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Imagine if the British public were to start hearing headlines warning that the profits of iconic names like Rolls-Royce were to be hit due to rule changes that tax sales where customers are based.

The thought that iconic brands with a large presence here might pay less tax in the UK, and more tax in countries where their customers are based (and where they might only employ a few people), would seem offensive to many UK taxpayers.

However, this type of approach is being considered by many governments as a way of dealing with a perceived lack of tax take from internet companies such as Google, Facebook, EBay, and so on.

The current international tax framework is based on taxing profits where value is created, rather than at the point of sale. This means that if an overseas company does nothing other than sell into a market, and simply ships its goods or services here, it will have no profits here to tax.

The large internet companies I have mentioned generally do have some presence in the UK, but this is often mainly in sales and support, rather than the “creative hub” of the company. There is value created by such activity, but it is only a small slice of the whole – so the amount of tax these companies pay here is small.

However, because these giants have such an influence on our lives, it is thought that they should be paying more. This has led to many calling for taxes on revenues from customers, rather than on profits.

But if you assume that every country does the same, and extend this attitude to an increasingly digital, globalised economy, we will end up with British names being taxed more heavily overseas than in the UK.

Do we really want that to happen?

The UK government does not seem to think so. In a position paper issued last year, the Treasury reaffirmed its commitment to the “tax where value is created” principle.

But in an interesting development, the Treasury suggested that the digital age has created a new source of value. Where user participation on an internet platform is vital to the business model (for example, it drives advertising revenue), this can itself be regarded as a source of value.

This source of value creation is not generally considered when dividing up the tax take on a company’s profits, so arguably some profits may be going untaxed, or are taxed in the wrong place.

In our response to the Treasury paper, we welcomed the government’s commitment to the value creation principle, and conceptually we can see the case for new indicators such as user participation.

However, there are a number of key issues that need to be dealt with before we see significant changes to how the internet giants are taxed.

Changes need to be agreed on a multilateral basis, especially if what is being considered is a reallocation of tax rights from one country to another, rather than an additional tax take. There also needs to be more clarity on how user participation can be measured.

There is plenty of scope for governments to disagree on how these issues should be resolved, so we expect controversy in the meantime.

Despite these problems, keeping with a value-based approach is preferable to simply taxing revenues, which moves the focus of taxation from product creation to mere consumption.

Worryingly, the Treasury suggests that taxes on revenue could be used as an “interim measure”. So those headlines about Rolls-Royce may come about after all. Be careful what you wish for.

Original Article

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