In March 2018 the UK has issued an updated position paper on corporate taxation and the digital economy, following an earlier consultation on the issue.
The UK government considers that the engagement and participation of users is important for value creation in some digital business models and is reflected in the contribution of content or in contributions to brand or other intangible assets. The international tax framework should be reformed to reflect the value of user participation and the OECD’s Inclusive Framework should develop international solutions. Until that reform takes place there is a need for interim solutions such as revenue-based taxes.
Allocating profits from user participation
The UK government suggests that the value a business derives from user participation is in the group companies that receive the residual profits of the business – the profits remaining after the activities of the group service providers have been remunerated at arm’s length. These residual profit owners control the decisions and risks within the group, probably including those that relate to the solicitation, engagement and retention of users, and realize profits resulting from taking those decisions and risks. They are most likely to own brands and user-related intangibles and to benefit from the increase in value of the intangibles resulting from user participation. Reallocation of the profits of those residual profit owners to the user jurisdictions is therefore justified.
Measuring user-created value
The UK considers that it may be necessary to reward the user-created value on the basis of a percentage share of the residual profit earned by the principal companies of the group. So the user created value would be represented by a share of the residual profit after remunerating routine functions with an arm’s length return.
Consideration would need to be given to how to tailor the share depending on the materiality of user participation within a particular group. This would reflect the fact that user participation could be more important for a social media group relying on user contributions and analysis of user activities than for a platform with self-developed content and more passive user engagement.
The UK could develop indicators of the share of residual profit applicable for different categories of business to be identified in OECD guidance and set out criteria for allocation of a particular business into one of the categories.
Allocation of user-created value to jurisdictions
An allocation key could be used to approximate the value of users in each jurisdiction. The key would need to take into account more than just user numbers in each jurisdiction because the extent of contribution to value by different users can vary greatly depending on the nature of their contributions. The key would need to look at active users or look at revenues attributable to users in each jurisdiction.
The allocation key would need to be tailored for each business according to the user characteristics that are most important for value creation in that business.
Taxation of user-created value
The user jurisdictions could be given the right to tax the companies in the digital group that are realizing the value from user participation. The user jurisdictions would tax the proportion of their profits considered to arise from local users.
The paper notes that this could lead to more than one company being taxed in user jurisdictions on user-created value, where there are multiple owners of intangibles and several companies making valuable contributions to profit generation.
Alternatively user jurisdictions could be given the right to tax a company in the group with which users have some connection. This could be difficult however as a number of group companies could have a direct or indirect link to users. It may therefore be necessary to identify the taxable company based on a particular feature such as the company with which users enter into a legal agreement to use the platform or the company that earns revenue from a platform aimed at local users. There would also be a need to prevent double taxation.
Limiting taxing rights of user jurisdictions
User jurisdictions would be subject to limitations on the amount of profits they could tax, for example by pre-determined parameters for the share of profits from user participation and a threshold for the presence of users in a jurisdiction above which level the profits from user participation could be taxed.
Further considerations
There could be significant divergences between taxable and accounting profits as a result of taxing profits from user participation. In some cases the scale of the divergence could create challenges. Also there could still be multiple companies in the group sharing in the results owing to reasons such as management of IP or control of risk; and challenges could arise with measuring residual profits from different lines in a group; coping with currency differentials; or arising from residual losses within a business. There could also be an additional administrative burden for groups.