Government considers how it can tax digital businesses via “user participation”

SUMMARY:

The government has come under scrutiny in recent years for letting digital businesses avoid paying taxes by choosing to locate in low-tax regions.

The British government has released a paper that provides some insight into how it foresees it could tax international digital businesses in the future, following years of criticism for letting the likes of Google, Facebook and Twitter pay minimal tax to the Treasury.

It’s worth stating at this point that there isn’t thought to be anything illegal regarding the tax affairs of these internet giants, rather they are able to take advantage of outdated tax rules within the context of a new global, digital economy.

For example, the likes of Amazon, Google and Facebook have been heavily criticised for using low tax EU states as havens to route their revenues through, in order to reduce their tax bills. They have all, in response to the public criticism, made some form of public commitment to pay more tax – whether that be through agreements with individual countries to pay some back-dated tax, or by making promises to route more money via the countries that they earn the money in.

The European Union recently indicated that it  is set to unveil a new tax for the world’s largest tech giants, which will likely be in the 2% to 6% range. The move comes at a time of growing public and political discontent at the way that tech giants (legally)

It’s a complex tightrope walk, given that politicians want the technology giants to keep growing their businesses in-region, not wanting to scare them off with huge tax bills, but also needing them to compete fairly with home-grown businesses.

However, the British government is proposing a novel way of taxing digital businesses, based on “user participation”. I’m no tax expert, so I won’t go into the nitty gritty of how the government proposes that this works in practice (although there is still a lot of ambiguity around whether this has been fully thought through yet), but you can read the full proposal document here.

Instead, we will take a top level view of what is being suggested, given that the government rightly notes that the “speed and scale of the changes caused by digitalisation have naturally had implications for the UK tax system”.

It adds that this is particularly true for corporation tax, where the development of certain business models has challenged the government’s understanding of how and where companies create value.

The document explains:

While it continues to support the principle underpinning the international corporate tax system – that the profits of a business should be taxed in the countries in which it creates value – it believes that this principle is being challenged by business models for which value creation is in part reliant on the engagement and participation of users.

The government’s view is that the tax system has not kept pace with these changes and that action is needed.

And the government wants these challenges to be solved, as it believes that the misalignment between where digital businesses are taxed and where they create value threatens to undermine “fairness, sustainability and public acceptability of the corporate tax system”.

It hopes to find a multilateral solution to this challenge and hopes that the upcoming OECD report and G20 summit in Argentina will help set out a programme of work for achieving that.

User participation

Central to the government’s thinking is that “user participation” is an important value driver for certain types of digital businesses – and its aim is to figure out how to tax this specific area of value creation for digital companies.

It defines user participation as “the process by which users can create value for certain types of digital businesses through their engagement and active contribution”.

And in its proposal paper, the government has identified four areas where it deems that users can create value for digital businesses.

  • Generation of content – The paper notes that some digital businesses operate online platforms that are substantially made up of user-generated content (e.g. a social media company that generates revenue from selling ads populated by users’ posts). The core business offering remains the content generated by users and the nature and quantity of that content “underpins the business’s ability to attract users and generate revenues”.
  • Depth of engagement with the platform – The relationship that users form with online platforms is often a function of the level of activity in contributing to content and interacting with other users. Sustained engagement allows businesses to tailor platforms to each user, with the aim of maximising user utility and delivering a personalised experience. The government notes that these platforms are able to generate valuable data on users’ behaviours, interests and consumption habits through the intensive monitoring of their engagement with the platform.
  • Network effects and externalities – For some digital businesses, the value that a user derives from a platform is strongly correlated with the number of other active users on that platform. Building large user networks can therefore be central to the success of these businesses, helping them to achieve economies of scale and allowing them to take advantage of the low marginal costs that there may be in making a platform available to new users. Users are at the core of such networks, and help to develop those networks through their engagement and through actions which foster connections between users e.g. sharing content, rating content and creating internal networks. This is relevant to platforms that rely on user-generated content, where the value of the platform to a potential user is directly linked to the actions of other users on the platform. It is also relevant to platforms for which the quality of a service to a user is indirectly linked to the actions of other users.
  • Contribution to brand – Some digital businesses, the government argues, are reliant on users for platform content or for the goods and services that are provided on the platform. Users can be seen as key contributors to brand strength and reputation. User participation in reviewing and rating content or services provided by third parties is also crucial in regulating what appears on the platform and establishing an important trust mechanism for other users. That is crucial to the performance and value of collaborative platforms that generate revenue from bringing together large volumes of buyers and sellers, and might have very limited control of the parties that are participating on their platform and the quality of goods and services being provided.

My take

It’s an interesting proposal and the government outlines a number of examples in its paper for how it might theoretically tax digital businesses that are reliant on user participation for value creation in one of the four areas outlined above. It’s worth exploring and it will need international collaboration and agreement to make any formal tax policy stand.

That being said, this is incredibly complicated and some experts don’t believe it is possible. For example, how do you decide what percentage of profits is attributable to user participation? Can you define user participation as a percentage of profits in any sort of fixed terms, given the diversity of digital businesses? Equally, identifying users online in any sort of reliable way is a minefield (e.g. bots). So, can we really say how many UK users, for example, are generating profits for the likes of Twitter and Facebook?

We will be tracking this closely.

Image credit - Image sourced via HMRC