Rethinking Tax in the Technology sector
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Tech businesses are generally seen as the disrupters of the business world, so you might think that rethinking business models is an everyday occurrence. To some extent that is true, new tech businesses commonly create whole new business models through which they can thrive. However, it is less common for large swathes of the tech sector to need to revisit their successful business models due to external events but that’s what happened in 2020.
In this series of articles we will consider how the COVID-19 pandemic, an ever more mobile workforce, the changing world of data and digital media trends are all conspiring to pushing tech businesses to adapt and evolve their business models. Tech businesses are increasingly outgrowing their traditional boundaries and we take a look at the practical consequences: of course, these are numerous but it is perhaps the tax implications that could have one of the biggest impacts on your bottom line.
DATA – NEW OIL, OR NEW SOIL, AND WHAT DOES THAT MEAN FOR TAX?
Contact: Paul Daly, Tax Partner
Data has been called ‘the new oil’, comparing its power to fuel the new economy with that of oil in fuelling the old economy. However, unlike oil, its value is less intrinsic, often depending on its particular properties and potential for monetisation, with the need for effort to realise its worth. As a key factor in the growth of the digital economy, data may therefore be seen as more akin to soil than oil – something from which value needs to be extracted.
Companies of all sizes throughout the world are using data to drive their value, and focusing on how they collect, store, extract and utilise data. The collection of data takes place in many ways, from direct collection by companies such as Google, with mobile equipment literally collecting data on the ground, for use in Streetview, to indirect collection of data by companies when customers make enquiries or order products or services.
Some types of data - for example, personal data - are particularly sensitive, and are therefore subject to strict regulation, leading to higher costs for secure handling. A failure to store or transfer data securely can lead to further costs by way of fines from regulatory authorities – with a maximum fine under the GDPR regulations of €20m or 4% of global turnover, if greater - and consequent reputational damage.
After raw data is collected, it needs to be curated by organising it, making it easier to analyse. It can then either be utilised for the business of the company that collected it – for example, by marketing other suitable products or services, or assisting the development of more products or services – or, alternatively, sold to another business or agency, provided it has the ability to do so.
Where is the value?
The valuation of data and its location are fundamental issues in considering a group’s international tax and transfer pricing arrangements.
Factors which make the valuation of data difficult include:
- Its usefulness and monetisation potential can decrease very quickly
- As data is a context specific asset, its value is higher within a particular transacting relationship than outside that relationship
- The different phases (collection, security, curation and exploitation) need to be distinguished.
With regard to location, whereas the supply of digital material can be taxed by reference to where it is consumed (as an example), it can be more difficult to determine the location of data as an asset for tax and transfer pricing purposes, and a number of consequences can flow from this determination.
For example, many tax regimes will endeavour to offer incentives to attract valuable businesses and their assets. This might take the form of incentives for R&D activity, or certain classes of intangible assets. Identification of the nature and location of the data asset in light of these regimes will be potentially beneficial.
To do this, in addition to assessing any legal ownership, value chains will need to be analysed, and a Development, Enhancement, Maintenance, Protection and Exploitation (‘DEMPE’) framework analysis can be used to help determine whether an entity has economic ownership of an intangible asset. There is then the question as to whom the data is being made available within a group, and what the price for that should be, and what taxes should apply to the fee charged (e.g. digital services taxes, indirect taxes and withholding taxes).
Groups will need to bear all these factors in mind when looking at their data models, to be clear on how and where value is created, and what the tax consequences of this may be.
Careful management of the data model will be important throughout the business lifecycle, as moving the ownership of data or changing a data processing or use model after data has already been collected could give rise to unintended adverse tax consequences if not carefully managed. Read more about the value of data and its potential uses in our Emerging Tech eBook.
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MEDIA – A DIGITAL FUTURE, AND NEW TAX CONSIDERATIONS?
Contact: Ross Robertson, International Tax Partner
The increasing adoption of digital media across the globe has opened up myriad of new revenue-generating opportunities and a wide range of business models to all media providers. Physical sales of both newspapers and magazines have been dropping for many years: newspaper sales fell by 55% over the past 10 years, but for some brands, revenues have held up through their move to digital channels.
