This is an abridged version of an article first published on Bloomberg.
Following years of debate, on 9 October 2019, the OECD Secretariat published its blueprint for a proposed new “unified approach” to address the perceived weaknesses in the current framework for digital transactions. The proposals of the “unified approach” stem from the work undertaken under the Programme of Work to Develop a Consensus Solution to the Tax Challenges Arising from the Digitalisation of the Economy (in particular, the Pillar One proposals).
As transactions are increasingly executed digitally/remotely, the OECD work program has the potential to drive significant change to the international tax system.
Unified approach – the general concept
The OECD’s proposal is designed to grant new taxing rights to market jurisdictions.
The unified approach pulls together the common features of the three proposals previously advanced under Pillar One, being the “user participation”, “marketing intangibles” and “significant economic presence” proposals.
Broadly, the unified approach seeks to achieve the following for in scope businesses:
- Introduce a new nexus rule irrespective of a business’s physical presence in the market or user jurisdiction;
- Go beyond the arm’s length principle to allow greater taxing rights to market jurisdictions through a formulaic allocation of certain residual profits;
- Keep the rules simple to apply, reducing the administrative burden for businesses and tax authorities and ensuring robust dispute prevention and resolution mechanisms.
The “unified approach” proposal is intended to facilitate further discussions towards achieving a consensus solution in early 2020.
Defining the scope
The proposals limit the rules to “consumer-facing” businesses. Further work is needed to define what a “consumer-facing” business is, and how to deal with intermediary transactions, components and franchise arrangements.
There is a suggestion that some sectors (for example, extractive industries and commodities) would be explicitly outside the scope of the rules, whereas discussions are still required about other sectors that may be included (eg financial services).
The proposal also notes the need to consider a size-based exclusion. What any size-based thresholds would be is subject to further discussion, though there is suggestion that using the existing threshold of EUR 750m global turnover (currently used for the transfer pricing Country by Country Reporting rules) may be appropriate.
It is not yet clear whether the proposed scope restrictions in terms of sector and size apply only to Amount A (see below) or to the package of rules in its entirety.
A new nexus rule
The new nexus would ensure that businesses that have a sustained and significant involvement in a market jurisdiction (i.e. through sales) are taxable there, even if a business does not create a physical taxable presence in that jurisdiction.
For nexus to arise, the proposals suggest some form of a revenue threshold for sales in the territory, adjusted to take into account the size of the market jurisdiction. Further work will be undertaken to define the revenues to be taken into account for a threshold test.
It is intended that the new nexus rule would be a standalone tax treaty provision, operating in addition to the existing permanent establishment article. Details of how this rule will be drafted and included in the treaties is not yet known, but it is assumed that a multilateral instrument would be required to ensure simultaneous adoption for all participating countries.
New and revised profit allocation rules
Once the right to tax is confirmed in a market jurisdiction under the new nexus rules, the next question is how much profit should be taxed in that jurisdiction – the proposals recommend a three-tiered composite profit allocation solution:
Part of the deemed residual profit/loss of a multi-national enterprise (ie profit after allocating a deemed routine profit on activities to the countries where the activities are performed) – starting from group consolidated accounts prepared under Generally Accepted Accounting Standards (GAAP) or International Financial Reporting Standards (IFRS).
A fixed return on baseline sales and marketing activities identified under current nexus concepts (i.e. permanent establishment and tax residence). Whether this is a single fixed percentage or a fixed percentage varying by industry and/or region or some other agreed method is yet to be decided.
This would apply where the business’s activities in a country are deemed greater than “routine” and those that have already been compensated by Amount B – ie the amount of profit that would be allocated to the jurisdiction under traditional transfer pricing rules. This means that profits could potentially be double counted (i.e. under Amount A and again under Amount C) depending on the business’s functional profile – so more work is required on this.
Businesses should closely monitor the ongoing discussions and critically review their tax and transfer pricing policies to assess the impact of the new proposals and factor the anticipated changes into their future business operating models.
Those businesses that expect to fall under these rules should consider updating their systems to allow them to track and collect the information necessary to comply properly with new rules.
In the meantime, unilateral digital tax measures continue to be implemented on a global scale – businesses will need to continue to monitor local developments to ensure they remain compliant.
We are undertaking new research worldwide on the Taxation of the Digital Economy and its impact on businesses across some 40 jurisdictions.
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For help and advice on international tax issues please get in touch with your usual BDO contact or Ross Robertson or Arjun Bhatia.
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