Taxation of the Digital Economy and pushing fiscal boundaries
There is widespread agreement that the international tax system needs reform to address the digitalisation of the global economy. Both the OECD and the EU published papers on this subject and the OECD subsequently released proposals on allocating profit to countries in which a multinational entity makes sales or derives value. The OECD also proposed the imposition of a global minimum rate of corporate tax. This is the OECD’s two-pillar approach, which is supported by the OECD/G20 Inclusive Framework on BEPS. On 12 October 2020 the OECD released draft blueprints of the technical aspects of the proposals under both pillars.
On 1 July 2021 the OECD through the Inclusive Framework announced broad based agreement – following a vast volume of technical work and discussion, though aspects of the proposals remain subject to political agreement as well as technical design. Over 130 members have now reached broad agreement – with an ambitious timeline to implement these new rules with effect from 2023. On 10 July 2021, the G-20 also backed the plan and tasked the Inclusive Framework with the momentous challenge of finalising the details and create an implementation plan by October 2021.
Whilst the announcement of 1 July 2021 is a positive step towards resolution, some of the statements are plastering over differences in opinion that still remain (e.g. the inclusion of a range on the amount of allocable profit for Amount A of Pillar 1, and references to a minimum tax rate of “at least” 15% under Pillar 2). The challenges of reaching political agreement on the reallocation of global taxing rights between territories under Pillar One, and the potential impact on jurisdictional tax sovereignty through the imposition of a global minimum tax rate under Pillar Two mean that many of the current proposals (particularly thresholds and tax rates) may still change before October.
Our Autumn 2020 ‘Rethinking the world tax system – the OECD and what a delay in global agreement may mean’, outlined how the delay to the OECD timeline for global agreement increased the likelihood of proliferation of unilateral measures and of possible shifts in tax authority behaviours. Since then, we’ve witnessed a further increase in the number of jurisdictions considering and introducing tax measures.
However, we now witness the European Union stating that it no longer plans to proceed with its digital levy at this time, and we expect it to stick to that commitment and instead refocus its efforts around, for example, the carbon border adjustment mechanism to raise own revenues for the EU Commission budget. It remains to be seen whether other countries follow the EU’s lead in rolling back on the introduction of, or accelerating the repeal of, digital levies, including DSTs. We expect many will wait until the OECD’s two-pillar approach is implemented into law, and even then, such levies may continue to be attractive mechanisms to raise revenue for developing economies.
The OECD’s announcement in early July is summarised in Two pillar deal on global business taxes set to go ahead.
The G-7 and G-20 have made commitments to provide international coordination to apply the proposed international tax rules, and to repeal the various unilateral measures that have proliferated in recent years. The EU’s recent statement is relevant here. It is assumed that the Inclusive Framework’s implementation plan for the two Pillar approach will have to set out how these have to be repealed by participating countries. Resolving the many outstanding issues by October 2021 seems a very ambitious goal. For example, it is the attitude of smaller countries, which may have less to gain as the proposals currently stand and face potential restrictions on their future ability to implement unilateral measures may form an insurmountable hurdle. Other important questions to resolve include the companies and sectors that would fall within the scope of the proposals, the thresholds that would apply for local administration, how the system would be policed, and how double taxation would be avoided.
Pillar One: Allocation of Taxing Rights
The OECD’s Unified Approach to Pillar One issues would give countries the right to tax profits of multinational enterprises (regardless of whether they have a base in a given country or not) based on calculating a new pot of profit in combination with enhanced dispute prevention and resolution mechanisms. This approach moves away from the long-established principle of “profit where the business has physical presence,” which has been the cornerstone of the international taxation framework, and represents arguably the most significant change in the international tax architecture in 100 years.
This proposal represents a reattribution of value to market jurisdictions where the revenues of a business are derived, coupled with an intended simplification of certain aspects of transfer pricing rules. The proposals initially focused on consumer-facing businesses and those providing automated digital services. However, the U.S. has called for the scope to be expanded to include businesses in all sectors, subject to a (potentially high) global revenue threshold. There appears to be increasing support for moving in that direction, in part as a matter of simplification and in part in recognition of the increasing digitalisation of the global economy.
Pillar Two: Global Anti-Base Erosion (GloBE) Proposal
The Pillar Two proposal is designed to prevent a so-called “race to the bottom” on global corporate tax rates, in an effort to reduce incentives for profit-shifting by multinationals to low- or zero-tax territories. This is particularly an issue with intangibles but is also seen more broadly in entities that generate profits from intragroup financing. This proposal would impose an effective minimum rate of tax on corporate activities. The G-7 communiqué suggests focus on a minimum corporate tax rate of “at least” 15%, but not all territories agree with that rate.
