Press Room

19 Dec 2019

Nature of the U.K. Tax Authority Inquiry Into Airbnb

Zoe Wyatt, Partner at Andersen, discusses the inquiry from the U.K.’s tax authority into Airbnb and what it means for multinational corporations.

Zoe’s article was published in Bloomberg Tax, 19 December 2019, and can be found here.

Airbnb has recently been in the spotlight due to the statement made in its December 31, 2018 accounts because of an inquiry from HM Revenue & Customs (HMRC). This article speculates as to the potential nature of the HMRC inquiry and the effect that it may have on profits taxable in the U.K.

U.K. Anti-avoidance Rules

Since taking power, the Conservative government has taken significant steps to crack down on perceived tax avoidance by multinational groups seeking to arbitrage opportunities presented by the asymmetries that exist between different international tax systems. The result being to erode the tax base in high tax jurisdictions, usually where the consumers/users are located, and shift profits to low/no tax jurisdictions.

As a result, in 2015 the Diverted Profits Tax (DPT), and in 2017 the anti-hybrid legislation were introduced, well before the Organization for Economic Co-operation and Development (OECD) concluded its recommendations to tackle such issues and before the effect of the EU’s Anti-Tax Avoidance Directive (partial anti-hybrid rules were only required by EU member states from January 1, 2019 and full anti-hybrid measures from January 1, 2020). Indeed, the EU’s actions borrow from the U.K.’s rules.

It would not be unreasonable to speculate that the inquiry relates to the DPT and/or anti-hybrid rules.

Assumptions as to Airbnb’s U.K. Operating Model

Airbnb is a U.S. headquartered digital services business that essentially provides a portal (or shop window) for private owners to let their properties to the wider world. Predominantly, Airbnb make its money by taking a commission/charging fee from those who are letting their properties via the Airbnb website.

Through our review of financial statements filed with Companies House in the U.K., we speculate that the U.K. operating model broadly works as follows:

  • when a U.K. based customer contracts to lease their property through the Airbnb website, they contract with Airbnb Ireland UC. The revenue from U.K. customers is earned by and belongs to Airbnb Ireland;
  • the customer contracting process is through (which we assume is owned by Airbnb Ireland, or a non-U.K. entity in a low/no tax territory and probably, although not necessary from a U.K. tax perspective, hosted on servers outside the U.K., as a tax break is given to digital companies by the U.K.); and
  • unlike other U.S. tech companies, it does not require salespeople on the ground in the U.K. negotiating or concluding contracts with U.K. customers or warehouses and a highly complex logistics network to fulfill orders.

Consequently, U.K. profits and U.K. corporation tax (CT) may, to the general public, seem relatively low as compared to revenue. However, this is comparing apples with oranges.

Digital Profits Tax

The profits of Airbnb Ireland will only be subject to U.K. CT if it is trading in the U.K. through a permanent establishment (PE). A PE can arise where the foreign entity:

  • has a fixed place in the U.K. 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 U.K. on its behalf, even if the formal signing of the contracts takes place outside the U.K. (Airbnb is unlikely to have such a U.K. agent since U.K. customers sign up via the Airbnb website not through a person).

It should be noted that a PE does not arise where U.K. activity is preparatory or auxiliary in nature (e.g. marketing or customer support).

There are two Airbnb U.K. entities:

  • Airbnb Payments U.K. Ltd; and
  • Airbnb U.K. Ltd.

According to the Airbnb Payments U.K. Ltd accounts, its principle activity is payment processing on behalf of Airbnb Ireland UC. We can see that Airbnb Payments U.K. Ltd’s revenue for year ending December 31, 2018 comes from Airbnb Ireland. In other words, Airbnb Ireland owns, and is entitled to, the sales revenue from U.K. customers; Airbnb Payments U.K. Ltd collects that revenue and pays it over to Airbnb Ireland UC, less its fee for the provision of payment processing and cash collection services.

