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OECD: Update on digital economy work; arm’s length implications
OECD: Update on digital economy work; arm’s length
The Organisation for Economic Cooperation and Development (OECD) today released a “policy note” concerning the digital economy.
The OECD policy note—Addressing the Tax Challenges of the Digitalised Economy [PDF 316 KB]—was approved by the entire Inclusive Framework on 23 January 2019, and has the consensus of a broad cross-section of developed and developing economies.
In a related presentation, the OECD acknowledged the growth in unilateral measures and expressed hopes that a multilateral solution would be delivered. According to informal notes regarding the OECD presentation, there are four leading proposals that will be explored by the Inclusive Framework over the coming months, with these proposals being divided into two “pillars” of work.
- Pillar 1 (issue of nexus and profit attribution)
- Proposal 1 (user contribution): Routine profits to continue being allocated on an arm’s length basis, with non-routine profits allocated on the basis of active-user contribution that would be expected to be restricted to highly digitalised business models that are based on active user contributions. This proposal would require an explicit deviation from the arm’s length principle in respect of the residual profit split as it applies to certain businesses. The OECD reported this proposal’s strongest advocate is the UK.
- Proposal 2 (marketing intangibles): Routine profits to continue being allocated on an arm’s length basis, with non-routine profits referable to trade intangibles continuing to be allocated on the basis of DEMPE (development, enhancement, maintenance, protection, and exploitation) of intangibles and a greater portion of non-routine profits referable to marketing intangibles allocated to market jurisdictions. This proposal would require an explicit deviation from the arm’s length principle in respect of the residual profit split as it applies to marketing intangibles. The OECD reported that this proposal’s strongest advocate is the United States.
- Proposal 3 (significant economic presence): Retention of the existing system but with a revision to nexus rules in certain instances. If there is a significant economic presence (i.e., if there are sales exceeding a certain threshold), the market jurisdiction would be able to exercise taxing rights over those sales (for instance, through a significant economic presence (SEP)). This Proposal may require an explicit deviation from the arm’s length principle as existing profit allocation rules would be unable to allocate meaningful profits to a SEP permanent establishment. This proposal’s strongest advocates are India and Colombia. It also has the support of many developing countries because it is seen as the easiest to administer and implement.
- Pillar 2 (completion of work from BEPS)
- Proposal 4 (minimum taxation): Development of additional rules designed to allow a minimum level of taxation in the jurisdictions of source and residence. This is similar to the GILTI regime in the United States. Three possible options include:
- Full or partial inclusion rules—residence countries including untaxed or low-taxed income derived from source countries.
- Tax on base eroding payments—rejecting the deductibility of a wider range of transactions (e.g., excessive royalties).
- Coordination rules—rules to eliminate or mitigate the risk of double taxation.
- Proposal 4 (minimum taxation): Development of additional rules designed to allow a minimum level of taxation in the jurisdictions of source and residence. This is similar to the GILTI regime in the United States. Three possible options include:
The OECD reports that this proposal’s strongest advocates are France and Germany. Proposal 4 is independent of Proposals 1–3; in other words, Proposal 4 may be the entire solution or may simply complement Proposals 1–3.
These solutions are intended to be further developed with a report due by May 2019 and then to be presented to the meeting of G20 Finance Ministers in June 2019.
The OECD acknowledged the degree of “multinational nervousness” over the possible explicit deviation from the arm’s length principle, the potential for double taxation, and the need for more effective dispute resolution mechanisms. It also acknowledged the views expressed by particular countries, especially China, that the rules need to provide a greater degree certainty to tax administrations and taxpayers.
KPMG observation
The proposals being put forward could affect all businesses, going well beyond the highly digitalised "platform" business models on which so much attention has been focused in recent years. New rules would apply in place of current international tax rules, from physical presence permanent establishment (PE) to the traditional transfer pricing arm’s length principle, for in-scope enterprises. In view of the 18 months set between the June 2019 G20 meeting and the end-of-2020 completion date, OECD officials have observed that the task is bigger than the BEPS project, and with less time.
Read a January 2019 report prepared by the KPMG member firm in Australia
Read a January 2019 report prepared by the KPMG member firm in China
Read a January 2019 report prepared by the KPMG member firm in Ireland
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