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Taxing the digital economy: Is change finally coming?

Businesses which trade online are in the government’s sights as it looks to address the ballooning budget deficit caused by emergency spending in response to Covid-19.

Even before the pandemic, the UK’s corporate tax system was out-dated and in need of overdue modernisation – a bricks and mortar model in an increasingly digital world. The question of how to tax digital businesses has become more urgent as Covid-19 has accelerated the shift to online retail while blowing a £400 billion hole in the public finances.

International tax rules are predicated on the idea that companies pay tax where they do business, but how does that work when multinational corporations can sell to consumers in the UK without setting foot here?

If you go to a shop and buy a record, not only do you pay VAT on that purchase, the staff who serve you are paying income tax and National Insurance on their earnings, the retailer is paying business rates on its premises and corporation tax on its profits. By contrast, if you pay to stream music online – as more and more people do nowadays – the chances are no tax will go to the Treasury. This is just one example of how the tax base is eroded when economic transactions are removed from the country the consumer is in.

Governments have been trying to work out how to tax digital businesses for over 20 years, but over that time every year more and more trade has moved into the digital marketplace, making the issue ever more pressing.

An international challenge

The UK is not alone in this predicament. The European Commission recently published a roadmap for the introduction of a digital levy “to address the issue of fair taxation of the digital economy”. While promoting the benefits of digitalisation, it states that “digital companies should also contribute their fair share to society”. Policy options being considered include a corporate income tax top-up for companies conducting certain digital activities in the EU, a tax on revenues from such activities or a tax on digital transactions between businesses.

Businesses with online sales should be alert to the likelihood of tax changes coming down the line

All this is happening alongside work by the Organisation for Economic Co-operation and Development (OECD) and G20 to reform the international corporate tax framework. The OECD is coordinating efforts by more than 135 countries to address the problem of tax base erosion and profit shifting by multinational corporations. Proposals to tackle tax avoidance and make international tax rules more joined-up are ongoing but have political and nationalist connotations given the dominance of US tech giants in the digital space and the emergence of Chinese competitors.

We may have left the EU, but what’s happening from a tax perspective in Europe and the rest of the world is a live strategic issue for British businesses which sell online to customers overseas and in the development of our tax regime.

Political tensions

While efforts to reach a global agreement continue, many countries have made their own attempts to tax the digital economy.

The UK’s Digital Services Tax (DST), introduced in April 2020, imposes a 2% levy on the revenues of search engines, social media services and online marketplaces derived from UK users. While the government has said it is an interim measure until an international solution is found, the DST is a political hot potato. The US Trade Representative recently argued that it discriminates against American companies, raising the prospect of retaliatory tariffs.

In January 2021, the Treasury Select Committee held a session on tax after coronavirus. Giving evidence, Jesse Norman MP, Financial Secretary to the Treasury, said the DST “has introduced a new basis for taxation: economic activity by UK users on online search engines, platforms, marketplaces and the like”.

Defending the Digital Services Tax, he added: “It has not been intended to raise a huge amount of tax. It is, by design, introduced to insert a wedge of taxation in an important new area, preliminary to a wider settlement that is under way with the OECD.”

Businesses with online sales should be alert to the likelihood of tax changes coming down the line, even if the details are yet to be worked out.

Taxing digital transactions

As Rishi Sunak looks to repair the public finances after the battering of Covid-19, reports have suggested he is considering increasing corporation tax, reversing some of the cuts made by his predecessor George Osborne. Having ruled out raising income tax, National Insurance and VAT, it seems clear the Chancellor will be looking to raise more money from corporates as we emerge from the pandemic, though debate persists about how soon to start raising taxes.

While the immediate focus is on our existing corporation tax, there continues to be a public perception that Amazon and others are undertaxed and in the long term all roads lead to taxing digital businesses. As Mr Norman confirmed to the Treasury Select Committee, the government is still reflecting on the idea of an online sales tax.

The government is almost certainly going to have to find a way of taxing online transactions, though no one is yet agreed how. Might consumers have to pay a few pence every time they buy something online or pay a tax demand before collecting online purchases? This might be unpopular but it’s easier for government to tax people who live here than companies based overseas.

As more and more economic activity moves online, taxing digital transactions looks like the only game in town if the government is to avert the collapse of the tax base.

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FEATURING: John Endacott
John is the firm’s head of tax. He provides high level tax advice combined with commercial acumen in terms of managing and advising on personal… read more
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