The OECD Secretariat’s proposal for a “Unified Approach” for taxing multinationals has been released for consultation.
It is a further step in the OECD’s Programme of Work to solve issues with taxing the digital economy and highly-digitalised business. The proposal progresses the Pillar 1 work stream, which focusses on the allocation of global taxing rights. Pillar 2 covers tax base concerns such as a minimum level of tax on multinationals’ global profits. The proposal does not address this.
Earlier work on Pillar 1 outlined a number of approaches to allocate global taxing rights. The “Unified Approach”, which synthesises the various approaches, is a potential landing for allocating taxing rights to different countries. Much of the detail of the proposal is still to be developed and agreed however.
The “Unified Approach”
At a high-level:
- Its scope includes not just highly digitalised businesses but potentially any consumer facing multinationals. Businesses in the extractive (i.e. mining) and commodities industries, and possibly financial services, are out of scope but further work is needed to define what exactly these are.
- Sales to a country without need for a physical presence will be sufficient to allow a country to tax profits. There will be two thresholds, a global one which determines whether a company is within the rules, and a country one which determines whether sales to that country are within the rules. The proposal acknowledges that country-specific thresholds will need to be calibrated to ensure smaller economies do not miss out.
- A new profit allocation rule is proposed, containing three layers:
- Residual profits of a global multinational group are allocated to different market countries using a formula. (Amount A)
- In-country marketing and distribution functions are allocated a fixed-return (which is similar to the current transfer pricing approach). (Amount B)
- Tax authorities can agree an additional profit allocation for in-country functions which exceed the standard in-country functions. (Amount C)
Importantly, a mandatory and binding dispute resolution mechanism relating to the calculation of all three amounts is proposed.
The formula for Amount A is, broadly:
|Determine the adjusted global consolidated accounting profit.||Accounting profit is said to be a robust measure, however, adjustments are contemplated (for example, to exclude capital sales).|
|Determine the Residual Profit (i.e. global adjusted accounting profit less the Routine Profit).||The level of Routine Profit is to be agreed by the OECD Inclusive Framework member countries.|
|Allocate the Residual Profit between market and other factors.||An agreed ratio may result from the OECD’s work.|
|Allocate the market profit to countries (which exceed the country sales threshold) based on an allocation key.||The allocation key may be based on sales, other factors, or a combination.|
|The profit allocated to a country is taxed at that country’s tax rate.|
|The home country prevents double taxation by allowing a credit or exempting the income allocated to market countries.|
What does the “Unified Approach” mean for New Zealand?
In June, the New Zealand Government released its options for taxing the digital economy. It discussed the OECD Pillar 1 and 2 approaches, as well as a possible standalone digital services tax for New Zealand. Further information is outlined in our Digital services: one-two punch? Taxmail article.
On the various OECD Pillar 1 approaches, the document noted that some would apply more broadly than others. Our concern for broad approaches, which still remains, is that that New Zealand may be a “net loser” fiscally because of the size of the New Zealand market relative to other countries.
The “Unified Approach” is a wide approach. However, there are aspects of this proposal which may be positive for New Zealand’s position. These include the suggested carve-out for commodities businesses and the need to ensure that country sales thresholds do not adversely impact small market countries.
Whether they are positive will depend on the definitions. For example, are commodities defined by product only or will there be a brand or other (“it comes from New Zealand”) intangibles test?
The suggestion that the “Unified Approach” should apply to…
“large businesses [e.g. global turnover of €750m] that market their products to consumers and may use digital technology to develop a consumer base [i.e. businesses for which customer engagement and interaction, data collection and exploitation and marketing and branding is significant]”…
has wide application. Businesses are increasingly harnessing data and technology to build or enhance their customer base and improve the customer experience. Such a definition is therefore likely to capture a large population of New Zealand’s innovative businesses operating cross-border.
The Unified Approach also raises questions for New Zealand’s tax system design. For example, if it makes sense to tax multinationals based on their accounting profit, does this mean that all businesses should be taxed in this way? There are some significant tax policy questions to be considered.
What are the odds for the “Unified Approach”?
It is worth noting that the “Unified Approach” is a proposal by the OECD officialdom. It is yet to be tested for the national interest and domestic political considerations of the 130-odd countries that have signed up to the OECD’s Inclusive Framework on BEPS. Those considerations may reshape the approach.
The scope and thresholds and the detail of the formulas will all be subject to debate. There will be different drivers for how these are defined and calculated.
Further, a key element of the proposal is mandatory binding arbitration. This was a part of the OECD’s original BEPS recommendations. However, this has not been universally applied by countries implementing the BEPS recommendations. If the objection to mandatory arbitration remains a point of principle for many countries, it may prevent the “Unified Approach” gaining consensus.
However, the “United Approach” has been released for consultation. This suggests that there is already a degree of support for the proposal. Media reports indicate there is a political will to make progress on this issue. Although changes can be expected, acceptance of the “Unified Approach” proposal, in some form, is in our view more likely than not.
Next OECD steps
The OECD is to present the “Unified Approach” to the G20 and G7 shortly. Submissions on the “Unified Approach” proposal are due by 12 November 2019. A report is expected in January 2020 for agreement by OECD Inclusive Framework members.
A word on a digital services tax for New Zealand
A unilateral digital services tax, as an interim measure, remains on the table as a New Zealand response to the digital economy. We believe a digital services tax is sub-optimal tax policy. It would also have wider trade and international implications for New Zealand, if implemented.
The current rules for taxing multinationals have lasted for the better part of 100 years. Although the nature of the global economy cannot be predicted, it is worth taking the time now to establish an agreed path for the next hundred. New Zealand should remain cautious about advancing any unilateral “solution”.
For further information, please contact Darshana Elwela.