Tim Flagg
Chief Executive, UKAIChief Executive of UKAI, the trade association for the AI economy in the UK, Tim Flagg explores the growing tension between the UK and US over the Digital Services Tax, its potential impact on trade following Trump’s โLiberation Dayโ tariffs, and the options facing the UK Government as it balances fair taxation with economic diplomacy.
Yesterday marks what President Trump has dubbed โLiberation Dayโ, with new tariffs looming this could have a significant effect on all UK businesses. At the heart of the negotiations is the UK’s Digital Services Tax (DST) and the question of whether the government should scrap it to avoid a trade war with the US.
Itโs important to understand some of the context, so UKAI has summarised the history of the DST.
The Origins of the Digital Services Tax
The DST was introduced in April 2020 by the UK Government as a response to a long-standing problem: major global tech companies generating huge revenues in the UK while paying very little tax. The UKโs corporate tax system was outdated for the digital economy, allowing global tech firms to shift profits overseas and avoid significant UK tax contributions.
To close this gap, the UK introduced a 2% tax on certain digital revenues from large tech firms (those with over ยฃ500 million in global revenue and ยฃ25 million in UK revenue). The tax applies to search engines, social media platforms, and online marketplaces, but excludes digital retailers like Amazonโs product sales.
Since its introduction, the DST has been a significant revenue generator, collecting over ยฃ1 billion so far, exceeding early government expectations. (Source: DLA Piper)
Why is the Digital Services Tax Under Threat?
The main reason DST is under scrutiny is pressure from the United States. The Trump administration strongly opposes the tax, arguing that it disproportionately targets US companies. The US has previously threatened tariffs in retaliation and is now considering a new wave of trade measures on the so-called โLiberation Dayโ that could harm UK exports. The UK government now faces a difficult choice:
- Scrap the DST to ease US tensions and avoid trade restrictions.
- Hold firm and risk economic retaliation but maintain a fairer tax system.
The UK originally promised to remove DST once a global tax framework was in place, but that framework led by the OECD has stalled.
The OECD Solution: Work in Progress
The OECDโs global tax deal, agreed in 2021, was designed to replace DSTs with a fairer, international tax system. It consists of two key pillars:
- Pillar One: Reallocating some taxing rights to countries where multinationals generate revenue, even if they have no physical presence there.
- Pillar Two: A 15% global minimum corporate tax to prevent profit shifting to tax havens.
While over 140 countries signed up, the US has not implemented Pillar One, delaying the systemโs rollout. As a result, the UK and other countries (including France and Italy) have kept their DSTs in place, waiting for the US to act first.
What Happens Next?
The UK government has three main options:
- Scrap DST immediately to avoid tariffs and improve US trade relations, but at the cost of losing a key revenue stream and undermining the UKโs ability to hold global tech companies to account in the future.
- Delay the decision and negotiate with the US, hoping for concessions or a commitment to the OECD framework.
- Hold firm on DST and risk economic retaliation, betting on international support for fairer digital taxation.
The most likely outcome is that the UK scraps DST in exchange for avoiding tariffs on key UK exports. The government may attempt to soften the move by pledging to replace DST with an alternative tax in the future or waiting for the OECD deal to progress.
Implications for the AI Sector
Many AI businesses in the UK rely on cloud services, digital advertising, and marketplaces provided by the large tech companies that currently pay DST. DST and any future tax could be passed onto to UK companies in terms of higher costs in the supply chain. If DST is removed, UK companies may benefit if the major tech platforms reinvest savings into UK operations and infrastructure, reducing costs and supporting UK businesses.
For businesses in AI and digital innovation, the key concern is whether the government will find an alternative way to ensure a level playing field, one that prevents large multinationals from dominating the market without making fair contributions to the UK economy.
UKAI will be tracking the news over the next few days and look forward to discussing this at our members lunch and fireside chat on Friday with Bruce Reed, President Bidenโs Deputy Chief of Staff.
