The OECD sets out new proposals that will radically transform business tax for the digital age.
When the OECD started the base erosion and profit shifting (BEPS) project several years ago, they originally talked about ring-fencing the digital economy and introducing targeted measures to tax digital businesses such as US-based tech giants.
Not anymore. No longer will BEPS only be about taxing digital businesses – it is expanding to take in the digital aspects of all business. The OECD’s latest Policy Note, “Addressing the Tax Challenges of the Digitalised Economy” proposes catching the digitalisation of ordinary businesses by introducing a new idea: a minimum tax to catch any kind of cross border payment which takes advantage of tax arbitrage.
The proposals start with an income inclusion rule. Say a parent company in one country has a fully-owned subsidiary in another. The OECD proposes that if the earnings of the subsidiary are not taxed at a particular minimum rate in the jurisdiction of the subsidiary, they should be taxed in the parent company’s jurisdiction (with the tax being topped up to a globally agreed minimum rate).
At present, UK companies can opt to exclude the profits from their foreign branches from UK taxable profits. Under the OECD’s proposals, that would no longer be the case as the income inclusion rule would apply to cover branch income as well as subsidiary income. The impact is simple: no matter how a group or company with overseas operations organises itself, income from subsidiaries or branches will no longer be exempt from tax and will have to be taxed at a minimum effective rate.
The second part of the proposals builds on further BEPS actions to tackle payments that are seen to be undertaxed or untaxed. For example, consider the situation where a subsidiary is paying a royalty to the parent. If the parent did not pay the minimum tax on the royalty income, then the subsidiary would not be able to claim a tax deduction for the payment under the OECD proposals. And if the parent were not subject to tax, then there would be restrictions on tax treaty rights: the parent would be subject to tax in the subsidiary’s location and there would be no relief, for example, for withholding tax.
Complex chain transactions would be caught under the OECD’s proposals too. A cascade effect would operate in multi-level group transactions so that if the first company in the chain did not tax the royalty then the second company (or the first recipient) would; if it did not then the next recipient would, and so on.
While the OECD’s Policy Note sets out the general proposed approach, there is clearly still a lot of work needed to co-ordinate the rules and to see how they would work with existing provisions (such as controlled foreign company rules). The OECD is talking about introducing conduit or imported rules which could create significant compliance burdens for affected taxpayers. Questions about how to eliminate double taxation risk and dispute resolution still remain.
But setting aside the detail, the message for companies is clear. BEPS is no longer only about technology companies. It’s about taxing the digitalisation of every business that operates cross border, and in a way that touches the operations of every international group. The OECD’s proposals taken together form a fully holistic reform of the tax code – and this is something which every international business needs to understand and prepare for.
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