In springing forward will we fall back?
In 2016 Philip Hammond announced the return to one single annual fiscal event and those of us working in tax breathed a sigh of relief.
The media has reported in the last few weeks that the Spring Statement will have ‘no red box, no official document, no spending increases and no tax changes’. Some are expecting it to last a mere 15 minutes.
Instead attention is likely to shift to consultation announcements around the statement itself and, following recent comments from Mel Stride, Financial Secretary to the Treasury and Paymaster General, the money is on some form of proposal around taxation of the digital economy. If this is right, then rather than enjoying a period of calm over Spring Statement (albeit this is a relative measure in the light of US Tax Reform) we may be looking at another round of consultations around complex changes to the UK tax system.
There is growing concern over how digital businesses are taxed within current frameworks. Even if a business is paying the right amount of tax under current tax rules, this may not adequately reflect how and where value arises in digital business models.
Even taking into account the OECD BEPS recommendations and the improvements those have brought, the taxation of digital businesses remains a thorn in the side of tax authorities across the globe.
The nub of the issue is that a digital business can create value from customers in jurisdictions where they often have little or minimal physical presence.
Most current tax systems need a physical presence in the relevant jurisdiction in order to obtain taxing rights. Tax authorities understand this and are increasingly turning their focus to questions of value; where and how it is derived, leveraged and monetised, and, as a result, where the taxing rights ought properly to sit. These are tricky matters.
Many jurisdictions are frustrated by the inability to appropriately tax digital business. There are a number of international initiatives underway including at the EU and the OECD. However, we are also seeing more countries taking independent action on the issue of taxing the digital economy. Whilst it is not clear whether this is the result of an increasing trend towards unilateral measures or an attempt by frustrated tax authorities to push for a faster global response, the risks to the cohesion of the international tax system of multiple solutions are a concern.
The UK issued two documents around the time of the Autumn Budget last year that impact on the digital economy. Firstly, a position paper titled ‘Corporation tax and the digital economy’; and, secondly, a consultation document on Royalties Withholding Tax. The period for comments on both of these documents has now closed and it is therefore very possible that we will see some announcements at the time of the Spring Statement.
The position paper on the digital economy acknowledged that an internationally recognised solution was the best answer to the problems posed but also stated that the government would explore interim options to ‘raise revenue from digital businesses that generate value from UK users such as a tax on revenues that these business derive from the UK market’. It is against this backdrop that Mel Stride made his comments about a tax on revenues being the preferred option.
The second document proposed a royalties withholding tax. Broadly speaking it attempts to mitigate the distortive impact to the UK domestic market that could arise as a result of a group’s ability to locate intangible assets in a low or no tax jurisdiction. The consultation set out proposals to expand the application of withholding taxes on royalty payments to deliver on this aim. The document acknowledges that many of the businesses affected by the proposals would operate in the digital sector.
Both of these initial documents were issued around the time of the Autumn Budget at a time when US Tax Reform was a twinkle in President Trump’s eye. Now Reform has become law and its impact on the international tax landscape cannot be underestimated. Not only did it ruin Christmas for many with December year ends (which may take some of us a long time to forgive!!), even now we are all still working through the full implications of such a fundamental reform, particularly one which was pushed through in a six week period and therefore contains a lot of inherent uncertainty.
The question is, however, whether US Tax Reform changes the conversation around these proposed measures.
The case for royalty withholding, in particular, looks to be considerably weakened by US Tax Reform. There can be little doubt that a significant target of the withholding proposals was large US multinationals who have accumulated profits in low or no-tax jurisdictions due to the high tax cost of repatriating those profits to the US.
Tax Reform changes that dynamic by severely reducing the incentives to do this going forward. Not only is the headline rate reduced, the reform introduces additional controlled foreign company provisions which subject low tax profits of subsidiaries of US entities to US tax.
At the very least it is hoped that the government will revisit the impact assessment for the royalty withholding proposals to enable a reassessment of whether they remain appropriate.
The answer in relation to the position paper on digital business is less clear cut but I do think there are fundamental questions around what unilateral measures of this nature will do to UK competitiveness.
Whilst taxpayers are heavily influenced by low headline tax rates many more factors play into the attractiveness of a location for investment. We hear time and time again that taxpayers want simplicity and certainty.
The findings from our own competitiveness survey show that the UK’s place at the top of the leader board is beginning to slip. A significant portion of this can be attributed to Brexit but, in our most recent survey, there was also an increase in responses from participants stating that complexity and changes to the tax legislation are the greatest challenges facing businesses in managing their tax affairs.
Unilateral action such as that proposed in the digital position paper are not popular. Our recent foray into unilateral action via the Diverted Profits Tax (DPT) has raised revenue but has frustrated many businesses, particularly as DPT now seems to be used to challenge situations nobody thought were within the original policy target. It would be interesting I think, to understand the impact of the Diverted Profits Tax specifically on the UK as a location of choice for investment.
I remain a firm fan of the UK as a place to do business. It has a lot to offer and I think we should do more to advertise its merits. But what seems to be the most likely digital proposal, a revenue based tax, is a fundamental change in the way that the UK has sought to tax business. The position paper tagged it as being a short term solution whilst a longer term one is found, but without firm commitments from the government about its withdrawal, I do not see many taxpayers trusting that this will happen. The likely expectation is that its withdrawal will be forgotten and it will become a permanent part of the UK tax system. The fact that it is unilateral will put more noise into an already cluttered environment still getting to grips with BEPS, struggling with complex UK reforms such as losses and corporate interest restrictions, and reeling from US Tax Reform.
Without a doubt there is a need to deal with the particular tax issues that are raised by digital business models. We cannot ignore these. Digitisation is going to become more pervasive. If we want a domestic or international tax system that is fit-for-purpose for today but also sustainable for future generations (and it is hoped that we do) then these issues must be grappled with, conclusions must be drawn, and change must happen.
The government acknowledges that the better answer is to do this in a collaborative way with international consensus so that the final solution is one that operates for the benefit of many. In the meantime, short term fixes, even if well intentioned, threaten to drive more confusion and complexity.
The UK is going through a time of unprecedented change and uncertainty with Brexit. US Tax Reform in and of itself is a threat to the competitiveness of many jurisdictions. Most businesses, at least in the short term, are in risk mitigation mode in response to both.
When the UK is at such an economic crossroads, surely there is a case to hit the pause button and make sure that we do not implement short term fixes without fully understanding the impact of those actions on our competitiveness. I can’t help thinking that now is the time to keep the UK in a ‘steady as she goes’ formation.
Ultimately we may need to be prepared for the Spring Statement to open the door to more complex tax changes. It is to be hoped that in the government’s enthusiasm to spring forward and embrace short term solutions to the digital economy we do not find ourselves falling back in our ability to attract investment.