Internet-based companies—ranging from Amazon and Facebook, to Tinder and Alphabet Inc.’s Google—will have to unravel the geographic origins of their revenue streams and customers to check if the U.K.’s digital tax would apply to their businesses.
Sounds simple? It isn’t. Companies are now required to link U.K.-based user-generated value—such as their Facebook likes and preferences—to revenues generated in the U.K.
In effect, how much advertising revenue is generated from U.K.-based Facebook user likes, will now need to be reported, to work out if the U.K.’s tax would apply to the revenue.
The newly proposed tax, currently under consultation, means the actual reporting of revenues must change. And in some cases, this will mean businesses have to invest in and apply new costly accounting systems, according to practitioners.
Further, there needs to be separation of their digital and non-digital revenue streams, not previously required for accounting purposes.
And calculating “in-scope” revenues could prove a challenge for some businesses with merged income streams that are partially in-scope, said Eloise Walker, a partner at Pinsent Masons.
For example, Amazon has a third-party warehousing and cloud computing division, which is taxable, but an e-commerce business where it sells its own goods is not subject to tax.
“It’s going to be very, very difficult. I’ve been in conversations with several heads of tax that will be effected and it’s not just the tax itself, which is aggravating enough, it’s how on earth you’re going to work out what is in-scope and how you split it,” she said.
The digital services tax announced in the U.K.’s Oct. 29 budget would impose a 2 percent tax on tech companies that generate more than 500 million pounds ($642 million) annually in global revenue from advertising and data—or “in-scope” activities.
In-scope business activities of social media platforms such as Facebook derive material value from user participation. The DST rules would assess taxable revenues, regardless of whether Facebook sells advertising, user data or subscriptions.
The government in its consultation paper said that the tax will be structured as a self-assessed tax, and the onus will be on the company to calculate its in-scope revenues.
A Treasury spokesperson said the department was “consulting on the detailed design of the Digital Services Tax, including the approach to attributing revenues between business activities. We will listen carefully to feedback from stakeholders to ensure the tax is implemented in a reasonable and proportionate way.”
The issue of calculating what is in and out of scope will prove most daunting for companies that are borderline cases, said Alenka Turnsek, partner, digital transformation, PwC UK.
“A number of companies may not realize when they are slipping from the e-commerce to the online marketplace category,” she said. These companies need to be careful as they grow to avoid falling into this bracket, as the calculation of this tax could prove costly and onerous, she added.
“The difficulty is going to come for companies that really shouldn’t get caught in the DST but are, because the draft tax is so woolly that will mean they have to spend an absolute fortune trying to figure out how they split their incomes to work out if they are on the right side of an arbitrary line,” said Pinsent Mason’s Walker.
Also effected are traditional businesses that are making the shift towards digital. These companies will need to address, as part of their business strategy, how this tax will affect their plans, she said.
The cost of making changes to the system depending on a companies’ existing enterprise risk management (ERM) systems and cost centers, explains PwC’s Turnsek.
These systems handle incoming and outgoing revenue for large businesses and if they are sufficiently robust and flexible enough could be adapted to calculate how much income taxable under DST that the firm generates, she said.
“The costs for companies really depend on their management controls today. If you are a healthy business, with a lot of good data, you are going to know how much revenue your different business lines generate. The problem is going to come around when you have multiple marginal revenue streams that are in-scope,” she said.
For companies that are already grappling with Brexit and other reporting and compliance burdens without adequate systems already in place it could prove a bigger challenge, she said.
Categorizing revenues could be another issue when calculating whether revenue is in-scope, said Glyn Fullelove, chair of the Chartered Institute of Taxation (CIOT) technical committee.
Currently, e-commerce businesses are exempt while online markets places are not. This division could become a point of contention, he said.
“We would have concerns that apportionment creates problems in the way in which the tax base is calculated. That is because the apportionment of revenues has long been a fertile area for tax disputes,” said Fullelove.
He drew parallels of the disputes between businesses and HMRC about whether packages of goods are liable for value added tax.
Additionally, CIOT said it would be difficult to attribute users to the U.K., which could become another point of contention when the tax is implemented.
Users can for example move to other countries or cease to use a digital service but continue to provide value to the business through the valuable data they generated when they were active.