Has the UK opened Pandora's Box?
Our €9.5bn corporate tax revenues are under threat as the EU, UK and others threaten to impose digital taxes as the OECD drags its heels, writes Dan White
Britain's Chancellor of the Exchequer, Philip Hammond, introduced a new digital services tax, AKA the 'Google tax' in last week's UK budget. The new tax is scheduled to come into force in April 2020 and is projected to raise £400m (€455m) a year.
"The digital services tax will only be paid by companies which are profitable and which generate at least £500m a year in global revenues," said Hammond. In other words, this is aimed exclusively at the Googles and Facebooks of this world rather than at indigenous UK startups.
Details on the proposed digital services tax are still sketchy. The first £25m of UK revenue will be exempt from the tax. Online search engines and social media companies will pay 2pc on advertising revenue, but it is unclear if online retailers such as Amazon will be affected.
The UK Office of Budget Responsibility reckons that about 30 firms will actually end up paying the new tax.
There will be a consultation period before the new tax comes into force, which may help to clear up some of the confusion.
So what does the new UK digital services tax mean for us here in Ireland? Most of the large US digital firms, including Google, Facebook, Apple and Microsoft, have major Irish operations.
Of the more than €9.5bn Paschal Donohoe expects to collect in corporation tax this year, well over 80pc will come from foreign-owned, mainly US, companies with just 10 companies contributing 40pc of total revenues. While Revenue isn't giving any names one can take it as read that several of the digital companies are included in the corporation tax top 10.
The issue of the taxation of digital companies has been brewing since at least May 2013, when the US Senate Investigations Sub-Committee revealed that Apple had paid an effective tax rate of less than 2pc tax on $37bn of profits routed through Ireland the previous year.
This led to the farcical situation of the EU Commission suing Ireland, alleging illegal state aid to Apple, until it collected €14.3bn in tax and interest from the company - money which our Government is adamant it doesn't want.
Of course it hasn't been just in Ireland that the digital companies have allegedly been playing ducks and drakes with national taxation systems.
In 2016 Google agreed to pay the UK £130m in back taxes following the revelation that in 2013 it had paid just £20m tax on British sales of £3.8bn. Amazon paid a mere €16.5m tax on sales of €21.6bn routed through Luxembourg in the same year. In February of this year the online retailer settled a €200m French tax demand for an undisclosed amount.
Taxing digital companies poses enormous challenges for traditional taxation systems.
"For the last 100 years companies have paid taxes where their activities were located," said Feargal O'Rourke, managing partner of accountants PwC.
Digital upends this model. "Do we need a new set of rules to reflect new business patterns," said O'Rourke?
What is clear is that all of our old notions about where value is created and taxes should be paid have been rendered obsolete by the digital revolution.
"Where is value created with digital? Is it the consumer who creates the value or the research and development? That is the big question," said Ibec director of policy Fergal O'Brien.
To take an example: Should online retailer Amazon pay tax where its distribution warehouse is located or in the country where the purchaser resides?
It gets even more complicated if, as is often the case, no physical goods actually change hands between seller and buyer. How does one tax the profits earned on American-owned software or digital advertising sold out of Ireland to a European buyer where the intellectual property rights are located in yet another country?
What is clear is that, with the digital economy powering ahead, doing nothing is not an option. While the CSO has yet to get a fix on Irish online sales, figures from the UK's Office of National Statistics show that online sales were 16.3pc of total British retail sales in 2017, up from just 9.3pc in 2012. With online gobbling up 17.1pc of UK retail sales in September, it will be even higher this year, probably at least 18pc.
And that's just retail sales. Whole swathes of business-to-business sales including software, advertising, financial services, etc have also migrated online.
In 2012, the G20 group of major world economies gave the OECD the job of drawing up a set of measures to combat tax avoidance by multinational companies, which is estimated to cost national exchequers $100bn-$240bn annually in lost tax revenues.
The resulting BEPS (base erosion and profit shifting) project consisted of 15 work streams, with agreement being secured on all but one - the taxation of digital profits. While the OECD issued an interim report on the tax challenges of digitalisation last March, full agreement on a global system of taxing digital profits is still some way off.
With the OECD unable to secure agreement the EU and several individual countries are threatening to jump the gun. In addition to the UK, other countries including France, Spain and Australia are all planning to introduce their own national digital taxes, while the EU has also pitched in with its plans for a 3pc levy on the sales of the large digital companies.
The EU digital tax plans have been strongly opposed by several countries including Ireland, Germany, Sweden and Malta. It has also, perhaps predictably, been opposed by the US tech giants.
What was perhaps not so widely anticipated was the opposition of many European digital companies with a group of 16 European companies including Booking.com and Spotify writing to EU finance ministers last week warning that while the tax was "designed with large and highly profitable [ie US-owned] companies in mind" it was likely "to have a disproportionate impact on European companies" instead.
Despite such opposition some sort of digital tax is now probably inevitable, the only question is what form it will take? For this country the key objective will be minimising the impact of any new digital tax.
"We are very much of the view that the only way it can be done is at a global level," said Ibec's O'Brien. Individual country digital taxes will, if implemented, be "ineffective and potentially counter-productive", he said.
Further complicating the digital taxation debate is the fact that most of the major companies are US-owned. With the US administration having already shown itself to be trigger-happy on trade issues, the unilateral imposition of digital taxes could well exacerbate an already tense situation.
"This tax has the potential to be absorbed into a tit-for-tat transatlantic trade war," said Kevin McLoughlin, head of the tax practice at accountants EY.
McLoughlin is almost certainly right to be concerned.
"[The US] Treasury is working very closely with the OECD and our counterparts there to address issues of base erosion and fair taxation," said US Treasury Secretary Steve Mnuchin last week.
"We believe the issues are not unique to technology companies but also relate to other companies, particularly those with valuable intangibles... I highlight again our strong concern with [other] countries' consideration of a unilateral and unfair gross sales tax that targets our technology and internet companies.
"A tax should be based on income, not sales, and should not single out a specific industry for taxation under a different standard. We urge our partners to finish the OECD process with us rather than taking unilateral action in this area."
So what can and should we in Ireland do?
O'Rourke said: "The last thing we want is individual countries bringing in a patchwork quilt of national digital taxes. The OECD is really under pressure to produce something over the next two years. Having hitched our wagon to the OECD we will have to support whatever it comes up with."
If or when international agreement can be secured on digital taxation, McLoughlin stressed the importance of giving companies time to change and adapt to the new regime.
"Ireland is seen as quite stable. Other countries have been more aggressive and unpredictable," he said.
The difficulty in securing agreement at either OECD or EU level means that the most likely outcome, at least in the short term, will be a plethora of national digital taxes. When announcing the digital services tax last week, Hammond specifically referred to these delays.
The chancellor said: "A new global agreement is the best long-term solution. But progress is painfully slow. We cannot simply talk forever."
While on their own none of these national digital taxes is likely to have a significant impact on Ireland - even if the full burden of the UK tax fell on this country it would still represent only just over 5pc of our total corporation tax revenues - the cumulative impact would almost certainly be much more severe.
O'Rourke said that "£400m could be the thin end of the wedge".
O'Brien added that: "The large consumer countries are grabbing more of the [digital] tax revenues. That could lead to other consequences for Ireland. There needs to be an OECD solution. They have a track record. Although they did not succeed on digital the last time, there is much more momentum behind it this time."
Sunday Indo Business