The OECD is considering a rewrite of global tax rules to give countries with large markets a bigger share of multinationals’ profits and the right to tax companies that lack a physical presence in those jurisdictions.
All 129 jurisdictions that are members of the Organization for Economic Cooperation and Development’s Inclusive Framework, including the U.S., would have to agree to change decades-old international tax rules on how countries divide a multinational’s taxable profits.
After a European effort to tax the digital activity of tech giants like Alphabet Inc.’s Google and Facebook Inc. stalled earlier this year, France, the U.K., Italy, and other European countries are pursuing their own plans. Opponents of such unilateral efforts have argued countries should wait for an OECD agreement by the end of 2020.
The OECD published detailed plans May 31 for work on two tracks, what it calls pillars.
The first pillar will consider new rules to establish nexus—criteria for a company having taxable presence in a jurisdiction without being physically present—and methods of reallocating more taxing rights to the “market jurisdictions” where a company’s consumers are located.
The second pillar would establish a global minimum tax for a multinational’s entities, alongside rules to prevent corporate tax base-eroding behavior.
Though the OECD’s work has been driven by concerns that digital activity isn’t taxed enough or in the right countries, potential solutions would reach far beyond the tech industry.
“This should be a wake-up call to anyone who thought this was focused on digital companies,” said Jesse Eggert, a principal at KPMG LLP and a former senior adviser with the OECD’s Center for Tax Policy and Administration. The work program outlines broad changes, including to transfer pricing rules, which govern how intercompany transfers are valued, and reporting requirements for companies.
Getting consensus won’t be easy. Giving more taxing rights to the market jurisdictions would mean less of the multinational tax pie for export-focused economies, such as Sweden. At the same time, countries including the U.K. are pushing to focus the rules on digital business models, while the U.S. has vowed to reject any plan that singles out tech companies.
The OECD is under pressure to finish the work by the end of 2020—a timeline it called “extremely ambitious” in the report.
The organization wasn’t able to eliminate any of three pillar-one proposals put forward by the U.S., the U.K., and a group of developing countries led by India. But it is aiming to find consensus on a “unified approach” by early 2020, Pascal Saint-Amans, director of the OECD’s Center for Tax Policy and Administration, told reporters on a May 23 call.
Once there’s final consensus on a solution, countries will likely adopt new rules through domestic legislation and changes to tax treaties.
The May 31 document, a “work program” that contains details of possible solutions and outlines the organization’s next steps, is to be presented to the Group of 20 for approval in June.
The potential solutions would upend some of the conventions of international taxation, including the long-standing requirement that a company must have physical presence in a jurisdiction to be taxed there.
The new nexus rules will mostly relate to digital models, where companies don’t have physical presence in a market, Saint-Amans said.
The work is exploring a remote taxable presence standard that would be reflected in bilateral tax treaties. It could either develop new standalone rules or expand the permanent establishment standards for taxable presence currently in the OECD model treaty to include situations where a multinational “exhibits a remote yet sustained and significant involvement in the economy of a jurisdiction,” the work plan said.
The three pillar-one proposals—from the U.S., the U.K., and the group of developing countries—seek to reallocate taxing rights among countries in a way that better reflects modern, increasingly digitalized business models.
“We had three proposals, and we still have three proposals,” Saint-Amans said. But the way the report presents the approaches identifies commonalities as the OECD tries to move toward a unified approach, he said.
The OECD still needs to reconcile different ideas about how to determine where, how, and how much of a company’s profits should be reallocated.
“They shifted the points of disagreement from which packaged solution to adopt to which profit allocation approach to adopt, followed by which nexus approach,” Eggert said.
The work plan outlined four possible approaches to new profit allocation rules:
- A modified residual profit split method, which would give market jurisdictions more of a multinational’s non-routine profits. The rules would sit alongside existing transfer pricing rules.
- A fractional apportionment method, which would reallocate all profits rather than distinguishing non-routine returns.
- Distribution-based approaches, which could “specify a baseline profit in the market jurisdiction for marketing, distribution and user-related activities,” or scale the baseline profit based on the group’s overall profitability, the work plan said. These approaches meet the demand for simplicity that many Inclusive Framework members say is needed for any solution to be workable, the report said.
- Business line and regional segmentation approaches, which would take into account different levels of profitability in different types of business or geographies.
The work will also develop rules to address how a company’s losses—not just its profits—are reallocated under the new system.
Companies should take heed of where the proposals could result in unintended consequences, said Jeff VanderWolk, a partner at Squire Patton Boggs LLP.
“For example, the document mentions that a simplified distribution-based approach might produce an allocation of profit that would be final—that is, not subject to review based on the taxpayer’s particular facts related to its actual profitability in the jurisdiction,” he said. “That strikes me as an alarming suggestion that the business community should take very seriously.”
Following an impact assessment in the coming months, the OECD will seek to find a unified, simplified approach to allocating more taxing rights to market jurisdictions, Saint-Amans said. “Then the debate will be how much of the residual profit goes there, what you do with the routine return, what do you do with the distributor issue,” and other technical work.
Reallocating taxing rights and rewriting nexus rules could raise double-taxation issues and disputes over which jurisdictions should be allocated what share of a company’s profits, the work plan said. The OECD will also consider adapting double-tax treaties and dispute resolution mechanisms in line with the new rules.
“What’s at stake is our ability through the digital angle, through the angle of the tax challenges of the digitalization of the economy, probably to achieve something like BEPS 2.0 to stabilize the international system by reaching a global deal,” Saint-Amans said, referring to the project on base erosion and profit shifting.
And that would shift taxing rights, create a new nexus standard, and increase certainty for business, he added. “These are the guiding principles of the work we’re doing.”