Two days ago, on 29 October, UK Chancellor of the Exchequer Philip Hammond proposed a digital services tax, to be implemented in April 2020, as part of his UK budget speech. Even though it is only a proposal at this stage, and it would only apply to certain companies, I would suggest that it is a very interesting development for all organizations to watch and think about as it evolves. Here’s why…
Firstly, let’s clarify what is being proposed. The proposal is that from April 2020, digital companies get charged a digital services tax equal to 2% of their UK revenues. It will apply only to social media platforms, internet marketplaces and search engines. It will also only apply to companies that have global revenues of more than £500 million, and are profitable. (A number of other regions and countries are in the process of considering and working through similar proposals, including the European Union, and Spain in particular.)
It is largely motivated by a desire to make sure that large digital companies pay an amount of UK tax that is appropriate based on the amount of revenue they derive from the UK. Some large digital companies paid of the order of 1% or less of their UK revenues as tax last year. (See the table in the Guardian article Hammond targets US tech giants with ‘digital services tax’.)
Plenty of people are saying that this announcement is not very interesting, because it might not get implemented, it will only apply to a few organizations, it might end up being replaced with an international standard, and it won’t cost the digital companies large amounts of money even if it does come into force. The estimate is that the total raised from all companies will be around £400m per year. Large digital companies would each be likely to incur a charge of a few tens of millions of pounds. By way of comparison, Amazon and Google/Alphabet each spent of the order of $30billion last year on R&D + capex.
Now this tax could get a little more substantial if lots of other countries follow suit, but I would suggest it is an interesting development to watch for a more generally important reason: it could be a weak signal of big changes to come, in terms of how financial measurement in general, and taxation in particular, work. Let me share my thinking:
While tax regimes vary from country to country, and change over time, it has almost always been the case that companies are taxed based on their profits. There is a sense that this is a fair way to do it, because profits are a good measure of what value companies have generated, and what they get to keep.
The main downside of profit as a measure is that it is somehow less straightforward to calculate and confirm than revenues, since there are decisions to be made about what costs apply to which line of business, transfer costs between business units, what can be capitalized, etc. This is especially true in complex, multinational companies. This issue is not specific to digital companies. Many famous non-digital companies have come under scrutiny in recent years around whether they pay a fair amount of tax in all countries they operate in.
But there is a digital-specific angle. And that is that the way we measure, report and tax financial performance in general may not work so well in the context of a digital enterprise, where there are few ‘hard’ assets, and value is often generated largely from intangible assets, like intellectual property, data and the ecosystem of participants engaged in each platform. These assets typically aren’t well reflected in the balance sheet, and some aren’t even owned by the company. Further, traditional measures of variable cost and marginal cost don’t necessarily capture the reality of what is required to generate revenues. And also when a digital company invests in a platform, a lot of the value of that platform is option value, the value to do things on top of that platform in future. We wrote a little about option value recently in Digital Business Needs Advanced Business Case Practices.
This has led lots of academics, governments and others in recent years to observe that digital businesses are a little different, in terms of how their performance should be measured. For example, take a look at the Harvard Business Review article Why Financial Statements Don’t Work for Digital Companies .
So whilst these digital services taxes based on revenues may be introduced to address specific tactical concerns, they may in fact be a weak, early signal that many aspects of performance measurement, management, reporting and taxation need and will get a significant overhaul for an increasingly digital world. And that would apply to the digital aspects of all our businesses. And those aspects will probably be an increasing proportion of most of our businesses. Gartner’s latest CEO survey shows that those who recognize separate digital revenues estimate that 29% of their revenues can be attributed as digital today, and that in 2020, the same figure will be 39%.
Let’s watch and see…