A big driver for international tax reform (and certainly the motivation for the renewed interest in it by the US under the Biden administration) is the desire to have one set of rules ensuring the largest and most profitable multinationals pay their “fair share” in the countries where they do business rather than a proliferation of unilateral digital services tax (DST) measures.
A fundamental part of Pillar One of the international tax reform package on which political agreement has been reached by 136 countries (see OECD/G20 Inclusive Framework announcement of 8 October), therefore, is to prevent the introduction of any new DSTs or similar taxes after 8 October, and to remove any such unilateral measures that were in place on or before 8 October once the new system is implemented in 2023.
So what happens during the period of transition to the new system? What is the method and timing for the removal of existing DSTs?
It seems that, rather than agreeing an approach at OECD-level, more bespoke solutions are being reached. On 21 October, the UK, Austria, France, Italy, Spain and the United States issued a joint statement outlining a compromise on a DST-credit system to bridge the gap between the DSTs and the new system. In return, the US will not levy tariffs in response to the existing DSTs nor impose further trade actions and the parties to the deal can keep the revenues raised from their respective DSTs until the Pillar One reforms become operational.
What happens once Pillar One is in effect?
Taking the UK as an example, multinationals will be able to use the difference between the amount of UK DST that they have accrued from January 2022 until the earlier of 31 December 2023 and the date on which the Pillar One multilateral convention comes into force, and what their UK tax liability associated with Amount A as computed under Pillar One would have been if Pillar One (rather than the DST) had been in effect for that interim period, as a credit against their future UK corporation tax liability arising from the new taxing right under Pillar One.
In a press release, the UK Chancellor, Rishi Sunak, said “This agreement means that our Digital Services Tax is protected as we move to 2023, so its revenue can continue to fund vital public services”. Of course all this assumes that the US is able to implement Pillar One, which is looking quite uncertain at present.
Assuming it all goes to plan, how will this leave the UK’s coffers?
The first payments of UK DST were due at the start of October for companies with an accounting period ending 31 December 2020. The DST was originally forecast to raise £500m per year, but according to the 2021 Budget forecast, the DST was expected to raise £3.2 billion overall by April 2026. But this forecast did not factor in the possibility of giving up the DST earlier in the event of an international agreement. If things go to plan, the forecast will need to be amended and it remains to be seen whether the additional revenues allocated to the UK under Pillar One will compensate fully for the removal of the UK’s DST. It is unlikely to do so because the number of companies in scope of Pillar One is smaller than those in scope of the UK’s DST and the agreement requires removal of DST with respect to all companies - not just those in scope of Pillar One. Moreover, earlier impact assessments indicated that developing (rather than developed) countries would tend to be the major beneficiaries under Pillar One.
So how will the UK plug the tax gap?
Rumours are flying around about a potential online sales tax. Perhaps all will be revealed next week in the Budget… One note of caution, though - the political agreement on Pillar One refers to "Digital Services Taxes and other relevant similar measures". Could an online sales tax be a "relevant similar measure"? No definition of that term has yet been agreed but the US will, no doubt, have strong views on the matter. So any new taxes enacted after 8 October will need to be carefully tested in this respect.