Tax Challenges from Digitalisation of the Economy: The OECD Secretariat's Proposal for “Pillar One”

On October 9, 2019, the OECD secretariat published a high-level proposal for the allocation of profit and the new nexus rule, the "Pillar One" of the Programme of Work to develop a consensus solution to the tax challenges arising from the digitalisation of the economy.

The Programme of Work—which was adopted by the Inclusive Framework on BEPS at its May 28–29, 2019 meeting and approved by the G-20—provides for the development of two pillars: Pillar One, the subject of the October 9 proposal, and Pillar Two, which aims to ensure that a minimum level of tax would be paid.

The proposal for a "Unified Approach under Pillar One" is open to public consultation, with the secretariat seeking comments on a number of policy issues and technical aspects. According to this proposal, some profits and corresponding taxing rights would be reallocated to countries and jurisdictions where MNEs have their markets. MNEs conducting significant business in places where they do not have a physical presence would be taxed in those jurisdictions through the creation of new rules stating (1) where tax should be paid (“nexus” rules) and (2) on what portion of profits they should be taxed (“profit allocation” rules). 

The Pillar One proposal does not represent consensus views of the Inclusive Framework; the secretariat created it by bringing together common elements of competing proposals from member countries.

A Pillar Two (“Global Anti-Base Erosion” or "GLOBE") proposal should be released in November 2019 with a public consultation in December 2019.

Details of the Pillar One Proposal

Large-size, consumer-facing businesses, including B2Cs and some B2Bs, would be in scope, with further work to be carried out on carve-outs such as for extractive industries and commodities. Regarding size, the €750million revenue threshold used for CbCR might be retained.

For businesses within the scope, the Pillar One proposal creates a new nexus not dependent on physical presence but largely based on sales. The new nexus could have thresholds such as country-specific sales thresholds calibrated to ensure that jurisdictions with smaller economies can also benefit. It would be designed as a new self-standing treaty provision to avoid spillover effects.

The proposed Profit Allocation Rule retains the current transfer pricing rules based on the arm’s length principle but complements them with these formula-based allocations:

• Step 1: Determine total profit: MNE group or business-line calculations
  
  
• Step 2: Exclude "deemed" routine profit to define residual: profitability threshold/fixed percentage(s)
  
  
• Step 3: Allocate a portion of "deemed " residual profit: formulary
  
  
• Step 4 : Allocate the relevant portion of the deemed residual among market jurisdictions: agreed allocation key

The activities in market jurisdictions, such as distribution functions, would remain taxable according to the existing transfer pricing rules (arm's length principle) and the PE allocation under Article 7. However, the proposal considers the possibility of using (negotiated) fixed remunerations to provide tax certainty.

Importantly, any dispute between the market jurisdiction and the taxpayer over any element of this proposal would be subject to legally binding and effective dispute prevention and resolution mechanisms.

Key Pending Questions

As indicated in the Programme of Work, there are a number of areas in which further work is required, such as the possible use of business line or regional segmentation, issues in connection with the treatment of losses and the elimination of double taxation.

What's Next?

A status update will be presented during the next meeting of G20 Finance Ministers and Central Bank Governors in Washington DC, on October 17–18, 2019.

The public consultation meeting on the Pillar One proposal will be held on November 21–22, 2019, in Paris and will likely produce the same level of comments as the February/March 2019 public consultation (over 2000 pages of comments and 400 participants). The (ambitious) deadline for a consensus–based approach is still 2020.