How does OECD BEPS 2.0 impact your business?

The OECD’s 2019 workplan on addressing the tax challenges of the digitalized economy signal a path towards a fundamental change in how the international tax framework will operate. It will have a far-reaching impact on multinational enterprises irrespective of how heavily involved these multinational enterprises are in their digital businesses.

The digital economy has revolutionized the traditional ways of conducting business across the world. Emerging production and consumer models along with new technologies have created a set of fresh tax challenges and have strained the existing international tax rules which have been slow to adapt to the new business environment. It is against this backdrop that governments of different countries are demanding greater transparency and introducing new rules and regulations for the digital economy. 

The prelude

In January 2019, the OECD released a policy note communicating that the renewed international discussions will focus on two central pillars: Pillar One and Pillar Two. Pillar One will address the broader challenges related to the digitalization of the economy and will focus on the allocation of taxing rights, and Pillar Two will sort out the remaining BEPS concerns. In May 2019, the OECD released the Programme of Work to Develop a Consensus Solution to the Tax Challenges Arising from the Digitalisation of the Economy (the workplan). The workplan’s timeline summarizes a long-term solution to address the digitalization challenges, which is to be submitted to the BEPS Inclusive Framework for an agreement in January 2020, and work on elaborating the policy and technical details of the solution will continue in 2020 to deliver a consensus agreement on the new international tax rules by the end of 2020.

The workplan

Pillar One contains three alternative proposals: the user participation proposal, the marketing intangibles proposal and the significant economic presence proposal. These proposals differ in the objective and scope of the reallocation of taxing rights. However, the common aspects in these proposals will allow to resolve the technical issues under Pillar One by grouping these issues into three building blocks, namely, new profit allocation rules, new nexus rules and implementation of new market jurisdiction taxing right. The workplan sets out three different methods – modified residual profit split method, fractional apportionment method and distribution-based approach – to quantify the amount of profit to be reallocated to market jurisdictions and methods to determine how the profit should be allocated. The workplan stated that OECD will explore the development of remote taxable presence and a new set of standards for identifying the existence of such taxable presence.

Response of business community on the developments

Multinational enterprises (MNEs) are concerned with the unilateral measures adopted by countries increasing the risk of double taxation and multi-jurisdictional disputes. MNEs are not in the favour of “ring fence” or carve-out business models or industries as both could incentivize/disincentivize businesses to move away into certain activities. Various stakeholders have shared their comments with the OECD on the possible solutions to tackle the tax challenges associated with digitalization of the economy^[1]. Instances below:

OECD’s proposal for a “unified approach”

On 9 October 2019, the OECD released a public consultation document^[2] outlining a proposal from the OECD Secretariat for a “unified approach” under Pillar One. The scope of the Secretariat Proposal covers highly digitalized business models and consumer-facing non-digitalized businesses. The proposal also includes a new nexus concept that is not dependent on physical presence and is largely based on sales but is proposed to be separate from the existing permanent establishment concept. The new nexus would operate regardless of whether taxpayers have an in-country marketing or distribution presence or the taxpayers sell through related or unrelated distributors. In addition, the proposal contains a three-part approach to new and revised profit allocation rules, which would provide a formulaic method to allocate deemed non-routine profits to market jurisdictions under the new nexus concept. Besides this, the approach provides a formulaic approach for a fixed return to baseline marketing and distribution activities in situations where there is nexus under the existing principles, and an approach for allocating additional profit to the market jurisdiction where the local activities exceed such baseline activity. Finally, the proposal contemplates binding effective dispute prevention and resolution mechanisms that would cover all three parts of the profit allocation approach. The proposal acknowledges that further technical work is required and includes an annex with a series of specific questions for public comment on significant policy, technical and administrability issues.

India’s perspective

India began its digital tax journey in 2012 with the amendment of the term “royalty” in the domestic tax law which now captures most technology/digital economy transactions. Further, the concept of permanent establishment (PE) as a nexus for taxing business profits has come under significant pressure, with tax authorities sometimes asserting virtual PE under the definition of traditional PE.

India was also the first country to implement an equalization levy of 6% of the amount received or receivable by a non-resident for providing specified digital services and facilities. 

India also sought to introduce the concept of Significant Economic Presence (SEP) to amend the rules on profit attribution to a PE. However, Central Board of Direct Taxes (CBDT) is yet to prescribe these rules

Conclusion

The reallocation of taxing rights under Pillar One has fundamental implications on the international tax framework. Thus, it is essential for all jurisdictions to implement such changes simultaneously to avoid double taxation. The proposals could bring significant changes to the overall international tax rules under which multinational businesses operate and could have important consequences on the overall tax liability of businesses and tax revenues of the countries.

[1]. http://www.oecd.org/tax/beps/public-comments-received-on-the-possible-solutions-to-the-tax-challenges-of-digitalisation.htm
[2]. https://www.oecd.org/tax/beps/public-consultation-document-secretariat-proposal-unified-approach-pillar-one.pdf