Tax developments in the digital economy
By Gavin Gafan, Senior Tax Manager and Vickram Khatwani, Associate DirectorTax, Deloitte Limited
In 2019 Gibraltar joined the Organisation for Economic Cooperation and Development (OECD) Inclusive Framework (the ‘Inclusive Framework’) on Base Erosion and Profit Shifting (BEPS). The OECD’s BEPS Project, sponsored by the G20, sets out to create a set of international tax rules to address base erosion and profit shifting, thus aiming to protect tax bases of jurisdictions while offering increased certainty to taxpayers.
Back in 2013, the strategy behind BEPS was set out in a 15-point Action Plan to address base erosion and profit shifting along three key areas, being the introduction of coherence in domestic rules that affect cross-border activities, the reinforcement of substance requirements in existing international standards, and the improvement of transparency as well as certainty.
Since the release of the BEPS Action 1 Report in 2015, addressing the tax challenges raised by the digital economy has been one of the main priorities of the Inclusive Framework.
To this effect, in 2019, member countries of the Inclusive Framework agreed to assess proposals to address the challenges arising from digitalisation in the form of two pillars:
- Pillar One addresses the allocation of taxing rights between jurisdictions and considers several proposals for new profit allocation and taxable presence (nexus) rules.
- Pillar Two proposes a set of interlocking international tax rules designed to ensure that large multinational businesses pay a minimum level of tax on all profits in all countries.
In October 2020, two detailed ‘Blueprints’ on these pillars were released in relation to the ongoing work by the OECD however these are currently still undergoing review. A summary of Pillar One follows.
Pillar One seeks to achieve a global consensus for new businesses through the adaptation of current rules for allocating taxing rights and nexus rules applicable to business profits. The goal is to expand the taxing rights of market jurisdictions where businesses have active and sustained presence in the economy through activities carried out within, or remotely directed at, said jurisdictions.
Pillar One also seeks to improve tax certainty through the introduction of mechanisms on dispute prevention and resolution.
To achieve these objectives, Pillar One contains three components:
(i) a proposed new taxing right allocating a share of global residual group profit to market jurisdictions using a formula-based approach, irrespective of local physical presence in said jurisdictions (Amount A);
(ii) a fixed return for defined ‘baseline marketing and distribution functions’ (Amount B);
(iii) processes to improve tax certainty through effective dispute prevention and resolution mechanisms.
(i) Amount A
The OECD Blueprint identified two main groups of businesses which can participate in an ‘active and sustained’ manner in the economy of a market jurisdiction, irrespective of local physical operational presence – these two groups would be in scope of Amount A.
- Automated digital services (ADS): these businesses generate income from remote services to a global customer base. The Blueprint on Pillar One sets out an indicative non-exhaustive list of in-scope services, which includes but is not limited to online advertising services, digital content services, online gaming and cloud computing services.
- Consumer-facing businesses (CFB): these businesses (including those operating through third-party intermediaries) generate revenue from the sale of good/services commonly sold to individual consumers and/or businesses that license or otherwise exploit intangible property connected to such goods/services.
A jurisdiction will be entitled to an allocation of Amount A if either an ADS or CFB nexus exists in that jurisdiction.
Some activities however are excluded in the Blueprint and therefore, if agreed, would fall out of scope of Amount A, including but not limited to certain natural resources, certain financial services and the construction, sale and leasing of residential property. There are also thresholds (the quantum of which is yet to be confirmed) applicable to multinational groups for Amount A to apply. It remains to be seen whether the Blueprint scope, which has been difficult to define and agree, is ultimately agreed by governments. The US Administration, in particular, is keen for the scope to be less targeted to types of activity and instead focussed on revenues and profitability of a smaller number of the very largest global multinationals.
The Blueprint sets out detailed rules on revenue sourcing to market jurisdictions and tax base determination.
(ii) Amount B
Amount B seeks to standardise the remuneration of related party distributors that perform ‘baseline marketing and distribution activities’ to simplify transfer pricing administration. Amount B potentially applies to all business sectors and is not subject to scope limitations. A fixed return commensurate with the arm’s length principle is proposed, the quantum of which is likely to be based on a comparable company benchmarking analysis.
For administrative ease and to limit disputes of what is in scope of Amount B, the Blueprint assumes that Amount B would apply to a number of in-scope activities as defined in a ‘positive list’ of typical functions performed, assets owned and risks assumed.
(iii) Tax certainty
For the purpose of increasing tax certainty for businesses and tax authorities, several measures are proposed. For Amount A, a binding dispute prevention process would be made available to businesses – this process will include a review panel as well as a determination panel to provide mandatory and binding outcomes.
Rules in respect of Amount B will be designed to limit potential for disputes, nevertheless mandatory binding dispute resolution mechanism will be available.
World economies are becoming ever more digitalised and businesses continue to transcend international borders. Accordingly, the proposals in respect of Pillar One heralds significant changes to the global tax landscape and its effects are expected to be far reaching. It is therefore important for businesses to monitor these developments to assess the potential impact of these proposals.
Whilst the Blueprints have been subjected to a public consultation process, there continues to be areas where the Inclusive Framework countries are not yet aligned, and substantial continued efforts are envisaged for a high level agreement to be reached in 2021.
In the absence of consensus, countries may still introduce elements of the OECD Pillars into domestic legislation, which, in the absence of a treaty between relevant jurisdictions, could result in a rise in double taxation and additional administrative burdens for tax authorities globally.