On 23 January, the Organization for Economic Cooperation and Development (OECD)/G20 Inclusive Framework on Base Erosion and Profit Shifting (BEPS) issued a report on addressing the tax challenges arising from the digitalization of the economy, which examined and developed two proposals, commonly referred to as the “Pillar One” and “Pillar Two”. This was followed by a public consultation document in February and a Programme of Work in May. Together, these two documents constitute what is colloquially referred to as the “BEPS 2.0 proposal”, the BEPS 1.0 proposal being considered Action 1 of the OECD Action Plan on BEPS.
Pillar One encompasses a number of revised nexus and profit allocation rules. These aim to address situations where highly digitalized businesses – such as social media platforms and online marketplaces – create value through the participation of users in states where these businesses maintain no or limited physical presence. The rules are as follows:
i. The “user participation” rule, allocating an amount of profit of a highly digitalized business to the state or states where the actively engaged users of that business are located;
ii. The “marketing intangibles” rule, allocating a portion of profits of highly digitalized businesses to the state or states where the marketing intangibles, as defined in the OECD’s transfer pricing guidelines, of those businesses alongside their associated risks can be attributed to; and
iii. The “significant economic presence” rule, allocating profits of a highly digitalized business to the state or states where this business is economically present (i.e. as measured by revenues) via digital technology or other automated means.
Pillar Two analyses the Global Anti-Base Erosion (GloBE) proposal, which aims to address the residual issues concerning BEPS arising from the digitalization of the economy. Nonetheless, it should be noted that the scope of application of the GloBE proposal is wider and will likely reach beyond highly digitalized businesses when implemented, by establishing a global minimum tax rate through the following mechanisms:
i. An income inclusion rule, including the income of a foreign branch or subsidiary entity in the tax base of the parent entity, provided that that income had been taxed below a minimum rate;
ii. An undertaxed payment rule, denying a deduction (or imposing source-based taxation, such as a withholding tax) on a payment to an associated party, provided that that payment had been taxed below a minimum rate;
iii. A subject-to-tax rule inserted into double tax treaties to deny treaty benefits, in cases where a payment to an associated party had been taxed below a minimum rate; and
iv. A switch-over rule inserted into double tax treaties to allow residence states to switch from an exemption to a credit method of double tax relief, in cases where profits of permanent establishments or immovable property had been taxed below a minimum rate.
On 9 October and 8 November, the OECD released two new public consultation documents on the proposals in an effort to engage stakeholders. After the Pillar One consultation closed, the public’s comments were made available on 15 November. For Pillar Two, public comments will be published after the consultation closes on 2 December.
The OECD “Unified Approach”
The Pillar One public consultation proposed a “Unified Approach”, which aims to align the gaps and commonalities of the rules outlined above. The scope of the new approach would affect all large consumer-facing businesses. Furthermore, it would establish a new nexus rule on the basis of a consumer-based involvement of those businesses in a state. Physical presence would not be necessary to establish a nexus. Finally, it includes a revised profit allocation mechanism that goes beyond traditional transfer pricing principles and aims to increase tax certainty through formula-based solutions. This mechanism consists of three tiers:
i. “Amount A”, which would establish a new taxing right for states where a portion of the profits of consumer-facing businesses would be allocated on the basis of pre-agreed sales-oriented formulas;
ii. “Amount B”, which would explore fixed returns for routine distribution activities as per the existing transfer pricing rules; and
iii. “Amount C”, which would develop legally-binding dispute prevention and resolution mechanisms.
The new approach seeks to explore ways of re-designing the Pillar One proposal, by addressing both technical and administrative issues arising from the complexity of the three rules. In that respect, the actual concept of consumer-facing businesses alongside the use of carve-outs would need to be defined. Moreover, attention should be paid to the interplay among the three “Amounts”, as well as the extent to which the traditional arm’s length principle should be abandoned under “Amount A”.
Public consultation on GloBE
The public consultation document on Pillar Two calls for public input on three technical design sets of questions:
i. The use of financial accounts for determining the taxable base of associated entities and addressing timing differences;
ii. The extent of blending (i.e. high and low taxed income from different sources) in determining the (minimum) tax rate; and
iii. The exploration of carve-outs.
The way forward
In light of the above, consensus from the members of the Inclusive Framework on BEPS is sought on how matters should be addressed. Besides that the framework should also consider advancing a consensus-based approach with respect to questions on how those coordinated measures would work alongside unilateral domestic measures already adopted, and questions on how Pillar One would interact with Pillar Two.
The OECD is holding public consultation meetings on the Pillar One and Pillar Two proposals. The OECD aspires for a consensus solution on both pillars to be developed in 2020, with an outline approach on Pillar One expected by January.
Vasiliki Agianni is Research Associate at the IBFD, the world’s foremost authority on cross-border taxation