OECD consults on digital economy taxation

The OECD has followed up its January policy note on a long-term solution for taxation of the digital economy with a consultation document containing high-level proposals on policy design, based around the two broad areas of BEPS issues and profit allocation/nexus rules.

The deadline for comments is 6 March. These will feed into the inclusive framework’s final report to the G20 in June.

The consultation document again stresses that work on these proposals is being conducted on a ‘without prejudice’ basis and, as such, does not represent a commitment on the part of any member of the inclusive framework beyond this consultation.

The BEPS action 1 report in 2015 recognised that it would be difficult, if not impossible, to ‘ring-fence’ the digital economy from the rest of the economy for tax purposes because of its increasingly pervasive nature, while the inclusive framework’s interim report in March 2018 highlighted continuing issues around BEPS and the allocation of taxing rights.

On BEPS, some countries still had concerns that BEPS risks remain for highly mobile intangible income-producing factors which can be shifted into low-tax environments based on contractual allocations accompanied by a relatively modest level of decision-making capacity. This applies both to highly digitalised multinational groups as well as to those with more traditional business models.

On the allocation of taxing rights, three characteristics were frequently observed:

• ‘scale without mass’ impacts the distribution of taxing rights over time by reducing the number of jurisdictions where a taxing right can be asserted over a business’s profits;
• heavy reliance on intangible assets strains the rules for allocating income from intangible assets among different parts of a multinational group; and
• data and user participation pose challenges to the existing nexus and profit allocation rules, especially in situations where highly-digitalised businesses exploiting data and user-generated content have little or no taxable presence in the jurisdiction where users are located.

However, there were differences of opinion among OECD countries on the extent to which these issues should result in changes to international tax rules.

The January policy note followed the interim report in splitting the issues into the two broad groups: BEPS challenges; and profit allocation and nexus rules.

Section 2 of the latest consultation document contains proposals concerning the ‘broader tax challenges’ to the existing profit allocation and nexus rules, while section 3 concerns remaining BEPS issues, outlining two sets of rules which in effect give jurisdictions the right to ‘tax back’ profits that are taxed only at low effective tax rates.

Three proposals are outlined for revising the profit allocation and nexus rules.

Firstly, a ‘user participation’ proposal would affect mainly social media platforms, search engines, and online marketplaces and would seek to revise the rules on:

• profit allocation, accommodating the value-creating activities of an active and engaged user base by replacing the arm’s length principle with a non-routine or residual profit split approach, allocating those profits between jurisdictions in which the business has users; and
• nexus, by giving user jurisdictions the right to tax that profit, irrespective of whether the business has a taxable presence there that meets the current nexus threshold.

Second, a ‘marketing intangibles’ proposal would affect a broader range of digitalised businesses, modifying current transfer pricing and treaty rules by allocating the non-routine or residual income of the multinational group attributable to marketing intangibles and their associated risks to the market jurisdiction, which would be entitled to tax some or all of this income, irrespective of taxable presence.

Third, a ‘significant economic presence’ proposal would see a taxable presence arise in jurisdictions where non-resident businesses have a significant economic presence on the basis of factors that evidence a ‘purposeful and sustained interaction with the jurisdiction via digital technology and other automated means’, such as:

• the existence of a user base and the associated data input;
• the volume of digital content derived from the jurisdiction;
• billing and collection in local currency or with a local form of payment;
• the maintenance of a website in a local language;
• responsibility for final delivery of goods to customers or the provision of support services such as after-sales service or repairs and maintenance; or
• sustained marketing and sales promotion activities, online or otherwise, to attract customers.

This proposal also contemplates the imposition of a withholding tax as a collection mechanism and enforcement tool.

The BEPS issues are addressed in a global anti-base erosion proposal, based on two rules aimed at the creation of a multilateral framework which makes business location decisions less sensitive to tax considerations:

• an income inclusion rule would tax the income of a foreign branch or a controlled entity if that income were subject to a low effective tax rate in the jurisdiction of establishment or residence, by requiring shareholders with a direct or indirect ownership interest of at least 25% to bring a proportionate share of that income into account; and
• a tax on base eroding payments would include an ‘undertaxed payments rule’ to deny deductions for defined categories of payments made to related parties not subject to tax at a minimum rate, and a ‘subject to tax rule’ to deny treaty relief for certain payments taxed at too low a rate.

These rules would be implemented by way of changes to domestic law and double tax treaties and would incorporate a co-ordination or ordering rule to avoid the risk of economic double taxation.

The OECD has scheduled a public consultation meeting in Paris for 13-14 March, for which prospective attendees must register by 1 March.

See bit.ly/2X4N6Dx.