Our direct interaction with the OECD during and after the formal consultation process, along with views gathered to date from global business through our ongoing surveys, continue
s to provide insights. You can view BDO’s submissions to the OECD on Pillars One and Two as well as other subjects here.
The question of taxation of the digital economy remains politically sensitive, with different stakeholders holding different views. The U.S. wishes to broaden the scope of Pillar One to include companies in any industry, but to limit its reach, initially, with size and profitability thresholds. The U.S. is also advocating for the repeal of unilateral measures and the setting of a high bar for the global minimum tax rate. Meanwhile, the EU envisages potentially a more significant number of companies in scope for Pillar One, with a digital tax levy coexisting alongside the Pillar One and Pillar Two proposals. Developing nations feel they may stand to gain little from the proposals as currently drafted and want to ensure that they are able to participate fairly in the discussion of reattribution of taxing rights. Other territories use their corporate tax rate as an incentive to drive foreign direct investment to their economies, and therefore are concerned about the impact of a potentially high global minimum tax rate.
However, the OECD is under tremendous pressure to come to a consensus. There is some concern that if the timelines are not met, there could be a proliferation of domestic taxes on digital activities (see the BDO Global Tool) and trade wars. We will monitor the OECD activities in this regard and provide regular updates.
Leading Insights – highlights
BDO has been a leading commentator on the debate on the taxation of the digital economy, with our opinions on the subject featured extensively in Bloomberg Tax, Financial Times, The Wall Street Journal, The New York Times, Global Finance and more. .
- July 2021: OECD achieves broad based consensus in Two pillar deal on global business taxes set to go ahead. Followed by the G-20 backing of the plan, in mid-July, in G-20 backs G7 support for global minimum tax and new allocation rules - what's the real impact?
- June 2021: G-7 Finance Ministers Announce Support for Global Minimum Tax and New Allocation Rules, follows the announcement by G-7 Finance Ministers in early June 2021.
- November 2020: ‘Rethinking the world tax system – the OECD and what a delay in global agreement may mean’, outlines how the delay to the OECD timeline for global agreement increases the likelihood of the proliferation of unilateral measures and of possible shifts in tax authority behaviours. The Insight article is published in full by Bloomberg Tax as ‘The OECD and the ticking clock – what a delay in global agreement may mean’.
- October 2020: ‘OECD releases blueprints of digital tax plan’. Laurie Dicker, BDO US Transfer Pricing, Technical Tax Leader discusses what has been accomplished, what should businesses be doing now that these reports have been released, and what can we expect over the next months and into 2021?
- Rethink Transfer Pricing: BDO’s series of Transfer Pricing Insights into current transfer pricing issues. Perspectives from around the world that cover developments from tax authorities, other government agencies, judicial bodies, and the OECD. We explore how current economic and political conditions may impact transfer pricing structures and policies.
- February 2020 Update: following the statement by the OECD/G20 Inclusive Framework on BEPS (IF) issued at the end of January. There is a common international desire to find an international solution to this global challenge, but finding such a solution is not easy. The OECD Inclusive Framework includes 137 countries who believe change, in some form, is needed. We describe the areas of consensus. However, while there are some attempts to simplify the administration of a new Unified Approach, the price of consensus appears to be a creation of an increasingly detailed set of rules and therefore potentially increased complexity for businesses.
- BDO Global Tech & Media Watch Blog - March 2020: BDO US Tax partner David Yasukochi provides answers to how new rules on taxing the digital economy might affect your business
- BDO US Tax Outlook Survey - February 2020: a survey of senior tax executives at companies with revenues ranging from $100m to $3bn finds that understanding the impact of the ongoing OECD work on taxation of the digital economy is the #1 international tax concern, with 88% believing there should be an international framework in place.
- BDO's interview with the OECD on 3 December 2019: members of BDO's global Taxation of the Digital Economy Taskforce, were joined by Stewart Brant, head of Transfer Pricing at the OECD. Exploring key themes arising in particular from the Pillar 1 proposals, such as scope, threshold, avoiding double taxation, administration and timing, we shared early insights under consideration, and not then yet in the public domain.
- In BDO Canada's Cross-Border Tax Podcast Series, BDO Tax Partner Harry Chana, alongside BDO Cross-Border Tax professionals Rita Trowbridge and Dan McGeown, talk about BEPS, pillar two of the OECD, and the concept of substance in transfer pricing, and how they all impact businesses crossing the border.
- Tax Notes reporter Ryan Finely's summary of the OECD’s pillar 2 consultation draft and BDO’s Monika Loving provides her take on the proposal.
- Read BDO International Tax Partner, Ross Robertson’s initial response to the OECD announcement of 9 October, and a leading article, recently published by Bloomberg Tax which explores the issues further
- Robert Aziz, BDO Global Head of Tax, in an extract from a recent video interview below shares his perspective on What should a fair and workable global tax system look like in our modern global economy: