Documents considered by the Committee on 13 June 2018 Contents

4Digital revenue tax

Committee’s assessment

Politically important

Committee’s decision

(a) (b) (c) Not cleared from scrutiny; further information requested; (d) (e) Cleared from scrutiny.

Document details

(a) Proposal for a Council Directive on the common system of a digital services tax on revenues resulting from the provision of certain digital services; (b) Proposal for a Council Directive laying down rules relating to the corporate taxation of a significant digital presence; (c) Commission Recommendation of 21.3.2018 relating to the corporate taxation of a significant digital presence; (d) Communication from the Commission to the European Parliament and the Council: Time to establish a modern, fair and efficient taxation standard for the digital economy; (e) Communication from the Commission to the European Parliament and the Council: A Fair and Efficient Tax System in the European Union for the Digital Single Market.

Legal base

(a) Article 113 TFEU; special legislative procedure; unanimity, (b) Article 115 TFEU; special legislative procedure; unanimity, (c)—, (d)—, (e)—.

Department

Treasury

Document Numbers

(a) (39585), 7420/18+ ADDs 1–3, COM(18) 148; (b) (39586), 7419/18 + ADDs 1–3, COM(18)147; (c) (39590), 7421/18; (d) (39591), 7418/18 + ADD 1, COM(18) 146; (e) (39054), 12429/17, COM(17) 547

Summary and Committee’s conclusions

4.1On the 21st of March 2018, the European Commission published proposals for two Council Directives and a Commission Recommendation on the taxation of businesses in the digital economy. This follows on from a Commission communication published on 21 September 2017, which the Committee has scrutinised separately.52

4.2The chief effect of the Communication was to press the OECD’s Task Force for the Digital Economy’s (TFDE) interim report to the G20 in spring 2018 to present “meaningful policy options” which have the potential to tackle these concerns. The Commission’s Communication also outlined three possible short-term approaches which could be used to address the issue on a temporary basis at EU-level, if progress was not made at a global level: an equalisation tax, a withholding tax on digital transactions, and a levy on revenues generated by digital transactions or advertising activity. The Government said that it would evaluate these proposals on their merits.

4.3In the Government’s response53 to the Committee’s report on this proposal on 13 December 2017, the Financial Secretary to the Treasury, the Rt. Hon Mel Stride MP, drew the Committee’s attention to a Treasury position paper “Corporate tax and the digital economy”, informing the Committee that the position paper:

4.4On 16 March 2018 the OECD Task Force on the Digital Economy released its interim report on the tax challenges arising from digitalisation. The report was unable to reach a consensus on either the need or justification for interim measures or the direction of any long-term solution. It set out a proposed direction of work on digitalisation and the international tax rules through to 2020.

4.5On 22 March 2018 the Treasury published an update to its position paper on corporate taxation in the digital economy, which firmly established that its preferred interim solution was a revenue tax applicable to certain digital providers. The Minister told the BBC that the Government considered a revenue-based tax to be “the potentially preferred route” to address the issue.

4.6The following week, the Commission presented two legislative proposals:

4.7The proposals are described in more detail in the background section of this report, along with the Government’s response to the proposals in its Explanatory Memoranda, which were submitted one month after the due date because of unspecified difficulties in gaining internal clearance. The Minister indicates that both proposals comply with the principles of proportionality and subsidiarity in the Government’s assessment, and that both are broadly in line with Government thinking—particularly the proposed levy on revenues—although the Government also identifies a wide range of aspects of both proposals in relation to which further exploration is needed. Furthermore, the Government clearly regards Directive 7419/18, which would create a virtual permanent establishment, as an attempt to move the global debate forward, as opposed to something which is likely to be agreed by the Member States.

4.8A debate on digital taxation was held in the House of Commons on 27 March 2018,54 during which the current proposals were discussed, with members generally expressing support for a levy on the revenues of digital service providers, irrespective of whether it was an EU or a domestic measure.

