Plato’s Aether.

Aristotle was a pretty smart guy. After the Ancient Greeks sought to explain the world in its most basic elements of earth, water, air and fire, he believed there was a fifth element.

His teacher Plato referred to it as aether, George Lucas called it ‘The Force’ and the Mondoshawan’s in Luc Besson’s cult classic called it the ‘Fifth Element’.

For centuries it was considered to exist between the terrestrial world and the celestial world, i.e., in the ‘void’, and at one time it was even credited for holding up planets. Even Newton and Einstein considered its existence, or not.

But, try as everyone did to prove, measure and capture it - not a chance.

Cloud.

Fast forward to the digital world, and we have a more technological construct of ether - it’s called the Cloud.

Made affordable by AWS, Google Cloud and Microsoft Azure due to elasticity, the Cloud functions across the void as a virtual global supply chain and delivery channel for online market places and other online solutions.

The Cloud exists in the physical world in the form of connected server farms, data centres, processors and software; but because the software enabled solutions can be accessed from any device anywhere, some consumers think of it as part of the ethereal world.

Cloud tax.

Unlike ether, revenues generated from offering the Cloud and from operating in the Cloud, can be captured, observed and measured.

That’s why it should be no surprise that UK, European and other regulators have decided to tax revenues that have been enabled by this modern magic, to the extent that online revenues are generated from within their borders. This has been in the melting pot for a few years now.

But, on Monday, the UK announced that unless an international alternative can be agreed, it will start in April 2020 to levy a 2% tax on UK-generated sales of US tech companies that are profitable and report global annual sales of more than £500m. This will include search engines, social-media services and online marketplaces.

Think about a US based online provider that makes, say a 12.5% net profit margin. It gets corporate taxed at 21% on the US component of those earnings, in the US. However, a 12.5% margin implies that sales would be 8 times as much. In other words, a 2% UK tax on sales would be similar to a 16% tax on profits generated from sales in the UK.

It follows that a 3% tax on a company generating those sorts of margins would be akin to a 24% tax on profits, which is a provocative thought when thinking about tax domiciles.

And, in that camp so far are Spain and the EU.

Spain has its so-called ‘Google Tax’ and whilst it still has to go before the Spanish Parliament, it provides for a 3% tax on all sales of online advertising, user data and online platforms. Caught in the Spanish net will be companies with annual revenues of over €750 million worldwide, and at least €3 million in Spain.

The European Commission is still looking to implement a 3% tax on all sales, regardless of whether the tech company is profitable or not. All member countries are still to agree.

Aimed at Amazon, Google, Facebook, etc., if these directives or variants are passed into law, it is likely to materially regulate behaviour, plus many smaller groups that pass the test will also be caught in this seemingly widening and expensive net.

Indirect effects.

A redistribution of wealth out of US big tech to the tax base of Europe is probably a fair thing.

Still, given the quantum, these taxes are likely to show up in US growth and employment figures in due course as big tech seeks to minimise the impact; and this will go some way to counteracting the benefits from the Trump tax cut sugar fix delivered earlier this year.

It may also cause a further drag on tech stock valuations.

Add to that, interest rate hikes in the US, a potential end to QE in Europe and the US-Sino trade war amidst a further weakening yuan - and we may start to see valuations come off.

The effect on M&A and Equity Financing is unknown, because on one hand the forward growth forecast for tech stocks should be more subdued, but on the other hand, non-tech stocks looking to reinvent and/or survive will most likely be forced into consolidations and roll ups.

That said, this is unlikely to have a direct impact on Western Australia at this time, which is a good thing.

Mike.

We are one of a very small number of independent corporate finance industry pioneers with decades of experience delivering conflict-free M&A, Growth Capital and Strategic Corporate Advisory solutions. With a focus on solutions that capture competitive advantage, our sole objective is to help our clients to successfully buy, sell, finance or invest in companies and assets of any size, in and out of Australia.