A Global New Tax for Digital Economy
The Organisation of Economic Cooperation and Development (“OECD”) is currently working on a new proposal to further address the Base Erosion and Profits Shifting (“BEPS”) project, which is also commonly known as “BEPS 2.0”. BEPS 2.0 has two components, namely Pillar One and Pillar Two. Pillar Two (i.e. the imposition of a global minimum tax rate) was discussed in issue 6. This time, we discuss Pillar One, which mainly impacts Automated Digital Services (“ADS”) and Consumer-Facing Businesses (“CFB”).
These two groups of businesses are considered by the OECD as having the ability to participate actively and in a sustained manner within the economic life of a market country, with or without local physical presence. ADS refer to services that are both automated (i.e., the provision of the services to a particular user requires minimal human involvement) and digital (i.e., services to be provided over the Internet or an electronic network). CFB is defined as those businesses that generate revenue from the sale of goods and services of a type commonly sold to consumers, including those selling indirectly through intermediaries and by way of franchising or licensing.
Broadly speaking, the objective of Pillar One is to develop a unified approach on updating the traditional allocation of taxing rights thereby expanding the taxing rights to market jurisdictions where the services or goods are being consumed. There are three basic elements of Pillar One:
- A new taxing right on a portion of a multinational group’s residual profits allocated to market jurisdictions (“Amount A”).
- A fixed return for certain baseline marketing and distribution activities performed physically in a market jurisdiction (“Amount B”).
- A dispute prevention and resolution process to improve tax certainty (“Amount C”).
- Amount A
Amount A will apply if a multinational group’s business falls into the defined scope and meet the specified size thresholds (i.e., the annual consolidated group revenue threshold and a de minimis threshold for foreign in-scope revenue). Different nexus rules will then be applied for ADS and CFB to determine the entitlement of a market jurisdiction to an allocation of Amount A. The calculation of Amount A will be based on profits before tax in the consolidated group financial accounts prepared under the generally accepted accounting principles. Amount A will be determined based on the following three-step approach.
Step 1: A profitability threshold to determine the amount of profits of the group in excess of an agreed profitability threshold which would be considered to be the so-called residual profits;
Step 2: A reallocation percentage that defines an agreed fixed percentage of residual profits or allocable tax base, that is allocated to market jurisdictions; and
Step 3: An allocation key to portion the residual profits to market countries based on locally sourced in-scope revenues.
Amount A will be determined based on the above approach, which diverges from the determination of the allocation of profits within a multinational group under the arm’s length principle. As such, there would be a mechanism to reconcile the new taxing right with the existing profit allocation rules under which double taxation arising from Amount A should be relieved.
- Amount B
Amount B seeks to standardise the remuneration of related party distributors that perform baseline marketing and distribution activities with the objectives of simplifying the administration of transfer pricing rules and increasing tax certainties. Amount B will apply to entities or permanent establishments with existing nexus and not be related to the new nexus rules of Amount A.
- Amount C
The OECD seeks to establish two set of rules to enhance tax certainties, namely (i) dispute and resolution rules for Amount A and (ii) another set of rules for amounts beyond the application of Amount A rules.
The OECD’s proposal has not been finalised and will likely be subject to political discussions and thus changes. The OECD’s aim is to bring the process to a conclusion by mid-2021 and works to address the political and remaining technical issues will continue