DST43420 - DST Operating Margin

The alternative basis for calculation involves calculating the group’s operating margin from providing that digital services activity to UK users.

The margin is calculated per category of digital services activity. Where a group provides more than one type of digital services activity it should calculate the operating margin of each category of digital services activity separately. Therefore, it is possible for a group to have up to three different operating margins, one for each type of digital services activities (Social Media, Search Engine, Online Marketplace).

If a group has many businesses of the same type of digital services activities, the operating margin should be calculated on the combined revenues from all the activities under that category of digital services activity. For example, if a group has multiple online marketplaces, some of which are highly profitable and others are loss making, the operating margin should be calculated for all online marketplace activity combined. It is not possible to elect for only part of an activity to be included in the calculation.

This section provides guidance on the costs which are deductible from the DST revenues when calculating the UK operating margin for a category of digital services activity. DST uses a measure of the operating margin of the activity that is intended to reflect the commercial costs of operating that activity.

This operating margin calculation is based on accounting concepts and does not replicate the adjustments or deductions from revenue in calculating chargeable amounts for other UK taxes.

Consolidated accounts

The starting point is the consolidated income statement (or profit and loss account) of the group.

A deduction will not be allowed unless the expense has been calculated in accordance with an acceptable accounting standard and included in the consolidated income statement for the DST accounting period.

Therefore, intra-group charges and items which are expensed in the statement of other comprehensive income, like losses on equity instruments designated at fair value, cannot be taken into account in the operating margin calculation. Similarly, capitalised expenses in the balance sheet cannot be deducted.

Operating costs

Businesses can take operating expenses into account. Therefore, costs that have been included in the following lines of the consolidated income statement are in principle deductible:

  • Cost of sales;
  • Distribution;
  • Administration;
  • Other operating costs;
  • Amortisation and depreciation

Costs which are not part of the normal costs of running the business activity cannot be deducted.

Disallowable costs

There are some expenses in the consolidated income statement which cannot be deducted in calculating the DST profit margin.

These include costs which are not operating expenses of the DST activity and exceptional items. This is because the DST operating margin is intended to reflect the underlying operating profitability of the business as an ongoing business and should not be distorted by one-off or non-recurring events. This means the following expenses cannot be deducted from DST revenues:

  • Interest expenses
  • Expenditure on acquisitions
  • Changes in the valuation of tangible or intangible assets (e.g. FV movements)
  • Tax costs, including the cost of the DST
  • Occurring otherwise from in the normal course of business

This list is not exhaustive. Other expenses which would not be incurred on a normal basis, or which are otherwise exceptional, should be excluded.

Example A

Business X incurs a regulatory fine in relation to data protection breaches in relation to the provision of a social media platform across various EU markets, including the UK. This does not represent a normal operating expense reflecting the expenses incurring in supplying the in-scope activity to UK users and so is not allowable

Example B

Business Y has developed a new marketplace which it thinks will have a unique selling point relative to its competitors. It is continuing to incur large one-off expenses on the technology needed to run its platform. It is also running a series of promotions to break into the UK market, but expects to withdraw these once it achieves a certain level of market share.

The costs are capitalised on Business Y’s balance sheet and the resulting assets are depreciated/amortised over the useful life of the assets. The capitalised expenditure in the period will not be deductible in the operating margin calculation. This is because the expenditure is not recognised in the consolidated income statement. However, the depreciation/amortisation expense recognised in the period in the consolidated income statement will be deductible. This is because the expenditure is incurred in the course of providing/developing the online marketplace.