Digital Services Taxes: Principle as a Double-Edged Sword


The United Kingdom (UK) adopted “value creation†as the guiding principle for designing its digital services tax (DST). This article argues that this principle acts as a double-edged sword. On the one hand, it fits the UK’s general view on the allocation of taxing rights and provides some cover against criticism of the DST. On the other hand, this principle, which is questionable on positive and normative grounds, gives rise to a number of difficult design and implementation issues for the DST. The article concludes that the value creation principle leads to a tax that is complex, arbitrary, and hard to comply with and enforce.

Research Highlight 2020

The UK’s Digital Services Tax

This research paper evaluates the Digital Services Tax (DST) introduced by the UK in Finance Act 2020. While DSTs can be an attractive policy option, the timing of the UK DST’s introduction is controversial, as are its objectives, and design. 

The timing is controversial because the UK DST may have a negative impact on ongoing negotiations between the UK and the US over a post-Brexit trade deal. It is also controversial because it is a temporary, unilateral measure to address perceived flaws in the international tax system adopted just as 137 countries (the G20/OECD Inclusive Framework) are engaged in a process aiming at collaborative reform. The adoption of the DST may be a strategic move by the UK on both fronts, but it is a risky one as it clearly antagonised the US.

The DST’s objective is to “ensure certain digital businesses pay tax reflecting the value they derive from UK users”. This is controversial because it is based on the ‘value creation’ principle, which is questionable on both positive and normative grounds. Furthermore, the objective is based on tenuous distinctions. It posits that the value created by users of certain highly-digitalized businesses should be taken into account in allocating taxing rights over business profit, but the value created by users/consumers of any other business should not. This distinction is unclear, unprincipled, and unpersuasive.

DSTs have a number of positive properties which flow from the relative immobility of users; they include robustness to profit shifting and incentive compatibility. Users’ relative immobility also means that the DST should not distort businesses’ location decisions. But DSTs in general also have a number of negative properties, including the economic distortions that arise from a tax on revenues, and enforcement issues. The UK sought to address – but did not eliminate – these problems through the DST’s design. This is commendable, but the UK DST’s particular objective of targeting the value created by UK users of certain highly-digitalised businesses leads to significant design issues. It creates a number of borderline cases, which will be hard to resolve. The UK DST’s base is complex, involves arbitrary and difficult distinctions, requires taxpayer judgement, and is based on information that may not be easily verified. It runs counter to several of the basic tenets of ‘good’ tax policy design.