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KPMG report: OECD’s digital economy project, implications beyond the digital economy

KPMG report: OECD’s digital economy project

The Organisation for Economic Cooperation and Development (OECD)/G20 “Inclusive Framework” on base erosion and profit shifting (BEPS) is considering several proposals to develop a consensus-based solution to address the tax challenges arising from the digitalization of the economy. The outcome may affect multinational entities (MNEs)—regardless of their involvement with or use of a digitalized business model.


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This report (a version of which was published in the “International Bureau of Fiscal Documentation” (IBFD), authored by KPMG tax professionals Doreen Liu, Jaap Reyneveld, and Charlotte Straatman) discusses the environment in which these proposals were developed and considers potential perspectives and implications for countries and for MNEs.

New taxing right

Tax challenges related to the digitalization of the economy have been a top priority for several jurisdictions. To address these challenges, the OECD/G20 BEPS Inclusive Framework is considering several proposals that are organized into Pillar One proposals and Pillar Two proposals.

The Pillar One proposals discuss the possibility of introducing a “new taxing right” that would aim at allocating more profits and more taxing rights to market jurisdictions.

  • This new taxing right would not be limited based on physical presence. It would go beyond the arm’s length principle, and would be based on a new type of nexus and on new profit allocation rules.
  • The new profit allocation and nexus rules could supersede or could continue to apply in conjunction with the existing rules.
  • The total amount of group profit to be re-divided among related parties would remain the same, and the new taxing right is not intended to result in double taxation. Therefore, what market jurisdictions gain, headquarters/entrepreneur/IP countries by definition lose. The Inclusive Framework is considering three proposals for new profit allocation rules, and explored new nexus rules.

The scope of businesses subject to the new taxing right still must be determined. The new taxing right could be ring-fenced and apply only to certain highly digitalized businesses—but it also could have a much broader reach. Thus, MNEs operating in various industries that are not necessarily associated with highly digitalized business could be affected.

BEPS Action 1—tax challenges of the digital economy

The BEPS Action 1 final report (October 2015) included an analysis of the tax challenges of the digital economy.

  • One conclusion was that because the digital economy is increasingly becoming the economy itself, it would be difficult (if not impossible) to ring-fence the digital economy from the rest of the economy for tax purposes.
  • The Taskforce on the Digital Economy (TFDE) examined three options (none of which was recommended at the time):
    • A new nexus in the form of “significant economic presence” for net-basis taxation with deemed profit attribution methods
    • Application of a withholding tax on certain types of digital transactions
    • An equalization levy

While there were no recommendations made, it was noted that countries could introduce these measures in their domestic law to address BEPS issues for the short term and to gain practical experience that could help “coordinated domestic law approaches and [inform] possible future discussions.” Since then, some countries have introduced or have announced that they plan to introduce unilateral measures.

Among these unilateral initiatives are digital permanent establishments, permanent establishments based on significant economic presence, and a “digital services tax” that is targeted at certain highly digitalized business models and levies a tax on in-scope revenues.

While these unilateral initiatives may share certain commonalities, they also present challenges for taxpayer compliance as well as the possibility of double taxation if there is no tax credit for the digital services tax in the counterparty jurisdiction.

During their meeting in March 2017, the G20 finance ministers renewed the mandate of the TFDE to deliver an interim report by April 2018 and a final report in 2020.

Interim report (March 2018)

The 2018 interim report (March 2018) contains the Inclusive Framework’s agreed “direction of work” on digitalization through to 2020, and explores the implications of digitalization on business models and value creation.  The report identified three characteristics frequently observed in certain highly digitalized business models:

  • Cross-jurisdictional scale without mass. Digitalization allows businesses to “scale” globally across different countries and be involved in the economic life of these countries without having significant physical presence (“mass”) in these countries. As a result, enterprises can, for example, generate sales or data from many countries without having a taxable presence in these countries for income tax purposes.
  • Reliance on intangible assets, including intellectual property. Digitalized enterprises rely heavily on intangible assets (including software and algorithms), and realize revenue from investments in these intangibles through creating or leasing them. Development, enhancement, maintenance, protection and exploitation (DEMPE) functions for the creation of these intangibles may be located in, for example, one jurisdiction and result in the allocation of a large part of the profit (and thus taxing rights) to this one jurisdiction.
  • Data, user participation and their synergies with intellectual property. Data and user participation are common characteristics of digitalized businesses, but there was no agreement regarding when, where, and to what extent data and user participation represent a contribution to value creation by the enterprise.

