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How the EU will tax cyberspace

14 May 2018 by Russell Cockburn

How the EU will tax cyberspace - Read more

The EU is considering how it can make technology firms pay their fair share

In March 2018, the European Commission published proposals aimed at clarifying how the digital economy should be taxed in the future. There has historically been some confusion over precisely where digital business activities carried out within the EU should be taxed.

Although the impact of Brexit on these proposals is unclear, it seems likely, given the recent announcement of the two-year ‘transitional period’, that UK business will need to continue to follow EU pronouncements for the foreseeable future – and even thereafter.

Given the OECD, an international grouping of mostly rich countries, has also been involved in formulating these proposals, it seems likely UK businesses will be affected by the digital tax proposals over the longer-term anyway.

The main proposal is that business will be deemed to have a taxable ‘digital presence’ in a particular fiscal jurisdiction if it can be seen to meet criteria set out by the EU and the OECD for tax purposes in future.

A secondary proposals is that there will also be an ‘interim’ tax on businesses’ revenues arising from digital activities when ‘users play a major role in value creation’. This is initially proposed to be set at a rate of 3%.

The suggested longer-term regime is heavily tied up with, and indeed probably dependent upon the eventual introduction of, the European Commission’s proposals to introduce the Common Consolidated Corporate Tax Base.

It is also linked to the general reform of corporation tax across all states, with the broad intention that corporate profits should be registered and subjected to corporate tax when a business can be said to have ‘significant interaction with users via digital channels’.

“Business operating in the digital economy must keep a close watch on how things develop”

When a digital platform will be held to have a taxable digital presence, or more prosaically a ‘virtual permanent establishment’, is proposed to be subject to specified criteria.

A business will meet the test in a state if it satisfies any one of several conditions: €7 million revenue in a member state; more than 100,000 users in a member state in a tax year; or more than 3,000 business contracts for digital services with business users in a tax year.

The proposal for the interim tax rate on business revenues is aimed at specifically identifying situations in which platform users have a significant role in ‘value creation’. This could be, for example, involvement in online advertising, facilitating interactions among users with each other and sale of data generated by the users themselves.

The aim is that tax revenues would be collected by member states where those users are actually physically located. At the moment the intention is that these rules would only apply to the largest business, currently proposed at a level of worldwide revenues of €750 million with EU revenues of €50 million.

Although the above are only proposals, at the moment it is clear that the EU and the OECD are intent on moving these issues forward rapidly in the coming months. Business operating in the digital economy must keep a close watch on how things develop, and ensure that they are ready for these changes as they are introduced.

Personal services companies

The recent case of Christa Ackroyd Media v HMRC UKFTT 69 [2018] saw a tribunal find against a BBC presenter who had gone through a personal service company to provide her services to the broadcaster as a television journalist over several years.

The tribunal ruled that the intermediaries legislation in the Income Tax (Earnings and Pensions) Act 2003 ought to have been applied by Ackroyd, highlighting the ongoing pursuit of such arrangements in the media sector by HMRC. A significant amount of tax and National Insurance contributions are apparently in dispute here and many similar cases are believed to be under challenge.

The tribunal’s decision seems to have been heavily influenced by the apparent ‘ultimate control’ that the BBC could exercise over how, when and where Ackroyd carried out work for the corporation, and also how she had to comply with its editorial guidelines.

Given the nature of the work carried out and the dominance of the BBC in the market, these factors ought to have been looked at more neutrally when weighed against other factors, such as the specialist nature of the services being provided and the level of specialist professional expertise being brought to bear when Ackroyd presented.

In another case, MDCM Ltd v HMRC, a construction contractor won against HMRC. Here, more weight was apparently given to the absence of more mainstream employment indicators such as holiday and sick pay, other employment benefits, no payment of expenses and the payment of a fixed daily rate for the work done.

Specifically, it was important that the level of control exercised over the contractor was no more than that exercised over others doing similar work. This point is clearly relevant to the issue of Ackroyd having to comply with editorial guidelines.

What also came out of Ackroyd’s case was a clear indication that she had been encouraged by the BBC to work through a personal service company. She perhaps had genuine reason to believe that she had dealt properly with her tax affairs and now falls victim to a general challenge by HMRC in a matter over which she had and has little control.

“It was important that the level of control exercised over the contractor was no more than that exercised over others doing similar work”

It seems likely that similar cases will emerge in the coming months. The advent of the off-payroll working rules from April 2017 may well bring the use of such arrangements to an end in the public sector, but sorting out the history seems likely to take some time.

The ominous hint in last autumn’s budget that these rules may be extended to the private sector will currently be making many organisations review their use of individuals supplying their services through personal service companies.

Is it perhaps time now for government to intervene, or at least consider whether the BBC has some residual responsibility in helping many potentially affected by this case ruling in settling their tax liabilities, which may have arisen because they simply followed advice.

Automatic penalty invalid

Khan Properties v HMRC UKFTT 830TC has been receiving fair attention of late, both in the tax and wider press. Its key decision relates to the validity of penalty notices issued automatically by the ubiquitous HMRC computer system for late filing of tax returns.

The judge in the case ruled that the penalty notices were invalid without a named HMRC officer on the notices themselves. He commented that the specific statute involved here required a ‘flesh and blood human being who is an officer of HMRC’ to make the penalty determination, and that had not been true in this case.

Some observers suggested enthusiastically that this ruling could be a major problem for HMRC, and that it might even be akin to recent ‘misselling’ scandals in financial services. Other pointed out that the judge was specific in stating that the ruling only applies to corporate taxation and cannot extend into the wider field of self-assessment penalties.

But this latter point must be debatable, and it remains to be seen how HMRC will react on this wider front. In the meantime, corporates who have received penalty notices might wish to check them closely, to consider their validity and whether an appeal on these grounds could be worthwhile.

Large business risk review

After a consultation aimed at updating and modernising its internal corporate and large business risk processes, HMRC has agreed it should expand the number of risk categories that it uses. At the moment there are two main categories in use, low risk and non-low risk, but HMRC has accepted it would be better to use a wider range of categories.

A new pilot system will be tested later in 2018 to introduce a revised Business Risk Review process. This will see the implementation of new risk categories on the above lines, together with other changes, with the intention being to finally introduce a comprehensively-revised process during 2019–20.

“The aim of the new system is to give businesses a clearer set of risk-rating rules and a more objective set of guidelines”

The new system is expected to include a wider range of risk categories, plus implicit acknowledgement of the amount of risk management work relevant to tax already undertaken and required internally by the largest UK businesses.

It will also take more detailed account of the significance of the processes and systems operated by larger business that are subject to the Senior Accounting Officer regulations.

The aim of the new system is to give businesses a clearer set of risk-rating rules and a more objective set of guidelines for actions and timescales within which actions ought to be undertaken to comply with the various risk categories.

The UK’s biggest businesses are used to conducting risk review meetings with officers of HMRC, but the simplistic approach of the existing risk categories has long been felt too crude by many.

Thus it will be interesting to see this review progress and whether having more categories and clearer guidelines will meet with general approval. However, the broad aims of the review seem welcome for the moment.

Russell Cockburn is an independent tax consultant

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