However, while some brands have been able to harness many of the benefits of digital media to build new revenue streams, others have struggled to establish new business models. The reasons for this will affect the way that many businesses develop in future.
While digital platforms are far from an economist’s ‘perfect market’, they have moved the goalposts for media businesses. Good locations might once have referred to shop positions and the newsstand, but now they refer to URLs, screen layouts and social media promotion. There is then the question as to whom the data is being made available within a group, what the price for that should be and what taxes should apply to the fee charged (e.g. digital services taxes, indirect taxes and withholding taxes).
Brands like BBC Worldwide, Sky, Apple, and HuffPost compete with traditional newspaper brands for a share of the online audience, and their advertising-driven revenue models contrast with the subscription models adopted by some newspapers.
Magazines have struggled to move celebrity-based brands to subscription-based digital platforms, due to ‘free’ competition from Facebook and other social media platforms and free sites such as Mail Online, The Sun, and the Daily Mirror. An online subscription is far more of a commitment to a brand than simply buying one magazine at a newsstand. Of course, for some news magazines (such as Time or The Economist), strong brand loyalty can generate revenue from a global subscriber base.
Where is the value?
Whether publishers use a subscription or advertising-based model, it is their readers and their brand that are their biggest assets. Unsurprisingly, this has grabbed the attention of the tax authorities in many countries, and they are increasingly seeking to tax businesses active in their countries solely by digital means.
While that may seem an obvious development, as we all consume more digital media, it could bring huge financial headaches to brands and increase the risks of the same revenues being taxed by a number of different countries. The current international tax system prevents this through a network of double tax treaties, but the ‘digital services taxes’ that many countries are developing sit outside those rules. See our Global digital economy tax map.
The OCED has been working on global rules for the digital economy, but these will now not be agreed until mid-2021 at the earliest, and not implemented until perhaps 2023. In the meantime, around 30 countries are pressing ahead with their own rules, which means that global media businesses face a spaghetti of overlapping digital tax rules for their global client bases, as well as needing to consider transfer pricing issues. When you are selling the same services or advertising space in over 100 countries, how do you allocate your revenues, costs and brand value to each jurisdiction?
The new digital services taxes that are emerging mostly focus on gross revenue derived from customers in a particular country – great for the local tax authority, but not so good for the businesses that may have had to invest in significant marketing in that jurisdiction.
Digital channels offer a world of opportunity to media providers but, as their global revenues grow, so will the tax burdens and complexity of managing them. Careful management of the data model will be important throughout the business lifecycle, as moving the ownership of data or changing a data processing or use model after data has already been collected could give rise to unintended adverse tax consequences if not carefully managed.
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DIGITAL NOMADS: A WORLDWIDE TEAM?
Contact: Simon Bird, International Tax Director
Working from anywhere has been standard operating procedure for tech businesses for years and the COVID-19 pandemic has spread this to most previously ‘office’ based workers. But another trend will have a bigger impact on business models of the future: individuals working from different countries.
The pandemic has driven change in this area, with some employees moving closer to their family, whilst others have become marooned overseas due to COVID-19 restrictions or simply chosen to work from their holiday home. Either way international remote working has mushroomed this year. As a result, businesses have had to react to this enforced change and deal with the international tax consequences and compliance risks that arise.
A simple scenario
Let’s assume you have recruited a new worker from overseas but they have had to work from home due to travel restrictions. You may have obtained a UK Tech Nation visa to allow them to work in the UK, but as they have been working from another country during the pandemic, it has created a wide variety of issues in that jurisdiction, from labour licences to payroll tax and social security.
If the individual is a senior decision maker, there is also a risk they may also have created a taxable presence for the company in that jurisdiction or even changed the tax residency position of the company to the extent it is now considered to be “managed and controlled” from that new international jurisdiction.
For businesses that already have a footprint in other jurisdictions, they may have transferred employees to the local group subsidiary and then seconded them back to the UK business or recharged their services. But of course, this then opens further issues such as transfer pricing of these intra-group arrangements.
Many of these issues have been well documented over the past few months, but are these issues only for the short term, or will they lead to permanent change in the way your business operates?
