OECD consults on digital services tax aimed at changing international tax rules

Tue 05 Nov 2019

Following a webcast update on 9 October, the OECD has released a consultation on Pillar One (the allocation of taxing rights and review of profit allocation and nexus rules, in particular looking at “user participation”, “marketing intangibles”, and “significant economic presence”) of its work on the taxation of the digital economy.

A consultation on Pillar Two (work on anti-base erosion rules, such as minimum effective tax, income inclusion rules, co-ordination of CFC rules etc) is expected in November.

The aim is to propose a unified approach to these tax issues in January 2020, with a consensus being reached by the end of 2020.

The OECD presentation and the slides from it can be accessed here. For a further discussion of the technical and practical issues involved in the introduction of these changes, please get in touch with a member of the Mazars international tax team.

What are the details?

The proposals in the Pillar One document represent the OECD suggestions, as it has not yet been possible to reach a consensus. In broad summary the proposals are:

• Scope. The approach covers highly digital business models but goes wider – broadly focusing on consumer-facing businesses, but also encompassing some B2B activity. Further work is to be carried out on scope and carve-outs. Extractive industries are assumed to be out of the scope.

• New Nexus. For businesses within the scope, it creates a new nexus, not dependent on physical presence but largely based on sales. The new nexus could have thresholds including 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.

• New Profit Allocation Rule going beyond the Arm’s Length Principle. It creates a new profit allocation rule applicable to taxpayers within the scope, and irrespective of whether they have an in-country marketing or distribution presence (permanent establishment or separate subsidiary) or sell via unrelated distributors. At the same time, the approach largely retains the current transfer pricing rules based on the arm’s length principle but complements them with formula based solutions in areas where tensions in the current system are the highest.

• Increased Tax Certainty delivered via a Three Tier Mechanism. The approach increases tax certainty for taxpayers and tax administrations and consists of a three tier profit allocation mechanism, as follows:
  • Amount A – a share of deemed residual profit allocated to market jurisdictions using a formulaic approach, i.e. the new taxing right;
  • Amount B – a fixed remuneration for baseline marketing and distribution functions that take place in the market jurisdiction; and
  • Amount C – binding and effective dispute prevention and resolution mechanisms relating to all elements of the proposal, including any additional profit where in-country functions exceed the baseline activity compensated under Amount B.

The economics presentation indicated that the result of implementing the proposals could be a shift of tax revenues from developed to developing jurisdictions, and that those businesses that did not react to the changes could quickly have a tax profile that was significantly out of line with the rules.

Responses to the consultation are requested by 12 November 2019.