4.9Since the adoption of the proposals, a significant number of Member States—led by Ireland and Luxembourg, but also including the Netherlands, Greece, Belgium and Denmark—have indicated that they do not support the proposals.55 As unanimity is applicable to both measures in the Council of Ministers, it is therefore unlikely that either Directive will ever be agreed.

4.10We have taken note of the Government’s Explanatory Memoranda regarding the proposed Directives. While the Government would prefer global solutions, the lack of progress at global level means that it is potentially willing to support action on a multilateral basis, including possible interim measures, to address what it describes as the “mismatch between the location of value-creating activities and taxable profit for certain digital business models”.56

4.11The Government has been proactive over the past year in developing its own proposals as to how the digital economy should be taxed, and its thinking appears to be reflected in the Commission’s proposals, particularly the proposed levy on revenues of certain digital service providers—which the Government had identified as its preferred interim solution in advance of the Commission issuing its proposal. This could potentially raise €5bn in annual tax receipts across the EU, and help to reduce the discrepancy between the levels of tax paid by the digital economy and traditional brick and mortar businesses.

4.12The long-term solution proposed by the Commission, which would introduce a new form of permanent establishment based on “significant digital presence”, and lay down general principles for allocating profits to that presence which would allow for the market value of users and data to be taken into account, appears to be more speculative in character, because, to be fully effective, it would require third countries to modify their double tax treaties with Member States. We share the Government’s assessment that its principal effect is to provide “a basis upon which to explore options for global reform and may act to encourage non-EU countries to consider changes.”57 Nonetheless, this proposal is also broadly in line with the Government’s position paper, which posits that “user participation creates value for certain digital businesses”, “jurisdictions in which users are located should be entitled to tax a proportion of those businesses’ profits”, and that “some reallocation of the profits currently recorded by these companies to user jurisdictions is justified”.58

4.13Given that unanimity is required for both proposals in the Council of Ministers, and it is manifestly not in the national interest of some Member States such as Ireland and Luxembourg to agree to the proposals, we conclude that it is highly unlikely that either proposal will be agreed. This may lead some Member States to propose the use of enhanced cooperation in this policy area in the future.

4.14We request that the Minister provide us with any relevant updates on its position regarding those aspects of the proposals which the Government has identified as requiring further exploration or clarification, as enumerated in paragraphs 4.35 and 4.50 of this report.

4.15We also ask for responses to the following questions:

4.16Regarding EU exit, we ask the Government:

4.17We ask the Government to reply to these questions, and to provide the requested clarifications regarding the proposals themselves, along with any relevant updates on negotiations in the Council, by 25 July 2018. In the meantime, we retain the two proposed directives and recommendation under scrutiny. We clear the two communications relating to digital taxation from scrutiny.

Full details of the documents

(a) Proposal for a Council Directive on the common system of a digital services tax on revenues resulting from the provision of certain digital services: (39585), 7420/18 + ADDs 1–3, COM(18) 148; (b) Proposal for a Council Directive laying down rules relating to the corporate taxation of a significant digital presence: (39586), 7419/18 + ADDs 1–3, COM(18) 147; (c) Commission Recommendation of 21.3.2018 relating to the corporate taxation of a significant digital presence: (39590), 7421/18; (d) Communication from the Commission to the European Parliament and the Council: Time to establish a modern, fair and efficient taxation standard for the digital economy: (39591), 7418/18, COM(18) 146 + ADD 1 ; (e) Communication from the Commission to the European Parliament and the Council: A Fair and Efficient Tax System in the European Union for the Digital Single Market: (39054), 12429/17, COM(17) 547.

Background

4.18Internet companies, as with any multinational with operations in the UK, are liable to tax on that part of their profit which arises from value created in the UK. This source-based approach is the principle underlying all corporate tax regimes across the OECD.

4.19The rules are reflected in the OECD Model Tax Convention:

4.20In its position paper on Corporate tax and the digital economy, the Government concluded that this arrangement was not sustainable:

“These rules, and the guidelines underpinning these rules, 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 based on the channels set out above.”

