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OECD: Public consultation of tax challenges of digitalisation, March 2019

OECD: Public consultation, March 2019

The Organisation for Economic Cooperation and Development (OECD) will on 13 and 14 March 2019 hold a public consultation meeting to consider possible solutions to the tax challenges arising from digitalisation of the economy.

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As noted in the OECD release, the OECD is seeking public comments on key issues identified in a public consultation document [PDF 560 KB] with respect to possible solutions to the tax challenges arising from the digitalisation of the economy. This is part of the ongoing work of the Inclusive Framework on base erosion and profit shifting (BEPS).

In advance of the publication of the consultation document, the OECD in January 2019 released a “policy note” reflecting the agreement of members of the Inclusive Framework to examine proposals under two “pillars”—one that focuses on the allocation of taxing rights and a second pillar that addresses remaining BEPS issues. Read TaxNewsFlash

Several proposals have emerged that could form part of a long-term solution to the broader challenges arising from the digitalisation of the economy and the remaining BEPS issues. Work on these proposals is being conducted on a “without prejudice” basis—that is, this does not represent a commitment of any member of the Inclusive Framework beyond exploring these proposals. In this context, the Inclusive Framework is holding the March 2019 public consultation on possible solutions to the tax challenges arising from the digitalisation of the economy with an objective of affording external stakeholders an opportunity to provide input in the process. Comments on the consultation document are due by 1 March 2019.

KPMG observation

The OECD consultation paper on taxing the digital economy includes proposals that would affect almost all taxpayers, given that the OECD proposals are far-reaching and will change the international tax landscape if they are accepted in a final consensus. The consultation paper follows the general structure of the OECD’s high-level policy note published on 29 January 2019, but includes more detail on the various proposals being explored by the Inclusive Framework.  The OECD is still aiming for a consensus proposal by 2020.

The publication of the consultation document marks the start of a four-week consultation process (as noted above, written comments from interested parties due by 1 March 2019 to be followed by a public consultation in Paris on 13 and 14 March 2019). Attendees at the public consultation will be drawn from the pool of stakeholders who submit written comments by 1 March. 

Overview of consultation paper

The consultation paper has three sections:

Section 1 gives an overview of the journey since BEPS Action 1, and restates many of the common themes that the OECD has returned to throughout the evolving debate in this space, including:

  • The conclusion that it is not possible to “ring-fence” the digital economy
  • The assertion that highly digitalised businesses often display "scale without mass," rely heavily on intangibles, and generate value from data and user participation in a manner that is not captured by the existing international tax architecture.

Section 2 sets out three proposals that the Inclusive Framework is discussing in the context of re-examining the existing rules on nexus and profit allocation:

  • The “user participation” proposal
  • The “marketing intangibles” proposal
  • The “significant economic presence” proposal

Section 2 compares the three proposals, then looks at a series of important design considerations including scoping, the determination (and allocation) of profits, and the elimination of double taxation.  While the consultation paper does expand on the information contained in the 29 January 2019 policy note, the three proposals are still somewhat embryonic and will need further analysis and fleshing out by the OECD (in particular, the “significant economic presence” proposal, which is where the OECD’s thinking seems to be the least advanced).

Section 3 sets out a “global anti-base erosion” proposal, which is intended to address the perceived risk of diversion of profits to low (or no) tax jurisdictions.  This proposal comprises two elements:

  • An income inclusion rule;
  • A tax on base eroding payments.

The paper makes it clear that both sets of proposed new rules would operate broadly—they would apply not only to intangible property returns, but also to other mobile forms of income (such as cross-border financing), and perhaps even more broadly. The paper also includes high-level options on coordination rules that would ensure the Section 3 proposals interact as intended and do not overlap in a way that creates double taxation.

As with Section 2, the proposals in Section 3 are positioned as needing significant work around design and implementation. 

Looking further at Section 2

The three proposals under Section 2 all have the same over-arching objective, which is to recognise, from different perspectives, value created by a business’s activity or participation in user/market jurisdictions that is not recognised in the current BEPS framework for allocating profits.

The “user participation” proposal

Soliciting the sustained engagement and active participation of users is considered to be a critical component for some highly digitalised businesses. The existing tax framework is perceived to ignore (and as such, not tax) the value that certain business models derive from user participation.