Time to rethink your business model?
For some businesses, enforced remote working has validated previously held beliefs regarding the benefits of a diverse and disparate workforce. For others, it has been eye opening the way the new working model has still managed to succeed. Therefore, whilst the pandemic may subside in 2021, few people doubt that more international remote working is here to stay.
The significant cost of the financial stimulus provided by Governments to tackle the pandemic will also need to be repaid in the future, and much like the years following the 2008 financial crisis, there will be drive by Governments to attract significant amounts of new inward investment in order to balance the books.
Therefore it is not surprising that we are already seeing a number of countries announce measures to try and attract more remote workers to their country. Countries as diverse as Barbados, Bermuda, Dubai, and Estonia have all announced new remote working visas in an effort to attract more digital workers in order to boost consumption.
If this trend continues, what benefits might your business be able to realise? Would the benefit of being able to access a greater talent pool as part of a worldwide team outweigh the additional costs and compliance burdens of the business? Or might you miss out on the best talent by limiting recruitment only to those in your local jurisdiction?
How will you adapt your business model to realise these benefits? Should you expand your global footprint into overseas tech hubs or use a ‘global employment company’ as an internal agency for group companies? Will your existing share incentive plans be fit for purpose with staff in many different jurisdictions? Or might your business change to outsource more tasks and increase the use of contractors?
The step change in remote working in 2020 will drive changes for businesses in the next few years. Those that seize the opportunity, adapt to the change, and rethink their business model now can ensure that they are best placed to realise the benefits of new working patterns, whilst still managing the international tax risk that will undoubtedly proliferate.
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OUTGROWING THE TRADITIONAL BOUNDARIES - KEEPING ABREAST OF YOUR GLOBAL TAX
Contact: Gabriel Fuenmayor, Tax Director
The COVID-19 pandemic has significantly impacted businesses throughout the world in many different ways, with a range of reactions necessary to short term issues such as staff availability, travel restrictions, supply chain disruption and enforced closures during lockdowns. Short-term responses to create resilience by businesses include seeking to renegotiate contracts, defer payments and renegotiate financing.
Businesses will also be looking to longer-term realisation of new ways of working, including downsizing premises and increasing the use of remote working. Distributed teams and outsourcing will become strategies many businesses will consider in order to increase efficiency, reduce costs and become more agile. Technology businesses will be amongst those who are most likely to face, and perhaps embrace, such change.
The use of outsourcing (both internally within a group, and with external service providers) across territories will contribute to the blurring of geographical boundaries and fuel the evolution of global business models.
Combined with increased remote working likely to become part of the ‘new reality’ in many sectors, this will require new governance and control measures, particularly where remote workers are based in different jurisdictions. Failing to implement these measures will have a number of potentially significant tax consequences.
Tax and transfer pricing implications
Businesses that are intending to commence or increase outsourcing internationally for the first time, or whose supply chains and arrangements are otherwise affected by COVID-19, will need to take care in establishing or reviewing tax and transfer pricing models.
Businesses may have the luxury, or face necessity, of a global talent pool and functions may be established or rebuilt across borders. The location and activities of personnel can be of critical importance for a range of tax issues including:
- Tax residence of legal entities
- Payroll and employment tax
- Risks in relation to withholding taxes and possible double taxation
- Supplies of services impacting VAT and indirect tax positions
- Location of intangible assets for tax purposes
- Availability and nature of tax incentives for R&D and innovation
- Profit attribution under transfer pricing models
Businesses will need to be alert as to what a changing, international operation will look like as growth across geographic boundaries is not straightforward from a tax perspective. Not only will a business have to deal with the tax rules in any particular territory, but also how the rules of various territories interact. When it comes to personnel this is made doubly difficult by how fluid the position might be – teams are ever changing, and as the ebb and flow of people’s locations and roles change, so will the tax issues to be aware of. Compliance responsibilities will multiply, increasing the need for effective systems and processes to manage and maintain visibility.
LEARN MORE ABOUT RETHINKING BUSINESS MODELS.
Looking for further insights on tax implications of tech businesses having to adapt and evolve their business models? Email us to find out more at [email protected].
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