Airbnb Model Sheds Light On Tech Companies Tax Issues In UK – Zoe Wyatt
Zoe Wyatt, Partner at Andersen Tax UK, discusses the UK’s government plan to impose a 2% digital services tax and how it would disproportionally affect US tech companies, such as Airbnb, in Law360.
Zoe’s article was published in Law 360, February 18 2020, and can be found here.
A war of words has broken out between the UK and the US over UK government plans to impose a 2% digital services tax. As the tax would disproportionately affect US tech companies, the US has even responded by threatening tariffs on British cars if the new digital services tax is imposed. However, the HMRC’s interest in taxing multinational tech companies has a far wider basis than just the new digital services tax.
Airbnb is one of the US tech companies which has long been in the media spotlight due to benefitting from the asymmetries that exist between different international tax systems. It may also be impacted by the digital services tax. However, last year, HMRC began a probe of Airbnb’s tax affairs more broadly, prompting warnings of possible litigation by Airbnb. A look at Airbnb’s tax structures helps to illustrate the complex issues involved in taxing the UK earnings of multinational tech companies.
Airbnb essentially provides a portal – or online shop window – for private owners to let their properties to the wider world on a short-term basis. Predominantly, Airbnb makes money by taking a commission or charging fees to those that rent their properties via Airbnb’s website or apps.
Airbnb is a US-headquartered group, Airbnb Inc. However, when a UK-based host contracts to lease out a UK property through the Airbnb website, they are contracting with Airbnb Ireland UC. This means that revenue from UK hosts is earned by Airbnb Ireland. The contracting process is through Airbnb.co.uk (which we assume is owned by Airbnb Ireland, or a non-UK entity in a low or no tax territory and probably, although not necessary from a UK tax perspective, hosted on servers outside the UK). Unlike other US tech companies, it does not require salespeople on the ground in the UK negotiating or concluding contracts with UK customers or warehouses and a complex logistics network to fulfil orders. It should, therefore, come as no surprise that its UK profits, and therefore its UK corporation tax (CT) bill, are relatively low.
The profits of Airbnb Ireland will only be subject to UK CT if it is trading here through a permanent establishment (PE).
A PE can arise where the foreign entity:
- has a fixed place in the UK at its disposal (e.g. office premises, client’s premises, home office) through which it carries on profit generating activity by persons taking instructions from the foreign entity; or
- has a dependent agent that habitually concludes contracts in the UK on its behalf, even if the formal signing of the contracts takes place outside the UK (Airbnb is unlikely to have such a UK agent since UK customers sign up via the Airbnb website, not a person).
It should be noted that a PE does not arise where UK activity is preparatory or auxiliary in nature (e.g. marketing, customer support).
There are two Airbnb UK entities:
- Airbnb Payments UK Ltd; and
- Airbnb UK Ltd.
Per the Airbnb Payments UK Ltd accounts, its principle activity is payment processing on behalf of Airbnb Ireland UC. We can see that Airbnb Payments UK Ltd’s revenue for year-end 31 December 2018 comes from Airbnb Ireland. In other words, Airbnb Ireland owns and is entitled to the sales revenue from UK customers; Airbnb Payments UK Ltd collects that revenue and pays over to Airbnb Ireland UC, less its fee for the provision of payment processing and cash collection services.
Per the Airbnb UK Ltd accounts, its principle activity is promoting the Airbnb online marketplace in the UK. We can see that Airbnb UK Ltd’s revenue for year-end 31 December 2018 also comes from Airbnb Ireland UC. Airbnb Ireland UC pays Airbnb UK Ltd to provide marketing and promotion services in the UK.
Airbnb Ireland UC has, therefore, established subsidiary companies with a view to minimising its exposure to a permanent establishment.
For many businesses, payment processing and cash collection, or marketing and promotion activities, are a small part of the administration of their business and often considered preparatory or auxiliary in nature and, therefore, do not create a PE in the UK. In such cases, these activities, individually, may also be considered low value and often earn a low margin for the provision of such services to related party entities.
However, in the case of Airbnb Ireland UC, one might argue that these two services provided by Airbnb Payments UK Ltd and Airbnb UK Ltd are an “essential and significant part of the activity of” Airbnb “as a whole”. According to the Commentary to the OECD Model Tax Convention 2017, this is the decisive criterion in assessing whether an activity is preparatory or auxiliary. A fixed place of business whose “general purpose is one which is identical to the general purpose of the whole enterprise, does not exercise a preparatory or auxiliary activity”.
One might argue that separating (or ‘fragmenting’) the payment processing and marketing into two separate entities artificially seeks to fall within the preparatory or auxiliary exemption to avoid creating a UK PE. In other words, the sum of the whole is greater than the parts.