According to the Airbnb U.K. Ltd accounts, its principle activity is promoting the Airbnb online marketplace in the U.K. We can see that Airbnb U.K. Ltd’s revenue for year ending December 31, 2018 also comes from Airbnb Ireland UC. Airbnb Ireland UC pays Airbnb U.K. Ltd to provide marketing and promotional services in the U.K.

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, would not create a PE in the U.K. 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, HMRC might argue that, when considered together, 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, and that there has been a deliberate separation of the payment processing and marketing to avoid creating a U.K. PE by falling within the preparatory or auxiliary exemption.

The consequence would be an adjustment to the profits of the U.K. entities, subject to 25% DPT charge. Although, if Airbnb agrees to adjust the fee/price that Airbnb Ireland UC pays to Airbnb U.K. Ltd and Airbnb Payments UK Ltd under its transfer pricing (TP) policy, this additional U.K. profit will be subject to U.K. CT at 19% instead.

In effect, HMRC uses the DPT to strong-arm taxpayers into adjusting their TP more quickly and more effectively than simply launching an inquiry into a taxpayer’s TP (which can be a very protracted and complex negotiation).

Hybrids and Other Mismatches

The U.S. operates a regime commonly referred to as “check-the-box” (CTB) that allows a U.S. person to elect as to whether an entity will be treated as a corporation or transparent for U.S. tax purposes. Where that entity is in a foreign jurisdiction that treats the entity differently, a hybrid entity will exist.

If a hybrid entity exists and there is a tax mismatch, for example a double deduction for an expense or a single deduction for an expense but non-inclusion of income in the other jurisdiction, then the U.K. will either deny the deduction or increase the taxable income of a U.K. entity to counter such mismatch.

The U.K. anti-hybrid rules are far reaching and go beyond hybrid entities to hybrid instruments and other mismatches, analysis of which is outside the scope of this article. The rules are enormously complex and are accompanied by over 400 pages of guidance.

Without knowing the Airbnb group structure, it is difficult to say whether the entities are hybrids and, even if they are, whether a hybrid mismatch arises. Nonetheless, if a group has made any CTB elections or has an limited liability company (LLC) or limited liability partnership (LLP) within its structure, an analysis of the rules must be undertaken.

Particularly because of the “imported mismatch” provision where the U.K. can make an adjustment if the mismatch takes place between companies in two other countries, and neither of those countries “stop” it—from January 1, 2020, the rest of the EU will have implemented full anti-hybrid rules including those to stop imported mismatches.

In one recent case, the U.K. subsidiary corporation had to disallow a significant proportion of its payment to a U.S. LLC (for the provision of sales support, IP and other services) that was ultimately owned by a combination of U.S. citizens and Cayman entities. The Cayman entities held, albeit indirectly, 50% of the LLC and, therefore, 50% of the payment by the U.K. corporation was disallowed. If a hybrid mismatch does exist, taxpayers must also consider the “targeted anti-avoidance rule” that seeks to continue to levy a U.K. tax charge even if a group restructures.

Final Thoughts

Trying to bend existing tax laws and extend traditional tax principles to businesses that operate in wholly modern ways has proved difficult and ineffective.

Instead, governments and the OECD are considering new ways in which to tax digital service, social media, online marketplace, etc. that derive their value from user participation; with the U.K. introducing a digital services tax from April 1, 2020 on revenue from U.K. users in excess of 25 million pounds ($32 million) and for groups with worldwide digital service revenues of 500 million pounds or more.

More widely than the digital services industry, the base erosion and profit shifting practices of U.S. headquartered multinationals arose because of the U.S. eye-watering federal tax rate (which was 35%), and no exemption for dividends repatriated to the U.S. from foreign subsidiaries or gains on disposal of shares in substantial holdings.

However, following the introduction of EU wide anti-hybrid rules and U.S. tax reforms in 2017, which introduced a significant reduction in U.S. federal tax to 21%, there has been a marked change in the tax behaviors of such multinationals that now seek to adopt a whiter than white approach to their tax strategy.

Zoe Wyatt

Zoe is a Partner at Andersen Tax in the United Kingdom. Specialising in international tax, she develops the blue-print solution to her clients’ cross-border needs.

Email: Zoe Wyatt