Digital Services Tax in the UK

DST: Key features

DST was introduced retrospectively by the Finance Act 2020 as a temporary measure to address the challenges posed by the digital economy to international corporate taxation.

Effective from 1 April 2020, DST has raised £358m from large digital businesses in the 2020/21 tax year, 30% more than originally forecast (National Audit Office). The increase in tax collected is partly due to HMRC identifying more business groups falling in the scope of DST than originally expected. Importantly for digital companies, any business found to be liable will be retrospectively assessed for the 2020-21 tax year. According to the UK National Audit Office, most digital groups who are liable for DST now pay more in DST than corporation tax. Given the cost and reach of DST, digital companies who have not yet been found liable for DST but consider that they may be in scope are best revisiting their DST exposure analysis.

The parameters for how the DST works in practice include that:

• Tax liabilities are calculated at group level but are charged to individual entities in the group whose revenues involve UK users. These entities contribute to the tax thresholds in proportion to their contribution.
• The thresholds mean that DST only applies to groups with global revenues over £500m and UK revenues over £25m, which includes an allowance so that a group’s first £25m of revenues derived from UK users will not be subject to the DST.
• There are different considerations of what constitutes participation by a UK user depending on the activity in question:
• Online marketplace transactions will be considered to involve UK users if at least one of the parties is UK based, however the tax revenue charged will be reduced by 50% if the other user is located in a country with a similar tax to the DST.
• Advertising revenues will be considered to have derived from UK users when the advert is intended for UK audiences.
• A ‘safe harbour’ principle is available for in-scope companies who operate low profit margins or losses, allowing such entities to use an alternative basis of charge to calculate their liabilities and effectively lead to a lower DST liability, or no liability if they are loss making.
• DST is deductible as an expense of business, provided it is incurred wholly and exclusively for the purposes of a trade. However, it is not creditable against any UK corporation tax liability. This may result in double taxation.

Towards the withdrawal of DST

The UK has faced significant international (i.e. US) opposition to DST. The US has previously argued that digital services taxes "unfairly target" American firms and are discriminatory. The US threatened retaliatory commensurate measures if the UK and other European countries went ahead with their "unilateral" digital services taxes and vowed that it was "prepared to take all appropriate action to defend our businesses and workers against any such discrimination".

The inauguration of the Biden administration in January 2021 helped to restart the previously stalled OECD negotiations on the international tax challenges posed by global digital businesses. The UK, alongside various other countries, have since agreed a compromise with the US covering the interim period between January 2022 and either 31 December 2023, or the date Pillar One is implemented, whichever is earlier. Under this compromise (the “Unilateral Measures Compromise”), the UK is able to keep its existing DSTs in place until the implementation of Pillar One but US corporations subject to DSTs may receive tax credits against future tax liabilities. As a compromise, the US agree to terminate proposed trade action and refrain from imposing any future trade actions against the UK.

On 1 July 2021, the OECD issued a statement setting out its two-pillar plan to reform international corporate taxation (Digital Services Tax page), which the UK has committed to. Pillar One will enable the UK to tax a portion of the profits of the world's largest businesses that are attributable to consumption in the UK, including the profits of the world's largest digital businesses. As a compromise, the UK is to withdraw DST and commit to a 15% minimum level of global tax on large businesses under Pillar Two of the OECD's proposal.

On 20 December 2022, the OECD released a consultation document (Public Consultation Document – Amount A) setting out draft articles for the inclusion of the Multilateral Convention (MLC) in order to implement Pillar One. The MLC will require all members of the Inclusive Framework (of which the UK is included) to “remove all DST and other relevant similar measures with respect to all companies, and to commit not to introduce such measures in the future.” The Inclusive Framework aims to finalise the MLC for the implementation of Pillar One by mid-2023, for entry into force in 2024. The OECD intends to finalise the legislative framework during 2023, with the proposal to take effect from 2024. The UK has agreed to end its DST by the deadline of 31 December 2023 in order to adopt the OECD’s Pillar One model rules from 2024. The UK government anticipates that it will introduce a domestic minimum tax in the UK to complement Pillar Two, likely to come into effect from 1 April 2024 at the earliest.