As part of its follow-up work on tackling tax base erosion and profit shifting, the OECD has released its proposals for a rethink to international tax rules to enable countries to capture more tax from companies operating in the digital sphere.
The OECD's digital tax work is divided into two pillars. Under the first pillar, the proposals would bring about a huge shake-up to the current rules that allocate how taxing rights are divided out among territories, and bring more digital activities within the charge to tax.
Under the pillar two proposals, the OECD has set out rules that would ensure that multinational companies cannot use structures to pay little or no tax on their worldwide earnings. The proposal would subject their income to at least a minimum level of tax, wherever that may be.
The proposals under pillar one would overhaul international tax rules to allow market economies to capture tax from digital businesses regardless of whether they have physical operations in a territory. In particular, the changes will have broad implications for very large "consumer-facing" businesses that engage their users through the internet.
Currently, a non-resident company is taxable in a jurisdiction on its business profits only if it has a permanent establishment there. That means having some form of physical presence. Digitalisation has strained the applicability of this rule, the OECD said, as companies can increasingly do business with customers in a jurisdiction without having a physical presence there. The proposals are intended to fix these shortcomings.
The OECD has proposed changes to current "nexus rules", which determine the connection a business has with a given jurisdiction and the rules that govern how much profit should be allocated to the business conducted there. Specifically, the proposal put forward by the OECD would tie tax liability more to activities in a market economy, while looking also at a group's marketing activities and digital engagement activities elsewhere.
According to the OECD, its proposal – the "Unified Approach" – would retain the current rules based on the arm's length principle in cases where they are widely regarded as working as intended but would introduce formula-based solutions in situations where tensions have increased – notably because of the digitalisation of the economy.
Releasing the proposals, the OECD said:
"In a digital age, the allocation of taxing rights can no longer be exclusively circumscribed by reference to physical presence. The current rules dating back to the 1920s are no longer sufficient to ensure a fair allocation of taxing rights in an increasingly globalised world."
"It is also true that a number of the proposals that have already been made to address highly digitalised businesses fail to capture significant parts of the digitalised economy (such as digital services and certain high-tech businesses)."
"The Secretariat's proposal is designed to address the tax challenges of the digitalisation of the economy and to grant new taxing rights to the countries where users of highly digitalised business models are located. However, the approach also recognises that the transfer pricing and profit allocation issues at stake are of broader relevance."
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Under pillar two of its digital tax work, the OECD has proposed two sets of interlocking rules, designed to give jurisdictions a remedy in cases where income is subject to no or very low taxation. This work under pillar two considers a proposal that income should be subject to at least a minimum tax rate.
This work is intended to mitigate the use of low-tax territories by multinationals to avoid much of their income being subject to tax in higher-tax states, typically achieved by locating intangibles in a low-tax territory and saddling entities in high-tax territories with debt to create deductible interest expenses.
The OECD's "Global Anti-Base Erosion" or "GloBE" proposal is designed to give jurisdictions a remedy in cases where income is subject to no or only very low taxation. This would involve the introduction of a new effective tax rate test, which would also enable stakeholders to better determine in a harmonised way how much tax multinationals pay internationally.
The OECD's proposal is technically complex. In essence, its GloBE proposal would allow taxing rights to another state where a foreign branch or other controlled entity is subject to tax at below the effective rate (the "income inclusion rule"); or deny a deduction or impose tax at source (i.e. where the payment is made from) where the income received would be taxed at below the minimum rate.
The other two elements of the OECD's proposal would seek to either limit the availability of tax treaty benefits for income that would be subject to tax below the minimum rate in the jurisdiction in which that income is received, or by enabling more tax to be collected at source.
The OECD said:
"Like Pillar One, the GloBE proposal under Pillar Two represents a substantial change to the international tax architecture. This Pillar seeks to comprehensively address remaining BEPS challenges by ensuring that the profits of internationally operating businesses are subject to a minimum rate of tax."
"A minimum tax rate on all income reduces the incentive for taxpayers to engage in profit shifting and establishes a floor for tax competition among jurisdictions. In doing so, the GloBE proposal is intended to address the remaining BEPS challenges linked to the digitalisation of the economy, but it goes even further and addresses these challenges more broadly."
That minimum level of tax has yet to be agreed upon. Presently the OECD is in the initial stages of its work, developing its proposals with input from governments and business organisations and seeking to secure their support.