International tax reform to address the challenges of digitalisation and globalisation of the economy continues to be high on the OECD/G20 Inclusive Framework’s agenda. The current aim is to reach a consensus agreement by mid-2021. With renewed support from the US, it seems more likely than ever that the global tax rules will be subject to significant upheaval. While some of the proposals are focused on tech giants, others could affect all large multinationals.
What’s the issue?
Technological advances and increased online consumer activity now allow businesses to realise value from a jurisdiction without having to establish a physical presence there. This “remote participation” poses a challenge for traditional international tax norms that focus on where physical activities are performed, or where decisions are made, in order to grant a jurisdiction the right to tax.
The limits of these traditional tax rules have resulted in some jurisdictions taking the view that they are missing out on tax revenues – particularly from the tech giants. This has led to a number of jurisdictions introducing their own domestic digital services taxes or “DSTs”. In Europe, France led the way when it introduced a DST in 2019, but other jurisdictions have since followed – including Austria, Italy, Spain and the UK. More recently, the US State of Maryland has followed suit.
The US has looked unfavourably on the introduction of (non-US) DSTs, seeing them as targeting the profits of its tech giants. It has gone as far as finding that a number of DSTs discriminate against US commerce following “section 301 investigations” (an investigation to determine whether an unreasonable or discriminatory action has been taken by a non-US country which restricts US commerce, allowing the US to respond with retaliatory trade actions).
How is the OECD seeking to address this?
There is agreement across the 139 members of the OECD’s Inclusive Framework that uncoordinated unilateral domestic measures are not the best way of addressing this issue. Instead, it is proposed that there should be coordinated fundamental changes to the international tax system.
The OECD’s project to achieve this has culminated in a proposed “two-pillar” solution.
“Pillar One” is directly targeted at the issues outlined above, as the Pillar One proposals would reallocate certain taxing rights to “market jurisdictions”. These are jurisdictions where users/consumers are located that, in the traditional tax system, would not get a slice of the (tax) pie due to the lack of the supplier’s physical presence in them. Pillar One intends to allocate a certain amount of residual profit to market jurisdictions and to remunerate baseline marketing and distribution activities.
The reallocation would only apply to businesses of a:
- Specified type - these could include “automated digital services” (e.g. online advertising, online search engines, social media platforms) and other consumer-facing business selling goods or services.
- Specified size – there are expected to be revenue thresholds (both overall and in terms of the extent of cross-border activity).
Participating jurisdictions would withdraw their domestic DSTs (a number of the domestic DSTs have built in “sunset clauses” to allow for such withdrawal).
As the OECD’s project progressed, the proposals became more ambitious and it is now suggested that any solution should not be limited to targeting digital giants. Instead, it’s proposed that there should be a more fundamental reform. This comes in the form of the “Pillar Two” or “GloBE” (GLoBE standing for Global anti-Base Erosion) proposals.
The aim here is for all large multinationals - not just those providing digital services - to be subject to tax on their global income at a minimum rate, in order to reduce the incentive to shift profits to low tax jurisdictions.
The rules to achieve this would be complex. For example, they could involve an income inclusion rule, denying deductions for 'base eroding' payments, imposing withholding tax or denying treaty benefits where amounts are not subject to tax at a minimum rate. If these proposals are implemented, this is likely to impact all large multinationals to some degree.
Is consensus-agreement possible by mid-2021?
The return of the US to the OECD’s negotiating table since the Biden administration took office is seen as a significant step, creating additional momentum (see US Treasury Letter 25 February 2021). It now seems more likely than ever that some level of consensus agreement will be reached by mid-2021.
If the OECD does not deliver by mid-2021, the EU has made it clear it will take forward its own proposals in relation to the taxation of the digital economy and has already taken steps in this regard by initiating a public consultation on the matter in preparation for a possible proposal in June 2021.
It seems clear there will be further, potentially very significant, developments in this area during the second half of 2021. Whether that’s at a global or EU level remains to be seen.
Our briefing here provides further detail on this topic, including a recap on the OECD’s Pillar One and Two project to date and key features of the OECD’s proposals.
For all our thinking on this topic, see these blog posts.