INSIGHT: The OECD Digitalization Project—It’s Not Just About Digital

So, you’re a CFO, or a General Counsel, or any other type of non-tax professional, and you’ve been reading about how the G20 Finance Ministers have endorsed a work program put forward by the OECD. You vaguely remember that the OECD (a) is in Paris and (b) sets international standards. But the wordy title of the project—Developing a Consensus Solution to the Tax Challenges Arising from the Digitalizing of the Economy (DCSTCADE is not the most memorable acronym)—leaves you feeling as if this issue isn’t particularly relevant to your day-to-day work. You see “tax”, you see “digital”, and then you see “end of 2020” and think: “This only applies to tech companies, and is not something I need to worry about.” So, you turn back to worrying about tariffs, USMCA and other more immediate 2019 threats to business. Let me stop you there. Digital is a misnomer. This is big news. And this is happening now.

Here’s the reality: This project has the potential to dramatically change international tax rules, potentially resulting in your business paying more tax, having significantly more compliance issues, and getting caught in many more disputes between governments. More importantly, it could make your business model extremely unattractive.

So, What’s This Project About?

There are two parts to it:

The first part seeks to allocate more profit than the current rules do to the country where a good is sold, or service provided—to the “destination” or “market” country. Under current rules, profit is allocated to the country where R&D takes place, where IP is owned, where major management functions are performed, financing is provided, etc. These proposed changes could dramatically change that by allocating profit to the country where consumers, or users, are based instead. (To be clear, this is not about sales taxes, this is about income taxes on top of that.)

The second part relates to establishing a minimum tax threshold that a business would have to pay on its worldwide income. The U.S. enacted a rule like this in US Tax Reform (the so-called “GILTI” rules), but this proposal could be significantly more complicated—and burdensome—if a business has to pass the minimum tax test in each country where it does business, rather than on a worldwide basis. And another prong to this test would deny deductions for payments like interest and royalties paid to “no or low” tax jurisdictions—effectively raising the tax rate in the jurisdiction from which payments are made.

Under the program, the OECD will start to work out the details of what the G20 approved earlier in June. It’s going to be an enormously complicated task, and the timeline is incredibly ambitious—the end of 2020. There needs to be agreement not just among the G20, and not just among the other OECD members (of which there are 36), but among all 129 countries of the “Inclusive Framework” (which ranges from very large countries with advanced economies and huge populations to developing economies and small islands). This will be difficult because these countries bring different needs and different interests to the table—but also because under the first proposal, if one country gains tax revenue by the reallocation, then another will likely lose some. Losers don’t always agree so easily to take one for the team.

And The Effects on Business?

The first is the complexity. Some of the new measures will require new information to be collected and then reported. The ERP systems that collect and manage financial and other data may have to be reconfigured. Still more compliance staff may have to be hired. There is more danger of a compliance miss. Information looks free to governments—but it isn’t for business. (And that’s without getting to the increased number of disputes—I’ll also deal in a future article with the crucial need for greatly improved dispute resolution procedures between governments as part of this project.)

And the second effect is on the business model. How so? A number of potential ways. It may affect how you organize your supply chain. It may affect where you perform R&D. It may affect where you carry out management functions. It may reduce your incentives to invest in certain jurisdictions. It may affect the balance between insourced and outsourced functions. It may change government policies that seek to encourage certain types of economic activity.

At this point, you may be tempted to rush back to the nearest sandpit you can find and stick your head in it. But don’t! With the G20 seal of approval, and the very strong political support expressed by Finance Ministers (including the U.S. Treasury Secretary), this project is going to move forward. But some of you may be thinking—129 countries, 15-18 months … it can’t happen, this will collapse under its own weight.

Well, yes, that could happen, but I wouldn’t be wishing for it. Unilateral measures are even worse. Complex, uncoordinated, often leading to double taxation. The last few years have seen individual country “diverted profits taxes”, “digital services taxes”, and “virtual permanent establishments”. And there’s much more of that coming, in the absence of international agreement, with more countries looking at their own measures to reallocate global profit to market countries.

The alternative to this project is not a return to the “way things were.” Too much has already changed—with much more to come. No, the alternative to this project is chaos. So, while there are truly things to worry about in this project, the only way for business to prevent them from happening is to take this project very seriously, right now. Something will happen—and you stick your head in the sand at your peril.

This column does not necessarily reflect the opinion of The Bureau of National Affairs, Inc. or its owners.

By: Will Morris, Deputy Global Tax Policy Leader, PwC