We anticipate that HMRC has adopted this view and that it is seeking to apply the UK’s anti-avoidance provision known as the Diverted Profits Tax (DPT) to counter the arrangement. We believe that this is partly or wholly behind the contingency statement included in Airbnb UK’s 31 December 2018 accounts that it is “subject to tax inquiries and proceedings concerning its operations and intracompany transactions”.
The UK introduced the DPT in April 2015 with a view to extending its reach to catch (mainly) digital businesses as the current laws hadn’t developed at the same speed as technology companies. In fact, relevant UK case law dealing with whether a non-resident is trading in the UK law dates back to the Champagne Cases of 1888. The DPT is commonly referred to as the “Google Tax”. It applies in cases where a non-UK resident company has taken steps to ensure that it is not trading in the UK through a UK PE (e.g. by splitting out critical functions into separate entities / pricing as low level separate functions within the same entity), or where a UK company makes payments to and / or uses entities in low / no tax jurisdictions lacking economic substance. The thrust of the DPT rules is that the non-UK company in question has taken steps to artificially avoid a PE in the UK. The concept was also introduced by BEPS Action 7 and is somewhat counterintuitive in that by setting itself up in such a way that it doesn’t breach the PE threshold set out in a given DTA a company can be guilty of artificially avoiding a PE.
If HMRC were to successfully argue that Airbnb Ireland UC had taken steps to artificially avoid trading in the UK through a PE, it must then attribute profits of Airbnb Ireland UC to a deemed UK PE. Profits of a PE are, ordinarily, subject to UK CT at 19%. However, where this attribution arises as a result of application of the DPT, the profits are subject to tax at the punitive DPT rate of 25%.
However, if Airbnb concede that the UK profit allocation is not high enough, it can escape the 25% DPT charge by instead adjusting the fee/price that Airbnb Ireland UC pays to Airbnb UK Ltd and Airbnb Payments UK Ltd under its Transfer Pricing (TP) policy (which establishes how intracompany transactions are priced in accordance with the arm’s length principle (i.e. as if Airbnb Ireland and the UK companies were independent enterprises). Thus, HMRC’s stated aim of the DPT is to encourage behavioural change of multinationals “to ensure a fair proportion of their profits are declared and taxed in the UK, so that they fall out of scope of the DPT.”
Such agreement between HMRC and Airbnb can apply to both the tax years under investigation and future years. This is because HMRC must identify the best value for the exchequer under its Litigation and Settlement Strategy. In effect, HMRC can use the DPT to strong-arm taxpayers into adjusting their TP more quickly and more effectively than simply launching an enquiry into a taxpayers TP (which can be a protracted negotiation).
HMRC has stated that, where a group’s transfer pricing policy is up to date and “they are paying the right amount of Corporation Tax”, DPT won’t apply.
When assessing applicability of the DPT regime, it is likely that Airbnb have previously formed the view that the pricing of its Ireland / UK intracompany services was correct. However, HMRC launched the Profit Diversion Compliance Facility on 10 January 2019, following a review of multinational groups’ UK operations and TP concluding that groups continue to fragment valuable integrated functions into standalone functions across one or more UK companies. In other words, the behavioural change expected hasn’t yet materialised.
Alternatively, HMRC have found that what is happening on the ground does not reflect the TP policy, or taxpayers are using inappropriate comparables. Whilst Airbnb does not have individuals on the ground concluding contacts with their customers, the marketing function will no doubt include concluding contracts with suppliers / advertisers, supplier account management functions, market development, pre / post sales technical support functions and so on. There are few if any competitors to Airbnb and so direct comparables are not possible.
Trying to bend existing tax laws and extend traditional tax principles to businesses that operate in wholly modern ways is difficult and ineffective. It is for this reason that governments, the European Commission and the OECD are considering new ways in which digital service, social media, online marketplace, etc. that derive their value from user participation should be taxed, ripping up the principles of international tax on intragroup transactions.
The UK acted unilaterally in the implementation of the DPT (instead of waiting for the OECD’s recommendations on how to deal with such tax avoidance by large multinationals) and is doing so again with the introduction of a new digital services tax (from 1 April 2020) instead of waiting for the outcome of the OECD’s consultation on the same issues.
The UK’s new digital services tax will apply to a foreign entity’s revenue from UK users where the group’s worldwide revenues from these digital activities are more than £500m and more than £25m of these revenues are derived from UK users. The first £25m of revenues will be exempt from the tax, anything over this taxed at 2%. Taking the revenue due to Airbnb Ireland UC from Airbnb Payment UK Ltd’s FY18 accounts of US$353,749,821, this would raise additional UK tax revenue in excess of $6.5m.
The OECD in its consultation on taxation of the digital economy is likewise considering tearing up the arm’s length principle with its proposed Unified Approach that considers three ways in which taxing rights over revenue or profits from digital businesses is reallocated in favour of the user/market jurisdiction. We will have to wait and see if this stops the unilateral actions of its members and drives behavioural change by multinationals.