The OECD has published a public consultation on several proposals seeking consensus on how to tackle the challenges arising from the digitalisation of the economy and unresolved Base Erosion Profit Shifting (“BEPS”) issues. This marks the dawn of BEPS v2.0 and the prospect of significant change to the international tax system as we know it.
Pillar 1: Digitalisation of the economy
- User participation
The first pillar of proposals seeks to grant taxing rights to user jurisdictions. Although directed at the challenges arising from the digitalisation of the economy, some of the proposals have wider implications.
UK readers will be familiar with the idea of “user participation” given it forms the basis of the UK’s proposed digital services tax (read more here), and won’t be surprised to hear that the UK is the strongest advocate of this idea at the OECD.
This solution is narrow in a sense that it only focuses on three highly digitalised business models: social media platforms, search engines and online marketplaces. Engagement and participation of users is considered to be critical to the value creation in these businesses and traditional transaction transfer pricing methods do not adequately capture the associated value created.
Additional profits could be allocated to a user jurisdiction calculated through a non-routine or residual profit split and divided up based on certain user participation metrics. This proposal could mark the first steps away from the arm’s length principle (limited to routine returns) and a move towards formulary apportionment (for residual profits).
- Marketing intangibles
The marketing intangibles proposal has a broader scope, but would operate in a similar way to the user participation model in the sense that it would grant more taxing rights to better take into account both marketing and user activity in a jurisdiction.
The consultation explains that highly digitalised businesses use these assets to market for their own goods and services or sell to third parties, therefore more value related to marketing intangibles should be allocated to the market jurisdiction. This proposal, however, does not limit the scope to highly digitalised business models so this may have wider affect amongst multinational groups.
As with the user participation model, established transfer pricing rules would be adapted to better recognise the value of marketing intangibles in the market jurisdiction. This proposal is supported by the US (who have resisted proposals that focus solely on digital businesses) - no doubt with one eye on the potential receipts they might receive from non-US businesses with visible brands and strong markets in the US.
- Significant economic presence
The third proposal in pillar one borrows from the recent EU proposals (creating a digital permanent establishment) and provides new taxing rights to a jurisdiction if a business has “purposeful and sustained interaction” there. This would be judged by a series of factors like number of users; whether the billing is done in a local currency; and whether there is a website in local language etc. The days of taxing rights based on a physical presence with “bricks and mortar” or “boots on the ground” would be limited under this proposal.
Pillar II: Global anti-base erosion
The second pillar puts forward two new rules designed to allow jurisdictions the right to tax profits if they have been subject to no or very low taxation. Despite the achievements of BEPS v1.0 some jurisdictions believe that there is still further work to do in developing a comprehensive solution. The two-pronged approach proposes:
- an income inclusion rule that would tax the income of a foreign branch or a controlled entity if that income was subject to a low effective tax rate in the jurisdiction of establishment or residence; and
- a tax on base eroding payments that would deny a deduction or treaty relief for certain payments unless that payment was subject to an effective tax rate at or above a minimum rate.
These concepts borrow heavily from the US GILTI and BEAT measures respectively. The expectation is that these proposals would apply beyond highly digitalised businesses, and work in conjunction with existing measures like CFC rules and double tax treaties. This measure is actively supported by the US, France and Germany.
The consultation is open until March 2019 which will provide time for the OECD to analyse comments before it presents its proposals to the G20 finance ministers a few months later in June 2019.
At some point consensus will be needed on one proposal so that it can be worked-up and technical issues ironed-out ahead of when the final recommendation is due in 2020.
Although taxing the digital economy has been a contentious subject, the OECD is a master at reaching consensus - just look at the 15 action plans associated with BEPS v1.0. It is likely to be no different with BEPS v2.0 so multinational groups, even those outside of the obvious tech industry, should begin to make sense of what this change might mean.
As part of the ongoing work of the Inclusive Framework on BEPS, the OECD is seeking public comments on key issues identified in a public consultation document on possible solutions to the tax challenges arising from the digitalisation of the economy.