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OECD Issues New Proposal to Tackle Taxation of Digital Economy

OECD Issues New Proposal to Tackle Taxation of Digital Economy

Earlier this week, the OECD released its brand new proposal to tax multinational companies, including those involved in the digital economy, “wherever they have significant consumer-facing activities and generate their profits.”

Generally speaking, this proposal, which can be commented on by the public up until November 12, 2019, seeks to “re-allocate some profits and corresponding taxing rights to countries and jurisdictions where MNEs have their markets.”

The project “would ensure that MNEs conducting significant business in places where they do not have a physical presence, be taxed in such jurisdictions, through the creation of new rules stating (1) where tax should be paid (“nexus” rules) and (2) on what portion of profits they should be taxed (“profit allocation” rules).”

More specifically, this proposal tackles “user participation,” “marketing intangibles,” and “significant economic presence” by creating a “Unified Approach.”

Under this “Unified Approach,” the solution to the taxation of the digitalized economy would include the following points, as presented by the OECD:

Scope: The approach covers highly digital business models but goes wider – broadly focusing on consumer-facing businesses with further work to be carried out on scope and carve-outs. Extractive industries are assumed to be out of the scope.

New Nexus: For businesses within the scope, it creates a new nexus, not dependent on physical presence but largely based on sales. The new nexus could have thresholds including country specific sales thresholds calibrated to ensure that jurisdictions with smaller economies can also benefit. It would be designed as a new self-standing treaty provision.

New Profit Allocation Rule going beyond the Arm’s Length Principle: It creates a new profit allocation rule applicable to taxpayers within the scope, and irrespective of whether they have an in-country marketing or distribution presence (permanent establishment or separate subsidiary) or sell via unrelated distributors. At the same time, the approach largely retains the current transfer pricing rules based on the arm’s length principle but complements them with formula based solutions in areas where tensions in the current system are the highest.

Increased Tax Certainty delivered via a Three Tier Mechanism: The approach increases tax certainty for taxpayers and tax administrations and consists of a three tier profit allocation mechanism, as follows:

-       Amount A – a share of deemed residual profit allocated to market jurisdictions using a formulaic approach, i.e. the new taxing right;
-       Amount B – a fixed remuneration for baseline marketing and distribution functions that take place in the market jurisdiction; and
-       Amount C – binding and effective dispute prevention and resolution mechanisms relating to all elements of the proposal, including any additional profit where in-country functions exceed the baseline activity compensated under Amount B. 

OECD Secretary-General Angel Gurría said, “We’re making real progress to address the tax challenges arising from digitalisation of the economy, and to continue advancing toward a consensus-based solution to overhaul the rules-based international tax system by 2020.”

“This plan brings together common elements of existing competing proposals, involving over 130 countries, with input from governments, business, civil society, academia and the general public. It brings us closer to our ultimate goal: ensuring all MNEs pay their fair share.”

”Failure to reach agreement by 2020 would greatly increase the risk that countries will act unilaterally, with negative consequences on an already fragile global economy. We must not allow that to happen,” Gurría added.

OECD’s Digital Taxation Plan

Businesses & Civil Society React to OECD’s Digital Taxation Plan

Reactions to the OECD’s plan were varied with many businesses welcoming the proposal, while tax justice proponents criticized it for not doing enough.

American tech giant Amazon called this OECD proposal “an important step forward,” adding that, “achieving a broad international consensus is crucial in order to limit the risk of double taxation and unilateral distortive measures, while creating an environment conducive to the growth of world trade, which is essential for millions of people, clients and companies that Amazon accompanies worldwide.”

Furthermore, Ross Robertson, who is a tax partner at BDO, commended the proposal, but mentioned there is still plenty to be defined.

“There are many definitions and technical mechanisms to be agreed: for example, the threshold at which the new rule would apply and the fixed profit element for local activity,” Robertson said.

“And there will be many practical administrative problems to be resolved — not least as the OECD recommends the new rules take effect globally from one agreed date,” he added.

On the other hand, the Independent Commission for the Reform of International Corporate Taxation (ICRICT) has its doubts as to whether the OECD is the correct organization to follow through with much need reforms in this area.

In a report issued on October 6, 2019, the ICRICT rejected “the likely proposal of splitting “routine” and “residual” global profits of multinationals and making only a fraction of the latter subject to formulary apportionment,” which it believes “will keep the existing dysfunctional rules in place to determine how the majority of multinationals profits are taxed and result in little reallocation of taxing rights.”

Furthermore, the organization is “concerned about the likelihood that this reform is going to benefit OECD countries first and foremost, as the proposal results in a limited shift of taxing rights, and only to market jurisdictions.”

The report says: “An equitable distribution of taxing rights can only be achieved through a balanced formula which includes supply and demand factors, as allocation based on sales tend to advantage advanced economies who consume more whilst developing countries significantly benefit if employment is included in any allocation formula.”

Finally, the ICRICT “[believes] a global minimum effective tax should be set at 25%, as we are fully aware that what is now set as a global minimum may become in the future the global maximum.”

What are your thoughts on this new proposal pitched by the OECD?