UK budget proposes watered-down digital services tax, hits offshore intangible property income

by Julian Feiner, Dentons

The UK’s budget, delivered today, includes some controversial international tax proposals. The digital services tax will dominate the headlines and other measures, such as the tax on offshore intangible property income, should raise eyebrows.

Overall, however, my sense is that the measures will dramatically increase complexity while delivering only a moderate increase in revenue.

Digital services tax

The UK has taken the bold step of proposing a digital services tax, aimed at search engines, social media platforms, and online marketplaces. It is intended to raise £1.5 billion over four years.

The proposal is not, however, as daring as it could have been. The assurance that it will be “narrowly-targeted, proportionate and ultimately temporary” offers conciliation to its opponents. It applies a 2% rate on revenues of specific digital business models, rather than the generalised 3% rate proposed by other EU member states.

It portends immediate action, but its implementation is delayed until April 2020. It targets revenues, not profits, yet offers a safe harbour so that loss-making companies do not pay the tax and those with very low profit margins pay a reduced rate of tax.

These moderations soften the blow, so that the anticipated revenue is only £275 million in FY21, rising to £440 million by FY24.

Compare that with the recent Spanish proposal, based on the EU’s formula, which promises over €1 billion per year. And the UK version will be no less complex and uncertain in its application.

There are numerous unsettled technical issues and uncertainties to resolve through further consultation and deliberation. One wonders if it is all worthwhile. 

Offshore intangible property income

The budget also proposes a new tax on offshore intangible property income. This measure is a revised version of a previous royalty withholding tax proposal, which was targeted at payments to connected parties in jurisdictions that do not have a tax treaty with the UK.

Broadly, the tax will operate as an extra-territorial supplement to the diverted profits tax, applying when a foreign entity receives income from the sale of goods and services in the UK, without any taxable presence or avoided permanent establishment in the UK, and that entity makes a payment to the holder of intangible property in a low tax jurisdiction referable to those goods or services.

No longer applied on a withholding basis, the tax charge will arise directly to the foreign entity. Joint and several provisions would enable collection of the debt from connected parties.

Despite the banal title and subdued announcement of this measure, its impact may be significant. Projected revenue is £475 million in FY21; i.e., £200 million more than digital services tax. This is due in part to the fact it has been expanded to apply to payments to both related and unrelated parties.

Despite the banal title and subdued announcement of this measure, its impact may be significant. Projected revenue is £475 million in FY21; i.e., £200 million more than digital services tax.

This is an ambitious measure that has had little coverage and is intended to apply from April 2019. Taxpayers need to become familiar with the revised proposal quickly ahead of its implementation.

Capital losses, hybrid mismatches, corporate interest

The government continues to tinker with the measures it has implemented since 2017. In particular:

• There is a measure to extend the corporate loss reform to include a restriction for capital losses. Broadly, this would provide a restriction for carried-forward capital losses arising in a company to no more than 50% of the capital gains arising in an accounting period. A consultation will run for 12 weeks from 29 October 2018 to 25 January 2019.
• There are proposals to change and clarify aspects of the hybrid mismatch and corporate interest restriction rules, with technical and procedural amendments in Finance Bill 2018-19.

The government is also consulting on regulations to give effect to new EU Directive 2018/822 (regarding mandatory automatic exchange of information in relation to cross-border arrangements) and the new OECD model mandatory disclosure rules which the EU Directive largely mirrors.

Of course, further measures could be announced early next year in the event of ‘no deal’ in the UK’s negotiations to leave the EU. There is never a dull moment in international tax policy these days.