With a new administration in place in the United States, fundamental changes to the way certain businesses in the digital economy are taxed around the world may be agreed upon this year. Here, we summarise what these proposed reforms will encompass.
Addressing the tax challenges of the digital economy is one of the cornerstones of the OECD's base erosion and profit shifting (BEPS) project, which is a coordinated attempt by countries to adapt tax codes often designed in the early 20th century to the world of globalised and increasingly digitalised commerce. In short, these changes seek to tax companies that derive substantial revenues in a given country but which have little or no physical – and therefore taxable – presence there.
A Two-Pronged Approach
The 137 countries of the BEPS 'Inclusive Framework' have split the work in this area into two streams, known as pillars one and two.
Pillar One is focused on new "nexus" and profit allocation rules to ensure that the allocation of taxing rights concerning business profits no longer depends on a company's physical presence in a particular jurisdiction.
According to the OECD's Pillar One blueprint released in October 2020, the new nexus rules would be based on indicators of "a significant and sustained engagement with market jurisdictions."
Pillar Two is concerned with the introduction of a global minimum tax. This is intended to address the remaining concerns among the Inclusive Framework membership about profit shifting by highly digitalised businesses deriving much of their income from intangible assets. This will enable countries to utilise a range of rules to ensure that such income is taxed effectively.
The United States
It was originally intended that the Inclusive Framework would seek to agree on the details of these new rules by the end of 2020. This timetable slipped when the COVID-19 pandemic hit. However, a potentially more serious blow came in mid-2020 when the US withdrew from part of the discussions, arguing that the Pillar One approach unfairly discriminated against US companies and should be made effectively optional.
US participation in this global reform effort is surely crucial to its success. However, with the November 2020 election ushering in a new administration, the US stance on the Pillar One negotiations appears to have softened.
Following its February 19, 2021 meeting, the G7, which includes the US, issued a statement saying it would "strive to reach a consensus-based solution on international taxation by mid-2021." Further, OECD Secretary-General Angel Gurria said in a report to the G20 in February that a July 2021 agreement is possible with "very strong and positive messages from the new US Administration."
Despite the apparent change of heart in Washington, these important and far-reaching reforms are still subject to some uncertainty. There are many voices at the table and the US may yet harbour reservations about Pillar One given that the most affected companies are likely to be based in America. An agreement by July is therefore not guaranteed.