On 31 January 2020, the Organisation for Economic Cooperation and Development (OECD) in its role as Secretariat for the OECD/G20 Inclusive Framework on BEPS made statements on the status of its work programme on addressing the tax challenges arising from the digitalisation of the economy.
The work programme comprises two work streams, Pillar One and Pillar Two. Under a timetable set in May 2019, the ambition had been to obtain consensus approval by the Inclusive Framework of the outline framework of proposals in January 2020.
Whilst consensus has not been reached, sufficient progress has been made for the OECD’s work on both Pillars to continue with the aim of reaching a consensus-based solution by the end of 2020. The OECD’s 31 January statements acknowledge there remain critical policy differences which have to be resolved. The OECD has noted that suggestions by the United States of America of implementing Pillar One on a safe harbour basis (which implies a degree of optionality in its application) could raise major difficulties in reaching a consensus-based agreement. While the OECD’s technical work continues on the design of the proposals, the aim is to reach agreement on the key policy features of the proposals at the next meeting of the Inclusive Framework in early July 2020.
Pillar One is seeking to identify a new international framework under which part of the profits of global multinational corporations (MNCs) calculated using a fixed ratio could be allocated on a formulaic basis to market jurisdictions in which they have a sustained engagement with consumers. As part of building consensus on the design of the new framework under Pillar One, the OECD conducted a consultation at the end of 2019 on a proposed ‘Unified Approach’.
The Inclusive Framework has endorsed the Unified Approach framework as the basis for moving ahead to achieve consensus. The Unified Approach is an entirely new international tax framework for the allocation of profits of multinational corporations (MNCs) which carry on automated digital services or consumer facing activities which have sustained engagement with consumers in market jurisdictions.
The Unified Approach comprises three parts: (1) Amount A, a profit amount calculated using a fixed ratio based on revenues in the global consolidated financial statements of MNCs in relation to lines of business comprising automated digital services and consumer facing activities (including those with no physical presence). Where the profitability of the in scope business lines of the MNC exceeds a threshold percentage (to be defined), part of those excess profits are allocated to market jurisdictions that meet a nexus threshold (based on revenues and other factors) using a formulaic approach; (2) a fixed Amount B based on the arm’s length principle allocated to market jurisdictions to remunerate baseline, routine marketing and distribution activities conducted in the jurisdiction, and (3) Amount C profits allocated using transfer pricing principles to remunerate other non-routine activities in the jurisdiction.
The scope of the new profit allocation framework under the Pillar One Unified Approach is intended to extend beyond automated digital services to include those with significant and sustained engagement with consumers in a market. Suggested lines of business are described in the statement paper but the final definition of ‘in scope’ lines of business remains to be determined. The 31 January statement suggests that companies operating in the extractive sectors or commodotised end of supply chain as well as regulated financial services and airlines or shipping businesses should be excluded from scope.
As the work on refining the proposals progresses, businesses operating in Ireland will be interested to understand the potential application of Amount A to MNCs which exceed a certain global size of revenues, the potential application of carve outs for MNCs with de minimis revenues from in scope lines of business, the level of market jurisdiction nexus thresholds for revenues, etc. They will also be interested to understand the profitability threshold for the application of Amount A on the basis that the proposed new framework is understood to be targeted, in practice, at the most highly profitable MNCs with consumer market impact.
Ireland’s government has stated its policy support for achieving multilateral consensus on a new framework under Pillar One with the opportunity this affords to achieve certainty for business and investment going forward. The OECD is conducting ongoing economic impact assessment work for the Inclusive Framework members on the potential impact of Pillar One and Two proposals. In papers looking at the sustainability of Ireland’s corporation tax receipts, Ireland’s government has signalled that the implementation of Pillar One, if adopted, is likely to affect the level of Ireland’s future corporation tax receipts. This is on the basis that profits currently arising in Ireland to highly profitable MNCs with significant consumer impact in other markets could be reallocated under the proposed new framework from Ireland to the market jurisdictions.
The work under Pillar Two (known as the GloBE proposal) seeks to agree a global minimum tax rate. The proposal comprises four separate parts. Countries could enact legislation under an income inclusion rule which would enable parent companies to pay a top up amount of tax up to the global minimum rate on profits of their foreign entities which are not taxed at least at this minimum rate. This part could be complemented by other parts which could deny deductions for cross border payments within groups, deny treaty benefits or impose withholding taxes on payments where the recipient does not meet the minimum effective tax rate test.
OECD consultations held at the end of 2019 reviewed certain aspects of the proposals but much work is yet to be done to develop the design details and to test the operability of different rules as well as their interaction in practice. Work on Pillar Two is to proceed in tandem with the work on Pillar One.
The scale of impact of Pillar Two is potentially broader than Pillar One and could affect companies operating in a broad range of sectors. Ireland’s government has stated that it is not satisfied as to the appropriateness of seeking to set a global minimum effective tax rate. Ireland’s policy makers remain actively engaged in the work being done to refine the details of the proposals under Pillar Two.
Click here to read the OECD’s 31 January 2020 announcements.
To read an overview of the Pillar One and Pillar Two proposals to date click below to view KPMG’s On a Page summary.