These characteristics—while applicable for highly digitalized business models—are not exclusive or unique to digitalized business models, and thus give rise to doubts of certain countries in the Inclusive Framework as to whether it is possible to find a ring-fenced solution (i.e., an approach that limits its scope to the typical multinationals that the public associates with the digital economy).   

Read TaxNewsFlash

Inclusive Framework releases policy note and announces Pillar One and Pillar Two proposals (January 2019)

The Inclusive Framework earlier this year released a policy note stating that there was an agreement to explore proposals involving two pillars:

  • Pillar One—to address the broader challenges of the digitalized economy, and to focus on the allocation of taxing rights through revised profit allocation rules and revised nexus rules. The Pillar One proposals would allocate more taxing rights to market or user jurisdictions based on an allocation concept that goes beyond the arm’s length principle and a nexus concept that does not require physical presence. The Inclusive Framework recognized that the Pillar One proposals may affect not only highly digitalized businesses but could affect a much broader group of enterprises with cross-border business operations.
  • Pillar Two—to address the remaining BEPS risks of profit shifting to entities subject to no or very low taxation through anti-BEPS rules, including an income inclusion rule and a tax on base-eroding payments. This proposal would introduce taxing rights for jurisdictions to tax profits when the other jurisdiction with taxing rights applies a low effective tax rate to those profits.

Read TaxNewsFlash

Public consultation document and meeting (March 2019)

The public consultation document requested comments from stakeholders on policy and technical aspects on certain high-level proposals.  Some 200 written comments were submitted and discussed at the public consultation meeting in March 2019. Read TaxNewsFlash

Programme of work (May 2019)

The Inclusive Framework in May 2019 released a “Programme of Work” that sets forth a roadmap to finding a consensus-based solution and described several proposals on new profit allocation and nexus rules.

Read TaxNewsFlash

What’s next?

At present, it appears the OECD intends to hold another public consultation later this year, as early as in the fall of 2019.  The Inclusive Framework aims to agree on the outlines of the architecture and to reduce the number of proposals on new profit allocation and nexus rules by January 2020, and to deliver a consensus-based unified solution with a final report by the end of 2020.

KPMG observation

The focus of the discussion on the tax challenges of the digitalization of the economy—referred to as “BEPS 2.0”—is different from discussions that have taken place in the context of the BEPS action plan, which focused on measures to address instances of tax avoidance and double non-taxation. The starting point of the BEPS action plan was to continue applying the arm’s length principle as the basis for profit allocation; however, BEPS 2.0 does not necessarily consider the arm’s length principle as the “holy grail” for profit allocation. Rather, BEPS 2.0 explicitly focuses on the re-allocation of the taxable base of MNEs among jurisdictions.

What would countries want to consider? Some jurisdictions may have a clear interest in developing new taxing rights under BEPS 2.0 that would allocate more profits generated by consumers within their borders that use services or buy products from MNEs that may have limited or no physical presence in their country.  Other countries where MNEs have located their headquarters may have an interest in limiting the impact of any new taxing right, because these countries would want to reap the benefits of the investment and market risks undertaken by the headquarters/entrepreneur entities resident in their country. Developing countries may have the perspective that any new taxing approach should be simple and administrable given their limited resources to enforce the taxing rights in their country.

MNEs need to be aware there could be some “cost” to gaining certainty in the current global tax landscape (i.e., the greater taxing rights in market jurisdictions could increase MNEs’ global tax burden). However, for the highly digitalized MNEs that are targeted by the digital services taxes, a failure of jurisdictions to reach a consensus solution may be much less preferred. MNEs are generally seeking a solution that is simple to execute, does not entail uncertainty, and does not lead to double or multiple taxation. In the meantime, MNEs need to understand the possible implications of the proposals, and begin to assess and examine the impact of the proposals on their businesses.


For more information, contact a KPMG tax professional:

Doreen Liu | +1 (973) 912-6507 |

Jaap Reyneveld | +318890 91114 |

Charlotte Straatman | +318890 91869 |

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