The OECD moves towards implementing its Policy Note Addressing the Tax Challenges of the Digitalised Economy.
The OECD moved towards implementing its Policy Note Addressing the Tax Challenges of the Digitalised Economy in mid-March with a two-day public consultation on its proposals. The strength of feeling was clear as the consultation was significantly oversubscribed, with more than 400 people from 100 countries taking part.
The event was a listening exercise for the OECD, which wanted to hear about the issues that interested parties had identified and raised. This included many side discussions around the fringes of the consultation and business groups meeting with finance ministers and treasury officials.
The first day focused on issues of nexus and profit attribution as set out in Pillar 1 of the Policy Note. The Note sets out three Pillar 1 proposals, all of which go beyond the arm’s length principle: user participation, marketing intangibles, and significant economic presence.
While there were differences of opinion across countries and taxpayer sectors over which approach found favour, the balance appeared to tip towards marketing intangibles.
Following this route would involve routine profits continuing to be allocated on an arm’s length basis, with a greater portion of non-routine profits from marketing intangibles or intellectual property (IP) allocated to the markets involved.
However, the marketing intangibles solution might result in unforeseen consequences. Attributing IP to a country where the group is selling could mean that the IP has effectively been taken from another country. Transferring IP out of a low-tax jurisdiction and into a higher-tax one could mean that the transferee country collects less tax because the companies into which the IP is transferred are given higher-rate tax deductions.
In addition, the transfer could trigger exit taxes in the transferor country, while the consumer country is no longer seen as an importer of value and so loses the excise duties which may have been charged in the past.
At the moment most of the return from IP created by digitalised business falls to capital-rich exporter countries. However, financial models from a number of companies at the consultation suggest that the marketing intangibles option would reallocate some of this profit away from countries with smaller populations and reallocate it to larger consumer markets such as China and India.
The second day of the consultation reviewed Pillar 2 of the OECD’s policy proposals. These follow on from the original BEPS proposals to consider the introduction of a minimum tax rate to ensure a minimum level of taxation in jurisdictions of source and residence.
No recommendations came from the consultation but the OECD has said it will consider the representations made as it finalises its policy position. Its aim is to present a finalised work plan to the G20 meeting in Japan in late June for finance ministers to use in their technical meetings. The OECD has separately confirmed that the final report on the taxation of the digitalised economy will be published on 12 June.
Where are we now?
Our sense is that these recommendations will settle on some modified form of the marketing intangibles proposition, possibly with a formulaic approach baked in, and possibly with an attempt to bring along advocates of the 'significant economic presence' concept via a modified form of nexus that draws on that concept.
One big unresolved issue is whether the final position will include transactions with businesses as well as with consumers, although we believe that it is unlikely for any transactions to be left out.
Meanwhile countries continue to proceed with a number of unilateral measures. While the OECD was holding its consultation, the Chancellor of the Exchequer published a ministerial statement confirming that the UK’s digital services tax will come into force on 1 April 2020. France has imposed its own tax, which took effect from 1 January this year. Austria, Belgium, Italy and Spain are looking to introduce national digital taxes, while Germany is considering a withholding tax on advertising revenues.
What groups should be doing about this now?
First is scoping. Assuming the rules take a certain shape, such as those in the UK or France, companies need to consider whether they are likely to be caught by them. If they are, then they need to prepare models and forecasts to assess the impact on areas such as their effective tax rate, the impact on customers if they were to pass the tax on, and what the new taxes would mean to their shareholder returns.
They should consider the impact on their financial statements: should they make a provision for the new tax, disclose that there might be an impact, or do both?
‘Horizon scanning’ must be incorporated into the group’s global compliance work, monitoring for developments and working out their impact on transaction flows. This is especially the case for the global anti-base erosion proposals under Pillar 2. At the same time, groups should reassess their access to tax treaties and the deductibility of outbound payments in the light of Pillar 2.
Businesses should continue to engage with the consultation process and consider how they can shape the debate. The OECD has made it clear that it wants to hear groups’ views on the practicality and any administrative issues around the proposals. June is close, so time is of the essence.
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