Tax Challenges of the Digitalisation of the Economy – new OECD work programme

On 31 May 2019, the OECD published its programme of work for developing a solution to the tax challenges arising from the digitalisation of the economy (Programme of Work). The Programme of Work will explore technical issues in line with the ‘two-pillar’ approach set out in the OECD policy note of 29 January 2019 (see our tax flash here) and the OECD public consultation document of 13 February 2019 (see our tax flash here). Pillar One seeks to develop new profit allocation rules. Pillar Two focuses on achieving a minimum income taxation for multinational enterprises (MNEs). The Pillars go beyond the taxation of digital services and BEPS recommendations. The OECD aims at reaching a consensual solution by 2020.

Pillar One: Quantification of profit allocation and revised nexus rules

Pillar One aims to allocate more profits to the ‘market jurisdictions’ (New Taxing Rights). The OECD has been considering three policy alternatives on how income should be allocated among countries, based on (i) user participation, (ii) marketing intangibles, and (iii) the ‘significant economic presence’.

The OECD currently considers three different methods to quantify the profitssubject to the New Taxing Rights and their allocation among the jurisdictions:

  1. a Modified Residual Profit Split Method that would allocate to market jurisdictions a portion of an MNE’s non-routine profit (which is not recognised under the current profit allocation rules);
  2. a Fractional Apportionment Method, allocating profits based on a formula that may consider relevant factors such as employees, assets, sales and users; and
  3. Distribution-based approaches that could consider both non-routine and routine profits arising from activities associated with market and distribution.

The Programme of Work also aims at developing a new non-physical presence nexus rule that may involve either (i) amending the existing definition of permanent establishment in Article 5 of the OECD Model Convention, or (ii) developing a standalone taxable presence or source income rule.

Pillar Two: The Global anti-Base Erosion (GloBE) proposal

Pillar Two entails two measures aimed at reducing the incentive to shift profits to low-tax jurisdictions and effectively achieving a minimum taxation on MNE income, with no indication yet on the minimum tax rate.

  • An income inclusion rule that would operate as a minimum tax by including the income of a foreign branch or controlled entity in the tax base of the controlling taxpayer if that income was not effectively taxed at a minimum rate. This rule would be more far-reaching than traditional CFC rules. The Programme of Work in particular considers a top up to a minimum (fixed) rate. It also contemplates a so-called switch-over rule for tax treaties allowing the state of residence to apply the credit method instead of exemption in certain situations.
  • A tax on base eroding payments, which would effectively (i) deny the deduction of payments to a related party if that payment was insufficiently taxed beforehand and (ii) introduce a subject to tax rule that would grant tax treaty benefits only if the beneficiary is “sufficiently taxed” in the other treaty jurisdiction.

The OECD acknowledges the need to explore possible carve-outs for regimes compliant under Action 5 on harmful tax practices or other substance-based carve-outs. It also acknowledges the need to consider the compatibility of these rules with the non-discrimination provisions in tax treaties as well as their interaction with the EU fundamental freedoms.

Next steps

G20 leaders are expected to endorse the Programme of Work at their 8-9 June 2019 meeting. By January 2020, the members of the BEPS Inclusive Framework are expected to agree on fundamental issues (such as options to be pursued under Pillar One, or the interaction between the two Pillars) with the aim to deliver a final report with the consensus-based solution by the end of 2020.  

If the OECD does not achieve a reform of the international tax system, companies should expect EU Member States to further seek agreeing on and implementing EU-wide measures inspired by the OECD options.

It is recommendable for companies in all economic sectors to monitor proposed reforms and assess the impact of the proposals as laid down in the Programme of Work.