The issues were first raised at Autumn Budget, with a consultation which ran until the end of January. Now the latest policy paper outlines the critical considerations, ahead of next month’s meeting of the OECD and G20 in Argentina which will discuss progress towards developing a multilateral approach.  

The updated paper sets out the government’s view that the participation and engagement of users is an important aspect of value creation for certain digital business models, and is likely to be reflected through several channels, such as the provision of content or as a contribution to certain intangibles such as brand.

The paper argues the role of customers in creating demand for a product or service is different from the more complex role of users in co-contributing to a business’s offering through the generation of content or the provision of services. It follows that, for some types of digital businesses, users can be seen participating in a non-traditional value chain and performing supply-side functions that would historically have been undertaken by the business itself.

The Treasury says the focus is on ‘certain digital businesses for whom the collection of data from users results from a much broader and more active user relationship, which is central to how those businesses create value’.

The international tax rules, reflected in the OECD model tax convention, do not give recognition to the value created by user participation. For example, the presence of an active user base in a jurisdiction is not of itself sufficient to evidence a permanent establishment in that jurisdiction, and does not therefore entitle the jurisdiction to tax the business’s profits. Equally, even if a business has a physical presence in a jurisdiction that gives rise to a permanent establishment, the jurisdiction will only have a right to tax profits attributable to the economic activities and assets of that permanent establishment. It will not be entitled to tax profits that are considered attributable to value creating activities of local users.

The government’s position is that active user participation creates value for certain digital businesses, and that jurisdictions in which users are located should be entitled to tax a proportion of those businesses’ profits.

Reallocation of profits

The paper discusses a suitable approach to measuring the value of a user base to a business, and how that profit should be allocated between the different jurisdictions in which users giving rise to it are located.

The government considers that the simplest approach would be to give user jurisdictions the right to tax the companies in a digital business that are considered to be realising the value from participation of users (the principal companies). User jurisdictions would then be entitled to tax the proportion of those principal companies’ profits that are deemed to be attributable to the participation of their local users. This approach could lead to more than one company being taxed in user jurisdictions on user-created value, where there are multiple IP owners and several companies making valuable contributions to the generation of profit.

An alternative approach would be to give user jurisdictions the right to tax a company in the group, which may not be the principal company, with which users have some connection. However it may be difficult to link users to a single company within a digital business group given the number of companies that could be deemed to have a direct and indirect relationship with users.

The paper says such changes would require modifications to Articles 5, 7 and 9 of the OECD model tax convention, as well as modifications to the OECD transfer pricing and profit attribution guidelines.

Short-term measures

While the government intends to work closely with the EU and international partners on this issue The Treasury makes clear, that in the absence of such reform, there is a need to consider interim measures such as revenue-based taxes. The paper explores some of the considerations regarding the scope and design of an interim measure, and the steps that could be taken to ensure that it is well-targeted and protects start-ups and growth companies.

It is envisaged that an interim measure would be a tax on the revenues of digital businesses deriving significant value from UK user participation. The tax would apply to those businesses wherever they are located, and irrespective of the physical presence that they have in the UK.

The paper states: ‘The government believes that there would be value in multilateral coordination on the design of an interim measure and looks forward to engaging constructively with upcoming proposals from the European Commission. However, the UK equally stands prepared to act alongside a smaller number of like-minded countries, or unilaterally, in the absence of sufficient progress.’

There are in theory three legislative approaches that the government thinks could be taken to determining the scope of a revenue-based tax.  One would be to define the channels through which users create value for a business through their participation, and then impose a tax on the revenue streams of businesses for whom those channels are most relevant, based on a case by case assessment of their specific characteristics and value drivers.

The second approach would be to objectively define the categories of businesses that derive most value from user participation and then impose the tax on the revenue streams of businesses that fall into those categories. The third option would be to define the revenue streams that are commonly generated from those categories of business and then charge the tax on any business in relation to such revenues.

In the case of online advertising the government envisages that the UK would have a right to tax revenues from online advertising targeted at UK users of an in-scope online platform.

The Treasury says it recognises the need to ensure that the tax does not undermine wider government objectives for growth and innovation in the UK digital sector, including through the protection of start-ups.

Glyn Fullelove, chair of the CIOT’s technical committee, said: ‘Where value is created remains the most logical basis for deciding where and how much to tax multinational companies. Seeking international agreement on what the criteria for this should be is the most sensible way forward. The government’s updated paper makes clear that they share both these views and we welcome this.

‘It is important the government acts in co-operation with other states as far as possible, as unilaterally abandoning the currently negotiated international approach to allocating taxable profits between countries would certainly risk retaliation, double taxation and perversely, new arbitrage opportunities. This could increase rather than assuage public dissatisfaction – and damage rather than boost the net revenues available to the UK.’

Stella Amiss, head of tax policy at PwC, agreed, saying: ‘On the one hand the government says international agreement is essential, but the raft of options published today suggest there is a way to go if the government is to avoid confusion, double taxation and undermining the Chancellor's ambition to deliver an open and outward looking economy.’

Chris Sanger, EY’s head of tax policy, pointed out that the UK’s update on the taxation of the digital economy comes at a delicate time – just as the European Commission and the OECD are racing to get their ideas out on what the future should look like.

‘The debates next month at the G20 in Argentina will be difficult, and consensus will be difficult to achieve. In the absence of consensus, we may well be facing many years of double taxation, as countries like the UK apply taxes on turnover and others retain their approach to taxing profits. Such double taxation will make developing the UK more expensive, reducing the UK’s attractiveness.

‘The paper today did offer a glimmer of hope to those large businesses that are yet to make a profit. The Treasury acknowledges that they would not be helped by a de minimise exemption but has yet to find a suitable solution,’ Sanger said.

Corporate tax and the digital economy: position paper update is here.

Report by Pat Sweet