“The government thinks that this is creating a mismatch between the location of value-creating activities and taxable profit for certain digital business models. This chapter therefore sets out possible options for reforming the international tax rules to take account of the value created by users.”

The Commission’s proposals

Directive 7420/18: Digital services tax (DST)

4.21The Commission has proposed a Directive that would put in place a digital services tax (DST) which would apply to revenues, as opposed to profits, generated by digital services to which user participation is an essential input. The proposal is closely aligned with recent Treasury policy papers on the same subject.

4.22The tax would be levied at 3%, net of VAT, and it is suggested that this would raise €5bn annually in tax receipts across the Union.

4.23The tax would cover the following three sources of revenue:

4.24According to the Commission, these are also the main digital activities that currently escape tax altogether in the EU.

4.25A number of services are excluded from the scope of the proposed DST. Although all online advertising is included, in cases where the supplier of the advertising and the owner of the digital interface are separate, only the supplier will be subject to the tax (e.g. if Google provides advertising services on the dailymail.co.uk web-page, Google would be subject to the tax on its advertising services). Services not included are media and content distribution, communication services, and the sale of goods and services online (although the facilitation of e-commerce through an intermediation platform is). Most regulated financial services, including platforms for savings and investment and crowdfunding for investment, are excluded—it is unclear whether any are in scope, although further clarification may be sought on whether funding platforms such as TransferWise, which are arguably intermediation services, would be in scope.

4.26Two thresholds would have to be met for a company to be subject to the tax:

4.27The global threshold is intended to target large businesses for which the mismatch between value creation and corporate tax may be greatest. It is intended to exclude start-ups and growth companies, and to give a large, simple threshold so that companies can know easily that they are not within scope of the tax. The threshold is set at the Union level to disregard differences in market size between Member States.

4.28Taxing rights would be split between Member States according to different criteria depending on the service in question, although in all cases this would be based on the location of users and not the place of payment or underlying transaction. The location of users would be determined using internet protocol (IP) addresses, or alternative methods if businesses can argue for their effectiveness. Member States will be responsible for identifying the taxpayer, collecting the tax and allocating it to other Member States as appropriate. A digital One-Stop-Shop portal will be set up to help companies comply.

4.29In order to avoid the possibility of double taxation, companies will be able to deduct the tax as a cost from their corporate tax base.

4.30The proposed DST would only apply on an interim basis, until the reforms proposed in the second Directive (see below) were implemented.

The Government’s view

4.31The Government’s Explanatory Memorandum recognises that the taxation of the digital economy is an important issue which raises challenges, supports the view that global tax agreements no longer accurately capture how value is created by digital businesses and concludes that, although global action is preferable, interim measures such as a revenue tax—implemented either through the EU or more widely—may be appropriate.

4.32The Commission’s proposal appears to be broadly in line with a number of recent Government policy papers on this subject. The Treasury’s November 2017 position paper, “Corporate tax and the digital economy”, and a March 2018 update to that paper, broadly align with the Commission’s analysis. The latter paper specifically suggests that an interim measure might take the form of a revenue tax:

“Without reform, the disconnect in the digital economy between the location of value creation and taxable profit challenges the fair application of the UK corporate tax regime. This disconnect has implications for both market outcomes and the system’s sustainability.”

“As set out at Autumn Budget, it is for that reason the government has outlined its receptiveness to an interim measure, preferably implemented on a multilateral basis, to compensate for unrecognised user-created value pending wider reform of the international corporate tax system.”

“It is envisaged that an interim measure would be a tax on the revenues of digital businesses deriving significant value from UK user participation.”

4.33The Government also indicates that the proposal complies with the principle of subsidiarity, reasoning that:

“Actions undertaken by individual states would likely differ from each other, which could increase complexity, creating compliance burdens for businesses. In addition, the nature of digital activity is often cross-border, so multilateral solutions could generally be assumed to be more effective.”

