What is Digital Services Tax and How Does it Work?

27-07-2020 |   |  By Robin Mitchell

IBM has urged President Donald Trump to not react to the UK and other EU countries for launching Digital Services Tax. What is this new tax, and what arguments can be made to support it?

IBM and the Digital Service Tax

Since 1st April 2020, the UK government have brought in a digital service tax that will affect many large corporations including Google, Amazon and IBM. As most digital service companies are American, President Donald Trump is planning to launch an investigation into the introduction of the tax to determine how negatively it affects American businesses. The results of such an investigation would no doubt support the impression that the tax is undoubtedly attacking American corporations which is why many such companies are supporting the investigation. However, IBM has urged the President not to launch such an investigation, as well as exercising restraint when imposing counter-tariffs. IBM believes that such retaliation would negatively affect American interest via a shrunken economy, and counter-tariffs from many trading partners.

What is the Digital Service Tax?

The Digital Service Tax being introduced by the UK government, the EU, and other countries worldwide is a tax that is applied to companies in the digital service industry. One of the biggest problems that have faced tax authorities is trying to tax companies that provide digital services while being physically located in other countries. The combination of talented accountants and tax loopholes generally sees large companies pay very little corporation tax (such as Amazon and Apple), which sees governments lose funding for public services such as roads, healthcare, and education. This problem is further amplified when it becomes hard to determine how much to tax a company that hosts digital services while not delivering a physical product (which carries VAT). 

How does Digital Service Tax work?

The tax itself applies to any company that provides a digital service where its global sales exceed $500 million, and the UK sales exceed $25 million. The first $25 million is an allowance and as such is not taxed, while any profit above this is taxed at 2%. Profit generated by a UK citizen is considered as such when any revenue generated is connected to a UK user. Where one of the parties to a transaction on an online marketplace is a UK user, all of the revenues from that particular transaction will be treated as derived from UK users. 

Is the Tax Fair?

This is a fundamental question to answer, with many countries around the world believing it is indeed fair. While it can be argued that imposing such a tax will hurt large corporations, and potentially impact technological impact, these are relatively weak arguments to use. The first factor is that only the profit generated in the UK is taxed when over £25 million. Thus, a large company that produces 90% of its revenue outside the UK would see this income untouched by HMRC. The second counterpoint is that this tax legislation does not impede technical developments (such as IoT guidelines), and only taxes revenue after a sizeable profit has been made (of course, sizable is a relative term as large companies can spend this amount in research alone). 

When considering what the aim of the tax is, it can be argued to be perfectly fair for one main reason; digital-based services fundamentally rely on public services. While digital services do not use roads for the transportation of goods, they are needed for the transportation of users who are dependent on those services, as well as engineering services that need to maintain communication links. Digital services are also reliant on the consumption by the population, which in turn are reliant on health and educational services. The money spent on defence by the government helps to create a stable and safe economy which further benefits digital services are taking advantage of the UK market. Thus, regardless of the nature of the business, any business conducted in the UK is reliant on the ecosystem supported by taxpayers money. Considering that corporate tax is near 20%, a 2% tax rate is objectively a fair amount (those who may argue that this 2% is on top of the 20% need to keep in mind that corporate tax is often minimised substantially). 

Does this Tax Unfairly Target American Companies?

It cannot be denied that an investigation would clearly show that American companies are overwhelmingly affected. However, the aim of the tax is not to attack American businesses, but to instead put an end to large corporations using tax minimising techniques which produce arbitrary products that are not easily taxed using VAT. The tax is also not aimed at any specific country, and it is not the UK governments fault if the vast majority of digital service companies originate from America (and specifically, in Silicon Valley).

How Digital Services Tax Affect the Electronics Industry?

Electronics are a physical product, but many companies developing electronics also co-develop digital services. IBM is a classic example that not only produce computers but also offer AI and cloud services. Amazon is another example that develops electronic products such as Amazon Echo but also hosts digital services such as their AWS. The growing reliance on digital services by electronics will most likely see designers notice an increase in digital service costs that their designs utilise. And of course, as most are aware, this increase in cost from the digital service sector will find itself put onto the end-user meaning that the 2% tax may just see the value of goods increase in the long run.

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By Robin Mitchell

Robin Mitchell is an electronic engineer who has been involved in electronics since the age of 13. After completing a BEng at the University of Warwick, Robin moved into the field of online content creation developing articles, news pieces, and projects aimed at professionals and makers alike. Currently, Robin runs a small electronics business, MitchElectronics, which produces educational kits and resources.

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