On 9 October 2019 the OECD released on their website a public consultation document on a proposed “unified approach” for the overhaul of international tax rules. Comments are due by 12 November, prior to consultation meetings on 21, 22 November.
The unified approach details a new tax nexus rule which gives countries taxing rights over foreign enterprises without any physical presence in their markets, and a new formulaic approach to profit attribution. It is an effort by the OECD Secretariat and the Steering Group (SG) of the Inclusive Framework (IF) to bridge the gap between the three proposals put forward in early 2019 by the US, UK and India, and reach global agreement by 2020. Given the impact the new rules would have on multinational enterprise (MNE) global structures, supply chains, and business models, the China business community should highlight their concerns at this stage.
The unified approach
As explained in earlier 2019 KPMG China bulletins (China Tax Alert Issue 7 and Issue 17), in May and June a programme of work was fixed under which various Working Parties (WPs) would explore the technical design challenges for new nexus and profit attribution rules (Pillar 1) and a new global minimum tax (Pillar 2). In parallel, the IF SG, a subset of IF countries including the major economies and a representative sample of other countries (e.g. small open economies, developing economies) would work with the OECD Secretariat to hammer out a potential political compromise on Pillar 1, a process that is still ongoing. To this end the Secretariat has put forward the unified approach. Key features are as follows:
Nexus: A threshold, largely based on sales revenue, would be used to determine whether countries have taxing rights over in-scope enterprises. Revenue threshold possibly linked to market size (i.e. GDP). For highly digitalized businesses revenue could be sourced to the location of users (e.g. social media).
The new nexus rule would be ‘standalone’, i.e. a new treaty article separate from the existing physical presence based permanent establishment (PE) threshold in Article 5 of treaties. The nexus threshold would be applied at the MNE group level, and would require mechanisms to ‘trace’ supplies through third party intermediaries/platforms.
Scope: Large consumer-facing enterprises are targeted. This could cover sellers of branded goods, franchises, as well as highly digitalized businesses. The precise sectors in scope are yet to be determined, as well as explicit scope exclusions (e.g. extractives, financial services). A size limitation of EUR750m global turnover is mooted in the document, though could differ
Profit allocation: The profit allocated to markets (including to local subsidiaries) consists of 3 elements, Amounts A, B and C:
- Amount A starts with MNE group consolidated accounts. It allocates a share of MNE ‘residual profits’ (those in excess of ‘routine profits’) to markets. Simplified metrics are to be used for determining routine profits (e.g. X% of global revenue), the percentage of residual profits allocated to ‘the market’, and the allocation across market countries (e.g. ratio of sales across countries). In line with a July G7 statement, attention is being given to how the allocation of Amount A to countries could be designed to reflect the intensity of digital/user engagement with a country. The metrics will be determined through negotiation, with the economic analysis of tax revenue effects playing a key role.
- Amount B is a floor on the return to ‘baseline’ physical marketing and distribution activity in the market countries; definition of these activities, and rate, yet to be determined.
- Amount C uses standard TP rules to allocate further amounts to the market for functions beyond the Amount B ‘baseline’.
Amounts A, B, and C are all noted to need strong dispute mechanisms, possibilities mentioned in the question section being arbitration, ICAP or multilateral APAs. Business line/regional segmentation will be further explored. These profit allocation rules would ‘co-exist’ with traditional TP rules.
As noted in our earlier bulletins, the Pillar 1 rules aim to alter the balance of international tax rules. They look to allocate a greater share of taxing rights to market jurisdictions, while still avoiding double non-tax outcomes. IF jurisdictions are being driven towards compromise on this (which many of them would have earlier opposed) by the rising threat of widespread adoption of unilateral measures by countries (e.g. digital service taxes). Whether the new rules increase tax exposures for particular enterprises, and raise their tax burdens, depends on the ultimate design of the nexus, scope and profit attribution rules, as well as their business model and specific circumstances. In the consultation business could:
- Seek clarity on scope rules, for example explicit exclusions for suppliers of goods used by businesses in production activities and vendors of generic/undifferentiated consumer goods.
- Offer views on feasibility of business line/regional segmentation, ‘tracing’ through intermediaries, and implications for accounting systems, auditing standards, etc.
- Solicit detail on the simplified metrics for Amount A, provide suggestions on Amounts B and C scope, and seek clarity on the double tax relief, losses, disputes and enforcement mechanisms.
Work on the overhaul of international tax rules has now entered the ‘details stage’. The proposals set out in the unified approach are the most concrete to-date, even as many details remain to be clarified. While it is still far from assured that the IF jurisdictions will reach consensus in 2020, the November public consultation provides a key opportunity for the business community, including in China, to provide input and express concerns while the rules are still in formation.
In giving their consultation responses on the unified approach, businesses should also consider the parallel impact of the Pillar 2 global minimum tax rules; a public consultation document on this is due out early November, with consultation in December.
In order to best understand the impact of the emerging new rules on tax management, accounting systems, and MNE business and operating structures, close liaison with your KPMG advisor is highly recommended.