“Thus, there are significant benefits to interim solutions such as a revenue-based tax, to the extent they become necessary, being implemented on a multilateral basis—either in the EU or more widely.”

4.34The Government expresses support for a number of specific aspects of the proposal, including:

4.35Nonetheless, the Government considers that further work is needed to ascertain:

4.36It is suggested in the Communication, although not in the Directive itself, that a proportion of the tax raised could be dedicated as revenue for the EU budget. The government does not support this suggestion.

Directive 7419/18 and Recommendation 7421/18: Rules relating to the corporate taxation of a significant digital presence

4.37Alongside the proposal for an interim revenue tax on some digital service providers, the Commission has proposed an addition to existing corporate tax rules, which would enable Member States to tax profits that are generated in their territory, even if a company does not have a physical presence there, the aim being to ensure that online businesses contribute to public finances at comparable levels to traditional ‘brick-and-mortar’ companies. Member States would determine and apply their own corporate tax levels.

(i) Modify permanent establishment rules

4.38The first effect of the proposal is to modify permanent establishment rules so that it is not necessary for a company to be physically present in a Member State in order for it to be taxed. Permanent establishment rules will be modified to introduce a new form of permanent establishment based on “significant digital presence”. A significant digital presence, which has the effect of establishing taxing rights (a taxable nexus) for the host country, is deemed to exist if a company’s business consists wholly or partly in the supply of digital services through a digital interface (such as a website or an app) and one of the following conditions is met:

4.39These criteria are proxies for determining the ‘digital footprint’ of a business in a jurisdiction based on certain indicators of economic activity. They are intended to reflect the reliance of digital businesses on a large user base, user engagement and user’s contributions as well as the value created by users for these businesses.

(ii) Modify rules for attributing profits

4.40In addition to creating the concept of a significant digital presence, which will enable Member States to tax companies where they meet the criteria, the proposal also sets out principles for attributing profits to the significant digital presence, in order to establish which profits they are entitled to tax. The Commission proposes adaptions to the standard methodology (functional analysis of the permanent establishment) in order to better capture the value creation of digital business models by allowing the market value of users and data in the provision of digital services to be taken into account when allocating profits to tax in the future.

4.41The proposed rules only lay down general principles for allocating profits to a significant digital presence: the Commission envisages that more specific guidelines on the allocation of profits could be developed at the appropriate international fora or at EU level.

4.42The proposal would (i) enable Member States to tax significant digital presences where they met the criteria, and (ii) define which of the profits generated by significant digital presences Member States were able to tax through the incorporation of various intangible assets such as number of users in the analysis of the activities of the permanent establishment. This would modify which Member States were able to tax which profits, and result in a different reallocation of profit, but would not function like the Common Consolidated (Corporate) Tax Base proposal, by collating profits throughout the EU and then reallocating those profits according to a common EU formula.

(iii) Updating tax treaties with third countries

4.43The proposed new rules would also apply where a Member State does not have a double taxation treaty with a third country. However, when Member States have double tax treaties with third countries, the proposed new rules will not apply, as they will be superseded by those treaties. This means that, unless the tax treaties are adapted, the new provisions will not apply in situations where a business with EU users is tax resident outside the EU, and would only apply between EU Member States or between Member States and third countries where there is no tax treaty.

4.44The Commission has therefore issued a recommendation that countries update their tax treaties with third countries to reflect the new rules.

4.45In addition to the above changes, the Commission repeats its position that the Common Consolidated Corporate Tax Base (CCCTB) would lead to fairer and more efficient corporate taxation in Europe. The proposed Directive is separate from the CCCTB. However, the Commission say that if in future the CCCTB is introduced, it should incorporate the provisions of this Directive.

The Government’s view

4.46The Minister states that the Government welcomes the Commission proposals as a constructive step forward on the taxation of the digital economy, noting that the main potential benefits of this are that it provides a basis upon which to explore options for global reform and may act to encourage non-EU countries to consider changes.

