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OECD Moves Forward on Plans for Taxation and the Digital Economy

OECD Moves Forward on Taxation & Digital Economy

OECD eyes more public consultations as it refines digital tax proposals

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The OECD has released details on the next steps it will take in studying several possible tax proposals to revise geographic allocation of taxation rights through amended profit allocation and nexus tax rules. In its latest edition of "Tax Talks", the OECD overviews its recently released "Programme of Work to Develop a Consensus Solution to the Tax Challenges Arising from the Digitalization of the Economy", which outlines how it will come to a consensus-based agreement with the international community on these tax issues. The OECD says it will also continue to look at the proposed rules to ensure multinational enterprises (MNEs) face a minimum level of taxation.

The OECD notes that in the future, it will study the economic and potential overall effects of its proposals before it makes any final decision on new rules. It may offer public consultations on the new rules later, as the proposals are refined.

Background
These new digital tax proposals focus on the allocation of taxing rights, including nexus issues, and typically allocate more taxing rights to market or user jurisdictions where value is created through businesses' participation in the user or market jurisdiction that is not recognized in the current framework for allocating profits. These alternatives were initially outlined by the OECD in a "Policy Note" issued January, 2019, which was followed by a consultation report in February 2019. The proposals also address remaining BEPS issues and are generally intended to ensure MNEs pay a minimum level of tax, through the introduction of global anti-base erosion rules.

This recent agreement on the approach to discussing these issues was laid out by the 129 members of the OECD/G20 Inclusive Framework on Base Erosion and Profit Shifting (BEPS) and published on May 31, 2019. The planned approach was also endorsed by G20 Finance Ministers in Fukuoka Japan on June 9, 2019. In the report, the OECD confirms the international community's continued commitment to reach a consensus-based long-term solution on taxation and the global digital economy by 2020.

Profit allocation
The OECD says it is exploring three approaches to determine how much of a MNE's profit should be allocated to market jurisdictions, and how to then allocate that profit among those market jurisdictions. The three approaches being explored are:

  • Modified residual profit split method — Where a portion of a group's non-routine profit would be allocated to market jurisdictions
  • Fractional apportionment method — Where an entity's profits (no distinction between routine and non-routine profits) for sales to market jurisdictions would be allocated to those market jurisdictions under a to-be-determined formula that could consider factors such as sales, users, assets and employees
  • Distribution-based approaches — Where a baseline profit would be determined (including routine and non-routine profits) for marketing, distribution and user-related activities in a market jurisdiction, adjusted to reflect the MNE's overall profitability as a whole (or other factors), followed by an allocation of that return to market jurisdictions.

Other issues to be discussed, which would be relevant for each of the approaches above, will include:

  • Whether profits of an affected MNE could be segmented on a regional or business line basis
  • Potential scoping limitations for the new tax, which could be based on factors such as:
    • The size of an MNE group
    • The nature of the business
  • Ensuring that losses are treated in a symmetrical manner as profits under the approach that is ultimately adopted
  • Identification of the relevant taxpayer (as these approaches look at the profits of an MNE as a whole, rather than on a legal entity basis)
  • Co-ordination between the new profit allocation rules and the existing transfer pricing rules to avoid overlaps and potential double-taxation
  • Effective administration, including reporting obligations.

Nexus
A new "non-physical presence nexus rule" could allow market jurisdictions to tax certain profits generated within their borders using an alternative approach. This rule would require a remote but sustained and significant business presence at the MNE group level (rather than the legal entity level), and could consider factors such as revenue thresholds, targeted marketing activities and digital engagement in the jurisdiction, among other factors. The implementation of a new nexus rule could include changes to existing tax treaties, which could potentially be facilitated through the use of the multilateral instrument (MLI) or a new multilateral approach.

Global anti-base erosion rules
The global anti-base erosion rules are generally intended to ensure a minimum level of tax is being paid by MNE's. Under these proposals, four separate rules are being explored, which would provide jurisdictions with the ability to "tax back" profits that are subject to low effective rate of tax. The proposals that will be explored include:

  • An inclusion rule — Which 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; this could potentially operate as a "top-up" to achieve a to-be-determined minimum rate of tax
  • A switch-over rule — Which would be included in tax treaties to allow the state of residence to apply the credit method instead of the exemption method where profits attributable to a permanent establishment or derived from immovable property (which is not part of a permanent establishment) are subject to tax at an effective tax rate below the minimum rate
  • An undertaxed-payment rule - Which would deny a deduction or impose source-based taxation for a payment to a related party if that payment was not subject to a minimum rate of tax
  • A subject-to-tax rule - Which would be added to tax treaties to only allow certain treaty benefits if the item of income is subject to tax at a minimum rate.

Next steps
The OECD's next steps include technical work on the various proposals by different working groups, with the first impact assessment scheduled to be completed by the fall of 2019. By the end of 2019, the OECD hopes to find a unified approach among the proposals being explored, and launch a further public consultation.

For more information, contact your KPMG adviser.

Information is current to June 25, 2019. The information contained in this publication is of a general nature and is not intended to address the circumstances of any particular individual or entity. Although we endeavour to provide accurate and timely information, there can be no guarantee that such information is accurate as of the date it is received or that it will continue to be accurate in the future. No one should act upon such information without appropriate professional advice after a thorough examination of the particular situation. For more information, contact KPMG's National Tax Centre at 416.777.8500

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