the requirement to prepare consolidated accounts had applied.
What are UK revenues?
Revenues from in-scope services will be subject to UK DST
if they are attributable to UK users. As with the original
draft legislation, a user will be a UK user if it is reasonable to
assume he is normally located or established in the UK.
Businesses have consistently raised concerns over the
difficulty in establishing whether a user is normally located
or established in the UK. While the revised guidance on this
is relatively unchanged from the draft guidance, the message
remains that HMRC considers that this is a pragmatic
test based on available information and businesses are
not expected to obtain additional information about their
customers. In practice, businesses will have to consider how
to assess which users are UK based – and how to deal with the
situation where the information collected provides conflicting
evidence regarding user location.
Businesses will be concerned that the approach they take
to determine user location in one jurisdiction will not be
acceptable in another jurisdiction imposing a DST. While
the guidance indicates that HMRC appears relatively relaxed
about the method used, unfortunately there is no indication
of what measure of advance comfort will be obtainable from
HMRC as to the approach that should be taken.
The future for the UK DST
The government remains committed to developing a
multilateral solution to the challenges that digitalisation has
created. The revised guidance expressly states that the UK
DST will be disapplied once an appropriate global solution is
in place. In this respect, the legislation contains a requirement
that the UK DST be reviewed before the end of 2025, albeit
the hope and expectation is that the OECD’s work on reaching
a multinational solution will bear fruit long before then.
The OECD has announced that it is ‘working full steam’
and that this will continue on schedule despite the Covid-19
pandemic – the stated aim being to reach a political consensus
by July 2020, with an agreed solution by the end of 2020.
If the OECD is unable to keep to this timeframe, and
accordingly DST becomes chargeable, the UK can expect
to encounter strong resistance from the US. When France
introduced its digital services tax in 2019, this led to a trade
dispute with the US; a dispute which is currently observing a
truce as France has deferred collection of the tax for 2020. The
Italian DST is similarly in abeyance for this year.
Since the 2020 Budget announcement, the US government
has not made any public comment on the introduction of UK
DST, but it is to be noted that the UK and US will soon be
engaged in trade negotiations and it is perhaps inevitable that
the DST will be on the table.
Notwithstanding this uncertainty, affected businesses
should consider whether they are likely to be subject to this
tax – and, if they are, what systems should be in place to deal
with calculating the correct amount due.
Like many countries, the UK is likely going to need to raise
taxes to meet the costs of the Covid-19 pandemic. Given that
need to raise cash and the fact that some digital businesses
have thrived as a result of the current lockdown, the UK may
look to the DST to plug some of the gap.