4.47The Government outlined its own views on long-term reform of digital taxation in a position paper update published in March 2018, chapter 3 of which indicated that the government’s position was 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”, and that “some reallocation of the profits currently recorded by these companies to user jurisdictions is justified, and achievable in a way that minimises the impact on the current approach”. The paper then explored how user-created value could be measured and allocated to different user jurisdictions.

4.48Regarding subsidiarity, the Government states that global reform of the international tax rules would be preferable, but accepts that in the absence of agreement to do so there is scope for the European Commission to propose solutions. The Government concludes that the proposals “are justifiable under the principle of subsidiarity” because of the difficulty of acting unilaterally, and because actions undertaken by individual states would increase complexity of the tax environment and create compliance burdens for businesses.

4.49The Government also agrees with the Commission that any comprehensive solution will mean updating both the definition of permanent establishment and methods for allocating profits between different entities.

4.50However, the Government highlights a number of areas where further information is required. It suggests that:

4.51The Government emphasises that it continues to view the Common (Consolidated) Corporate Tax Base proposals as disproportionate, and that this would also apply to the merger of these proposals with the C(C)CTB, which is suggested in the Communication relating to these proposals, but not contained in the proposals themselves.

Debate in the House

4.52On 27 March 2018 a debate on Digital Taxation59 was held in the House of Commons, within the context of which the current proposals were discussed.

4.53The House of Commons Library has produced a short briefing on this debate.

4.54The motion was moved by Neil O’Brien MP (Con), who drew attention to the Treasury’s position paper, OECD work on base erosion and profit shifting, and both of the European Commission’s legislative proposals, which had been published five days previously. Regarding the Commission’s proposals, O’Brien noted the similarity between the Commission proposals and the Treasury papers, particularly on the levy on revenues, summarised the shared diagnosis of the underlying problem (“there is no real link between where value is being created and where tax is being paid”) and said that, as the UK moved towards being independent of the EU, he was sure that the Minister would be thinking about “how a UK tax might fit alongside an EU one”.

4.55Nick Boles, Damien Moore, Robert Courts, Lee Rowley, Ranil Jayawardena, Luke Graham, and Chris Philp took part in the debate. Most expressed support for digital tax reform, and for a revenue tax in particular. Chris Philp MP engaged specifically with the Commission proposal, stating that he supported a revenue tax, and that the proposed threshold seemed reasonable; that “care should be taken to ensure that the EU does not use it as a pretext for retaining the tax receipts and developing a European Union treasury function for the first time”; and that if the EU did not move quickly enough, the UK should take unilataral action.

4.56Mel Stride MP, Financial Secretary to the Treasury, responded to the debate by summarising aspects of the Commission proposals, suggesting that “a 3% tax on revenues would be appropriate … but that there should be a de minimis on the basis of those companies’ worldwide turnover and the level of taxable revenues that would fall due within the European Union”, and that it was “important, within EU domestic tax legislation and the treaties between member states, that we have a definition of the concept of significant economic presence, which captures this idea of creating value in the way that I described”.

Previous Committee Reports

Fifth Report HC 301–v (2017–19), chapter 10 (13 December 2017).


52 Fifth Report HC 301–v (2017–19), chapter 10 (13 December 2017).

53 Letter from the Financial Secretary to the Treasury to the Chair of the European Scrutiny Committee (19 February 2018).

54 HC Deb, 27 March 2018, volume 638.

55 Politico.eu, Europe’s digital tax map: Where countries stand (6 April 2018).

56 HM Treasury, Corporate tax and the digital economy: position paper update (March 2018).(March 2018).(m

57 Explanatory Memorandum submitted by the Treasury on 4 May 2018.

58 HM Treasury, Corporate tax and the digital economy: position paper update (March 2018).

59 HC Deb, 27 March 2018, volume 638.




Published: 19 June 2018