Should the Digital Services Tax be increased immediately to pay for CJRS?
Can it be our Excess Profits Tax for the 21st Century?
The UK Government has extended the Coronavirus Job Retention Scheme (“CJRS”) through from the end of May 2020 until the end of June 2020 – as expected.
As we move into the phase where the CJRS is now up and live and payments should start to flow from the Government (in the form of grants) to assist businesses to keep open the jobs that have been put in suspense by the impact of Covid 19, the question of who is funding the cost and paying for this will soon start to move into focus.
The cost is substantial. It was previously forecast to cost £45bn across three months, we can now expect that cost to be £60bn across four months. And that is probably an under-estimate.
The fear amongst financial commentators is that the true recovery of the economy will be slow, we will experience a phase of “mini lockdowns” and the cost of the intervention measures brought in by the Government will weigh on the economy for a significant period of time. Many economists regard the impact of Covid-19 on the economy as being significantly in excess of the impact caused by the banking crisis in 2007-2009. We were only really regarded as free from the resulting austerity measures from the financial crisis more than ten years later.
Should the online sector fund the cost?
So how can the cost of repairing the nations finances be funded after Covid-19 is brought to heel, but in a manner which gets the economy back to where it was in late 2019 as quickly as possible? I would suggest we consider taxing those who have done disproportionately well from the economics of the lockdown. The “online” businesses who have had customers funnelled their way by the lockdown.
As a parallel to look at, the financial impact (and the cost to the Government) is regarded as being comparable to the financial intervention needed in both the World Wars in the 20th Century. Following both of those wars, an “Excess Profits Tax” was introduced to seek to level out the financial impact between the businesses which had been hugely successful due to demand arising from war, and those whose businesses had suffered greatly.
The ”Excess Profits Tax” looked back at what the profits would have been normally prior to the event (in the 20th Century, the wars) and what they had become immediately after the event, and then imposed a significant level of taxation on the profits in excess of the “pre” level. After the second World War, there was a temporary 100% rate of tax on “Excess Profits”, ie profits which were in excess of the “pre” level prior to the event which caused the business to benefit.
In principle, we could already have a tax measure that could be used to achieve a modern, 21st Century, equivalent of the “Excess Profits Tax” and by co-incidence it came into force on 1 April 2020. It is called the Digital Services Tax.
What is the Digital Services Tax? From 1 April 2020, the government has introduced a new 2% tax on the revenues of search engines, social media services and online marketplaces which derive value from UK users. And notably it typically only will be imposed on “large” online businesses whose global turnover is in the hundreds of millions of pounds. Originally the Digital Services Tax was estimated to raise over £400m a year, with a total tax yield over the first six year period of operation of £2.15bn.
Critically the Government knew in designing the Digital Services Tax that there was no point in taxing “profit” with online businesses, as often the “profit” was deliberately recognised in a low tax jurisdiction and not the UK. So the Digital Services Tax is designed to tax revenues, not profits, so effectively taxing UK derived turnover.
Why am I equating the Digital Services Tax to the Excess Profits Tax? Historically, the use of an Excess Profits Tax has always been as an emergency measure to repay the cost to the UK Exchequer of a large scale and exceptional event where some parts of the economy have benefitted hugely and other parts have been brought to their knees by the same event. I think the Digital Services Tax could be amended as a short term measure to be the modern equivalent.
The greater part of the key beneficiaries of surges in revenues as a consequence of Covid-19 will be “mainly online”. And a greater part of those who have suffered significant, or potentially catastrophic, damage to their businesses, are “bricks and mortar” or at best “bricks and clicks”.
The “mainly online” businesses have had, as a consequence of the lockdown, a huge artificial direction of traffic to their sites, whether that be social media, video conferencing, online retail, content streaming and a wide range of associated digital business models. And as a consequence there will also have been an artificially forced adoption of new ways of shopping or working which, as consumers and businesses are now used to them, will continue to be used at a pace that would not otherwise have occurred (or at least, not without a huge amount of advertising spend over a long period).
If you want to see the impact that Covid-19 has had on the share price of the “online” economy, simply look up the shares of Amazon, or Google, or Netflix, or Microsoft (etc etc etc) for the month of March 2020. Growth of share values for the major businesses in the online business sectors of at least 20% in the month of March are typical across the sector. The sector is booming as economies around the globe are forced into lockdown and as a consequence consumers are forced to increase their use of online services.
At the same time, the “bricks and clicks” businesses will have suffered immediate damage, but also what is probably for some may be an irrecoverable change in consumer behaviour. A long period of social distancing may mean that some previously viable businesses cease to exist purely because the customer base have either learned a different way to buy the products, or have moved to different online brands, due to the length of time between the lockdown commencing and being able to buy from that business again.
How could the Digital Services Tax be altered to bring in the funds to pay for CJRS?
The “Excess Profits Tax” imposed after the second World War at 100% of the Excess wasn’t perfect, it quickly was changed to a tax on dividends instead – as taxing the excess profits was seen as stifling investment – whereas taxing dividends instead encouraged retention of monies in the business to fund investment.
The Digital Services Tax isn’t perfect either, it is horrifically complicated to work out what is in, or out, of scope and where something in tax is complicated, then it becomes unwieldy and unpopular. However, at the current time, I suggest the Government should consider expanding the reach of the Digital Services Tax as a short term measure to capture a greater amount of the “online” economy.
It wouldn’t be difficult to broaden the scope for a short period. I would suggest that If a business is above a certain size in global revenues (eg £200m), and it carries out a “Software as a Service” business model (eg Microsoft) or it operates in the field of search engines, social media services and online marketplaces (Google, Facebook, Ebay), or it carries out an online sales function for “essentials” (eg Amazon but also online food sales for the food retailers) then the Digital Services Tax should be applied, from 1 April 2020, to any increased UK turnover derived from the online activity. The changes could be time limited (eg stated at the outset as only applicable for 5 years).
That would help to plug the gap in the UK’s finances, with the businesses who have benefitted the most from the arbitrary nature of the lockdown providing the lion’s share of the money needed. And if as an outcome it put up the price of the online services, so the tax would increase. And if it caused people to switch off their devices and go and go and do something else once the lockdown was over, then that’s probably not a bad thing either. Socially distanced of course.
The Digital Services Tax, the foundations of an Excess Profits Tax for the 21st Century.
This blog was written by Alastair Wilson, Tax Partner at MHA Tait Walker.