This proposal seeks to revise the profit allocation rules to accommodate the value creating activities of an active and engaged user base and crucially dismisses the idea that the application of the arm’s length principle would be sufficient. Instead a more formulary approach would be applied using the profit split method. For instance, a pre-determined percentage may be applied to the non-routine profits of a group which would carve out a proportion to be allocated and taxed between jurisdictions where users are resident regardless of physical nexus.

The “marketing intangibles” proposal

This proposal is similar to the user participation proposal but rather than focusing on highly digitalised business models, it is broader in scope. This proposal considers that the BEPS Actions 8-10 did not go far enough in addressing the shifting of income that may still be accomplished by exercising a degree of decision making outside of the market jurisdiction.

In other words this proposal targets limited risk distribution models. It links marketing intangibles with the market jurisdiction, and emphasises that a proportion of the non-routine profits generated by a multinational enterprise (MNE) group would be attributed to marketing intangibles, thereby ensuring that an element of non-routine profit is taxed in every market jurisdiction. The allocation of some or all non-routine returns from marketing intangibles would apply regardless of legal ownership or DEMPE analysis of the functions relating to those intangibles.

The “significant economic presence” proposal

This proposal considers that a taxable presence in a jurisdiction would arise when a non-resident enterprise has a significant economic presence on the basis of factors that evidence a purposeful and sustained interaction with the jurisdiction via digital technology and other automated means. Revenue generated on a sustained basis combined with other factors would establish nexus in the form of a significant economic presence in the country concerned. These additional factors (six were identified) may include the existence of a user base and the associated data input, the volume of digital content derived from the jurisdiction, and the maintenance of a website in a local language.

Therefore while all three proposals have a global approach to the determination of profit, the first two proposals have more in common, and as mentioned above, are fleshed out more in the paper. Comments are requested on the policy, technical and administrability issues raised by each of the three proposals described above.

Income inclusion rule

The income inclusion rule would supplement (rather than replace) existing CFC rules, and would operate as a minimum tax.  It would apply in the context of overseas subsidiaries and overseas permanent establishments.

In the case of overseas subsidiaries, the rule would require a shareholder in a corporation to bring into account a proportionate share of the income of that corporation if the income has not been subjected to an effective tax rate of a minimum specified rate (to be agreed as part of the design process).  In the case of overseas permanent establishments, the rule would switch off the benefit of existing income exemption rules in the head office, replacing them with credit systems.

The paper indicates that the income inclusion rule will apply both to domestic and to overseas subsidiaries (presumably in order to address considerations around discrimination and (in an EU context) freedom of establishment and free movement of capital), and mentions that it will draw from certain aspects of the new U.S. tax regime for taxing global intangible low-taxed income (GILTI).

Tax on base eroding payments

This proposal comprises a rule to address so-called “undertaxed payments” and a rule to address situations where the recipient of a payment is not subject to tax.

The undertaxed payments rule would deny deductions for certain defined categories of payments (to be determined), when the recipient of the payment is not subject to a minimum effective tax rate in its jurisdiction.  The rate would be determined as part of the consultation process, and would take into account withholding taxes suffered in connection with the payment in question.  The paper also proposes that the undertaxed payments rule would cover “conduit” and “imported” arrangements (which have become familiar in the context of the BEPS Action 2 implementation around hybrids), and seems to position the rule as a complementary measure to the income inclusion rule.

The subject to tax rule would operate to disallow treaty benefits in situations where undertaxed payments would otherwise be eligible for relief under a double tax treaty.  The paper proposes that this would apply to the following provisions of a double tax treaty (using the OECD model treaty numbering convention):

  • Article 7 (Business profits)
  • Article 9 (Associated enterprises)
  • Article 10 (Dividends)
  • Articles 11 – 13 (Interest, Royalties, and Capital Gains)
  • Article 21 (Other income)

KPMG observation

The content of the paper is largely as anticipated, and provides further information about how the OECD’s view is starting to evolve in relation to the various moving parts in play.  However, a significant amount of information is still needed—not least of all in relation to the potential administration and compliance burdens of these new rules, and the way in which disputes will be resolved in a cross-border context.  Interested parties need to consider submitting their observations directly to the OECD by 1 March 2019, and taxpayers need to continue to monitor developments closely over the coming weeks.

 

Read a February 2019 report prepared by the KPMG member firm in the UK

Read a February 2019 report prepared by the KPMG member firm in China

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