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OECD work plan on taxing digital and global profits approved

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Tax Hot Topics newsletter The Organization for Economic Co-operation and Development (OECD) released the Program of Work to Develop a Consensus Based Solution to the Tax Challenges Arising from the Digitalization of the Economy on May 31. The work plan was agreed to by the Inclusive Framework on Base Erosion and Profit Shifting (BEPS) and presented to the G20 Finance Ministers meeting in Japan on June 8 and 9. 

 The Finance Ministers endorsed the approach of the work plan to develop a consensus based solution by the end of 2020. Given recent unilateral approaches to digital taxation by several jurisdictions, including the EU, the UK, France, New Zealand, Italy, Austria, and Spain, a common framework is critical in avoiding possible double taxation. These proposals would significantly change the way in which global companies are taxed and could be effective as early as 2021. 

The tax challenges of digitalization of the economy was addressed in the 2015 BEPS report in Action 1, where the tax challenges of the digital economy where described and it was indicated that it would be almost impossible to ring fence the tax aspects of the digital economy.    

In January 2019, the OECD released a policy note that proposed a plan to start to address the tax challenges of the digital economy. The policy note presented a two pillar approach which was suggested as a way to move forward in an agreed upon methodology. Pillar one focused on the allocation of taxing rights of countries including a review of profit allocation and tax nexus rules to match taxing rights with value creation. Pillar two addressed remaining issues with a focus on the development of tax rules that would provide jurisdictions the right to tax profits in other jurisdictions that have a low effective tax rate or have not exercised their taxing rights. 

The work plan reaffirms the two pillar approach with an expanded approach and presents alternatives to implement each pillar and how they would interact and suggested an aggressive timetable to agree on final architecture by January 2020 with a final solution by the December 2020. It is important to note both pillar one and two go beyond high tech and digital companies and present a global approach of taxation that would be relevant to all companies. 

The first pillar address new profit allocation and nexus (permanent establishment) rules. Under these rules more taxing rights and profits would be allocated to the jurisdiction of the customer or user (market jurisdiction) where value is created by business activity through actual or remote participation in that jurisdiction that is not currently recognized under the existing tax framework for allocating profits. Under pillar one, the amount of profit to be reallocated to market jurisdictions would be quantified and a method would be determined how these profits would be allocated to each market jurisdiction. These new allocation rules would take into account 1) establishing a taxable nexus in the absence of physical presence, 2) allocating more taxing rights to the jurisdiction of the customer and/or user, and 3) using simplified conventions to reduce compliance costs and disputes.

New potential allocation rules consist of:

  • A modified residual profit split, where a portion of the non-routine profit that reflects the value created be allocated to the market jurisdiction
  • A fractional apportionment method where profit ( both routine and non-routine) would be allocated to market jurisdictions using allocation keys such as sales, employees, users, and assets which would give rise to formulary apportionment
  • A distribution-based approach which would allocate more profits to market jurisdictions through evaluating both routine and non-routine profits from marketing, distribution and user-related activities.

Additionally, new nexus rules would include guidelines regarding have a remote taxable presence (taxable presence without a physical presence) in which market jurisdictions would tax their allocated profits under the new profit allocation rules. This would require amending the definition of permanent establishment in Article 5 and 7 of the OECD Model Convention and changes to existing tax treaties including the Multi-Lateral Instrument. 

Options will also be explored to minimizing issues related to double taxation and dispute resolution. 

The second pillar addresses the remaining base erosion issues through developing rules that would give taxing jurisdictions the right to tax profits where other jurisdictions have not exercised their primary taxing rights or the profits are taxed at a low effective tax rate. Under this pillar a new global anti-base erosion (GloBE) which is designed to address situations where profits are shifted to zero or low taxed jurisdictions. The GloBE proposal goes beyond just addressing intangible profits but is broadly based to encompass low tax profits in any jurisdiction regardless of the type of income earned. It proposes a solution designed to ensure that all global businesses pay a minimum level of tax. The proposal suggest the following approaches:

  • An income-inclusion rule that would tax the income of a foreign branch or controlled subsidiary if the income was subjected to an effective tax rate below a minimum rate. A switch-over rule would also be developed in the case of profits that are attributable to exempt foreign branches to allow foreign tax credits.
  • A tax on base eroding payments that would deny a deduction or impose a tax (including a withholding tax) for certain payments to related parties unless the payment was subject to a minimum tax.

This pillar would also require changes to existing double tax treaties.

The goal of the workplan is to have a consensus agreement by the end of 2020. Key milestones outlined by the OECD along the way are:

  • July 2019 Inclusive Framework meetings and agreement
  • December 2019 Progress report
  • January 2020 Political agreement on framework
  • Throughout 2020 Detailed technical work
  • December 2020 Final report

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Partner
Washington National Tax Office 
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David Zaiken
Managing Director
Washington National Tax Office 
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Cory Perry
Senior Manager
Washington National Tax Office 
T +1 202 521 1509

Mike Del Medico
Manager
Washington National Tax Office 
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