Digital Taxation – OECD Released Workplan

On 31 May 2019, the Organisation for Economic Co-operation and Development (OECD) released a Workplan (“Programme of Work to Develop a Consensus Solution to the Tax Challenges Arising from the Digitalisation of the Economy”) setting out a process to reach a new global agreement on future taxation of multinational enterprises. The workplan aims to resolve the tax challenges arising from the global  digitalisation of economies and explores technical issues to be resolved through two main pillars (see our newsalert here on the two main pillars).

The Workplan  is presented this weekend to G20 Finance Ministers for endorsement during their ministerial meeting in Japan. In January 2020 the features of the solution will be submitted to the Inclusive Framework for agreement and it is intended for the final solution to be delivered by the end of 2020.

Hereafter we will describe the taxation measures included in the OECD’s Workplan.

First pillar: Revised profit allocation and nexus rules

Allocation rules

The first pillar focuses on the allocation of taxation rights of income among countries. In particular, the OECD intends to allocate more profit to market jurisdictions (i.e., jurisdiction of the customer and/or end user), considering: (i) user participation, (ii) marketing intangibles and (iii) significant economic presence. To achieve this goal, existing taxation rules should be modified to recognize and tax the value created in market jurisdictions.

Besides changing existing taxation rights, a method to quantify the profit reallocated to market jurisdictions and to determine how such profit should be allocated is required. The Workplan describes the following three profit allocation methods:

1. Fractional apportionment method. This method involves the determination of profits subject to the new taxation rights without making a distinction between routine and non-routine profit. The Workplan appoints a potential approach to assess the profit derived by a non-resident enterprise whereby the overall profitability of the relevant group (or business line) should be taken into account. This method would involve three steps: (i) determine the profit to be divided, (ii) select an allocation key and (iii) apply this formula to allocate a fraction of the profit to the market jurisdiction(s).
2. Modified residual profit split method. This method should allocate a portion of a multinational’s group non-routine profit to market jurisdictions reflecting the value created that is not recognised under exiting profit allocation rules.
3. Distribution-based approaches. This approach might address, in addition to non-routine profit, profits arising from activities associated with marketing and distribution.

Nexus rules

The OECD also aims to create a new concept of remote taxable presence with a “non-physical presence nexus rule”. The non-physical presence nexus rule will allow market jurisdictions to tax profits realized without traditional physical presence. To achieve this the following changes could be expected: (i) amendments to the permanent establishment definition in Article 5 of the OECD Model Convention, (ii) changes to the profit allocation rules in Article 7 of the OECD Model Convention and (iii) creating a new standalone taxable presence or source of income concept rule.

Second pillar: Global anti-base erosion proposal

Under the second pillar taxation rights are created for jurisdictions where the other jurisdiction with taxation rights applies zero null or low effective profit tax rates. This pillar ensures a minimum level of tax paid by multination (digital) enterprises. Specifically, the global anti-base erosion proposal sets out the following two inter-related rules:  

1. Income inclusion rule. This rule operates as a minimum tax and provides tools for jurisdictions to tax low taxed profits of foreign subsidiaries and branches at the level of related investors. The income inclusion rule could supplement a jurisdiction’s CFC-rules. Also, a switch-over rule will be explored allowing residence states to apply a credit instead of an exemption in case of permanent establishments in low tax jurisdictions.
2. Tax on base eroding payments. With this (i) the source state could deny a deduction or impose source-based taxation for payments to related entities when the payment is not subject to a minimum tax rate, and (ii) tax treaty benefits could be denied where certain income is not subject to a minimum tax rate.

It is agreed that further work should be performed on, amongst others, simplification measures, thresholds and carve-outs to avoid double taxation. Also, the compatibility of the proposed measures with international taxation rules (i.e. non-discrimination and EU fundamental freedoms) will be reviewed. Lastly, it is mentioned in the Workplan that technical work will be performed to assess the economic impact of the proposals made.

Next steps

The Workplan is  already presented  during the last G20 Finance Ministers  meeting Throughout 2019 further meetings will be held to discuss policy and technical details on the proposals made.

Ultimately, the OECD aims for the features of the solution(s) to be agreed on by the Inclusive Framework by January 2020 and to submit the final report by the end of 2020.

Implications

No consensus has been reached yet and as such the final features and impact of the proposed taxation measures are still uncertain. However, it already seems that the proposed rules will not only affect highly digitalized businesses but all multinational enterprises. With this it is important to follow the coming developments closely.