OECD issues Policy Note on Addressing the Tax Challenges of the Digitalisation of the Economy
On 29 January 2019 the G20/OECD Inclusive Framework on Base Erosion and Profit Shifting (BEPS) released a short Policy Note to provide an update on their work on Addressing the Tax Challenges of the Digitalisation of the Economy.
The OECD will explore two areas (‘pillars’) in parallel to work towards reaching a new consensus-based long-term solution in 2020:
• Pillar 1: Allocation of taxing rights between countries, looking at both nexus and profit allocation rules and, in particular, reward for market/user countries.
• Pillar 2: Addressing remaining BEPS issues including the consideration of rules to strengthen countries’ ability to tax profits where income is subject to a low effective rate of tax.
The Policy Note is intended to provide an early update, and makes clear that countries have agreed to look at a range of proposals on a ‘without prejudice’ basis to allow for necessary further work without commitment at this stage to a particular course of action. In addition to the Policy Note, the OECD Secretariat presented an update on progress in their OECD Tax Talks webcast of 29 January 2019.
This Policy Note follows the Interim Report on taxation of the digitalised economy released in March 2018 and the earlier BEPS project work on Addressing the Tax Challenges of the Digital Economy. As such, it represents the latest developments as countries look for a consensus-based outcome.
A number of different options are being considered and no consensus has yet been reached on any of the potential options or whether the ‘two pillar’ approach is appropriate.
One important point to note is that among the options are several that extend to the taxation of all multinational businesses, and not just those that are highly digitalised. One example is businesses with limited risk distributors in market countries and profits from marketing intangibles. Some of the options being considered go beyond fundamental concepts within the current international tax framework, such as requiring a physical presence to be taxed in a country and allocation of profits according to the arm’s length principle. These will require double tax treaty changes to be adopted.
One of the challenges (recognised in the Policy Note) that will need to be addressed is finding solutions that strike a balance between the needs of large and small countries, and developed and developing countries.
The further work on anti-BEPS measures will require detailed consideration, including addressing the challenges of differing tax bases amongst countries as well as differing tax rates.
Businesses will be pleased to see that the Policy Note emphasises countries’ commitment to avoiding double taxation and providing certainty, including the recognition of the need for effective dispute resolution. There is also acknowledgement of the benefits of simplicity from both a business compliance and tax authority administration perspective. For many businesses the most damaging outcome would be a failure for consensus to be reached at the OECD/global level and a proliferation of uncoordinated unilateral measures by countries leading to double or multiple taxation. The Policy Note makes clear that significant further detailed work needs to be done by the OECD, and the timetable remains challenging, so this will be an important topic throughout 2019 and into 2020.
Pillar One: Allocation of taxing rights, including nexus issues.
Further work will be undertaken to consider how the existing rules allocating taxing rights between countries (‘nexus’), including in particular allocation of taxing rights to market/user countries where value is created. The Inclusive Framework has agreed that a coherent solution requires at the same time consideration of how profits are allocated to the different activities carried out by multinational businesses (‘profit attribution’).
A number of proposals are being considered, and are fundamental in that they look beyond existing international tax framework concepts such as requiring a physical presence for taxing rights and allocating profit/losses according to the arm’s length principle. The Policy Note acknowledges that these proposals will require changes to double tax treaties.
Options under consideration include:
• Revision of the existing rules on nexus and profit allocation by reference to ‘active user contribution’ to recognise the value created by users of digital services such as through a ‘significant digital presence’. This would apply to highly digitalised businesses.
• Revising the existing rules on profit attribution by reference to ‘marketing intangibles’ to recognise the value created by the market country. This would apply to all types of businesses, whether or not highly digitalised.
• A nexus in the form of a ‘significant economic presence’ to reflect situations where a business participates in the economic life of a jurisdiction without having a physical presence.
The Policy Note sets out the desire to find the right balance between ‘accuracy and simplicity’ so that solutions can be administered by tax authorities irrespective of different levels of development and capacity. Principle-based solutions, administrative simplifications and collection mechanisms will be explored. This could include withholding taxes provided double taxation does not arise.
Further technical work on the design considerations of the proposals is required, including potential scope limitations, business line segmentation, profit determination and allocation, as well as nexus and treaty considerations.
Pillar Two: Addressing the remaining BEPS issues
The second pillar seeks to address profit shifting to entities subject to a low effective rate of tax through the development of two inter-related rules:
• An income inclusion rule that would tax profits as income in the hands of a related party investor; and
• A tax on base eroding payments to deny a deduction (or impose withholding tax) in the source country on payments subject to no or only very low taxation.
The second pillar seeks to address the risk of uncoordinated, unilateral action, either to attract more tax base or to protect an existing tax base, with adverse consequences for all countries. The two rules would be implemented in co-ordination to mitigate the risk of double taxation.
Agreement and objectives
The proposals will be explored on a ‘without prejudice’ basis and lay the grounds for the Inclusive Framework to come to agreement on the way forward. Inclusive Framework members recognise that a coordinated, multilateral approach could address tensions in the international tax framework which has seen increasing numbers of countries taking unilateral measures.
Inclusive Framework members also agree that new rules should not result in double taxation or taxation where there is no economic profit. The Policy Note sets out the importance of tax certainty, the need for effective dispute prevention and resolution and the desire for a ‘level playing field’ between all jurisdictions, irrespective of size or extent of development.
A consultation document will be published in mid-February with more detail on the proposals under consideration, followed by a public meeting to be held at the OECD in Paris on 13-14 March 2019.
The Inclusive Framework will meet in May 2019 to agree a detailed programme of work with a view to reporting progress to G20 Finance Ministers in June 2019. A consensus-based, long-term solution will be delivered in 2020.