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OECD proposal on the reform to address tax challenges from digitalisation of the economy

The OECD Secretariat has issued two key documents since October 2019 that are based on so called pillars of the Programme of Work for Addressing the Tax Challenges of the Digitalisation of the Economy adopted by the Inclusive Framework on BEPS and approved by the G20:
  • Pillar One (“Unified Approach”) addresses the allocation of taxing rights between jurisdictions and considers various proposals for new profit allocation and nexus rules;
  • Pillar Two (“Global Anti-Base Erosion” or “GloBE”) seeks to comprehensively address remaining BEPS challenges by ensuring that the profits of internationally operating businesses are subject to a minimum rate of tax.
Both documents should facilitate the task of arriving at global long-term and consensus-based solution on approaches to Pillar One and Pillar Two until the end of 2020.
 
Pillar One
Key features of the proposed Unified Approach:
  1. The approach covers highly digital business models as well as consumer-facing businesses with further work to be carried out on scope and carve-outs.
  2. 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.
  3. New profit allocation rule is planned to be 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.
  4. 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.
At the same time, the OECD Secretariat is still working on the possible use of business line or regional segmentation, issues and options in connection with the treatment of losses, and the challenges associated with the determination of the location of sales under Pillar One.
 
Pillar Two
The four component parts of the GloBE proposal are:
  1.  an income inclusion rule that would tax the income of a foreign branch or a controlled entity if that income was subject to tax at an effective rate that is below a minimum rate;
  2. an undertaxed payments rule that would operate by way of a denial of a deduction or imposition of source-based taxation (including withholding tax) for a payment to a related party if that payment was not subject to tax at or above a minimum rate;
  3. a switch-over rule to be introduced into tax treaties that would permit a residence jurisdiction to switch from an exemption to a credit method where the profits attributable to a permanent establishment (PE) or derived from immovable property (which is not part of a PE) are subject to an effective rate below the minimum rate; and
  4. a subject to tax rule that would complement the undertaxed payment rule by subjecting a payment to withholding or other taxes at source and adjusting eligibility for treaty benefits on certain items of income where the payment is not subject to tax at a minimum rate.
Currently, the OECD Secretariat calls for inputs from stakeholders on three technical design aspects of the GloBE proposal that are under discussion:
  • the use of financial accounts as a starting point for the tax base determination, as well as different mechanisms to address timing differences;
  • the level of blending under the GloBE proposal, that is the extent to which an MNE can combine high-tax and low-tax income from different sources taking into account the relevant taxes on such income in determining the effective (blended) tax rate on such income; and
  • experience with, and views on, carve-outs and thresholds considered as part of the GloBE proposal.

 
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