On the 31st of January 2020 the OECD published a “Statement by the OECD/G20 Inclusive Framework (IF) on BEPS on the Two-Pillar Approach to Address the Tax Challenges Arising from the Digitalisation of the Economy”.
In line with the pre-announced timeline, the statement focuses on updating the outline for the proposed architecture of the Unified Approach (Pillar 1), the program of further work to develop a consensus-based solution for remaining Pillar 1 issues as well as an update on the progress of work on the Global anti-Base Erosion (“GloBE” or Pillar 2) proposal.
The part of the update most eagerly awaited by businesses and practitioners deals with more concrete details on how the Pillar 1 Unified Approach would potentially apply in practice. This updated draft guidance is provided on a “without prejudice” basis ( meaning “nothing is confirmed until all is agreed”) and covers some of the core elements of the Unified Approach.
This update may be read in conjunction with this previous post which includes an overview of Amounts A, B and C of Pillar 1.
Amount A – “New Taxing Right”
The updated draft addresses some of the key questions raised during the consultation process that are crucial for taxpayers, practitioners and tax authorities to gauge the potential impact as well as practical implications of Amount A.
- Emphasis by the OECD that the formulaic approach under Amount A will act as an “overlay or partial override to the arm’s length principle” and will be applied after the calculations of Amounts B and C;
- Updated guidance on which types of business will fall into the scope of Amount A. This guidance is newly divided into “Automated Digital Services” (such as online search engines, social media, online gaming and cloud computing services) and “Customer-facing businesses” (similar to previous draft definition focusing on B2C business models, with the added example inclusion of the automobile industry);
- Clarifications on proposed limitations to inclusion of business models selling intermediate products (i.e. B2B2C);
- Confirmation of the proposed inclusion in Amount A of business models generating revenues from licensing of intangible assets or franchising arrangements;
- An update to the list of proposed carve-outs, with the previously listed extractive & commodity industries now joined by most parts of financial services industry as well as international transportation (air & shipping) sectors;
- Proposed introduction of threshold level linked to the one already existing for Country-by-Country Reporting purposes (EUR 750 million gross revenues) with potential additional refinements such as application of the threshold only to revenues arising from in-scope business activities;
- Profit Before Tax confirmed as the proposed most appropriate profit measure for the Amount A calculation and further work needed on the mechanism for tax basis determination;
- Indication of further work needed to determine the parameters (percentages) to be used for the calculation of deemed residual profit levels, with the confirmation of sales as the most appropriate allocation key to be used for allocating profits to market jurisdictions.
Further work is required to resolve practical and political challenges crucial for achieving political consensus in order to adopt the Amount A “new taxing right”. Ensuring the prevention and elimination of double taxation is listed as top priority for this further work.
Amount B – Fixed Return for Defined Baseline Distribution and Marketing Activities
Amount B continues to be defined as applying to “baseline marketing and distribution activities” for distributors that buy products from related parties for resale. Importantly, there is no explicit mention of scope limitation of the applicability of Amount B to only “Automated Digital Services” and “Consumer-facing business”, as is the case for Amount A.
The updated proposals re-affirm the close link between Amount B and the application of the arm’s length principle, which the OECD suggest will be applied in order to set the target remuneration for the baseline marketing and distribution activities by reference to transfer pricing benchmarks. Without providing any more detail on actual percentage values, the updated guidance refers to the need for the remuneration levels under Amount B to ensure “differentiation in treatment between industries and regions”.
Whilst the OECD states that IF members do not expect there to be material overlaps between Amounts A and B, it is recognized that more work is needed to address the following areas:
- Definition of baseline activities;
- Consideration of an appropriate profit level indicator;
- Structuring the return as a fixed percentage at an agreed profit level (e.g. the median);
- Utilisation of benchmarking studies based on publicly available information to support the amount of the fixed percentage; and
- The degree to which there may need to be a differentiation in treatment between industries and regions in order to remain in broad conformity with the arm’s length principle.
Tax Certainty: Dispute Prevention and Resolution
The OECD noted that the question of dispute prevention and resolution is possibly the most challenging and contentious element of the IF discussions. While acknowledging discussions are ongoing on this topic in order to facilitate political consensus on the Unified Approach, the OECD provided the following insights:
- Clear guidance for the application of Amount C and its interaction with Amounts A and B will serve as a critical element of the dispute prevention and resolution framework;
- Mandatory binding arbitration may not be acceptable or feasible for all members of the IF;
- Instead, mandatory dispute prevention may provide the certainty required by taxpayers and jurisdictions;
- This might be achieved through the introduction of representative panels, that will resolve differences or disputes before final tax assessments are issued; and
- The Mutual Agreement Procedure (“MAP”) framework will continue to be important and will be the basis for dispute resolution in cases where existing double tax treaty mechanisms apply.
Overall Project Timeline
The OECD and IF members are committed to the previously announced timeline for achieving a consensus on the overall architecture for Pillar 1 by July 2020, with publication of the final report until the end of 2020. While the timeline has been described as “ambitious” by Pascal Saint-Amans (Director of the Center for Tax Policy and Administration at OECD), the OECD and IF members reaffirmed that they are committed to find a multilateral solution and to avoid a proliferation of unilateral Digital Services Tax. It was also confirmed that once all other elements of the architecture for the Unified Approach will be agreed, the IF members will also discuss and address the concept of optionality (“safe harbor”) for Pillar 1, as reflected by US Treasury Secretary Mnuchin in his letter from December 2019.
Pillar 2 Progress Status
While the focus of the OECD statement is on Pillar 1, it also confirms progress in connection with the Pillar 2 minimum taxation discussions. While further work is required before an updated draft can be published, the working group continues to achieve progress with refining the proposals. Examples of challenging areas that are being worked on include questions surrounding the definition of the applicable tax base, blending and possible carve-outs.
- Despite the many questions that must still be resolved, the OECD and the IF reaffirmed their commitment to Pillar 1 and Pillar 2. Taxpayers should assume that discussions will continue and should not assume that the project will fail, despite the obvious challenges.
- Digital tax and BEPS 2.0 continue to be widely reported. Heads of Tax should be prepared to explain, to internal stakeholders, the proposals and the likely impact of the proposals on their business.
- The new guidance today provides additional details on Pillar 1 which will allow taxpayers to assess the likely impact of the proposed rules on their business albeit many elements of the final OECD architecture remain work in progress.
- Further information on possible financial impact of the proposals will be discussed by the OECD in a webcast scheduled for 13 February 2020, with a draft consensus based Pillar 1 report to be expected in July 2020.