OECD consults on international minimum tax rate proposal

In May 2019 the OECD agreed with the G20 a programme of work, divided into two pillars, for addressing the tax challenges of the digitalisation of the economy. Pillar one addresses the allocation of taxing rights between jurisdictions and considers proposals for new profit allocation and nexus rules. Pillar two focuses on the remaining base erosion and profit shifting (BEPS) issues and seeks to develop rules that would provide jurisdictions with a right to tax where other jurisdictions have not exercised their primary taxing rights or the payment is otherwise subject to low levels of effective taxation.

The current consultation concerns pillar two, which is also known as the global anti-base erosion (GloBE) proposal. A consultation on pillar one, which looks at how taxing rights on income generated from cross-border activities in the digital age should be allocated among countries, closed on 12 November.  "The GloBE proposal is not limited to highly digitalised businesses and will potentially affect all types of business operating internationally. It is designed to stop the 'race to the bottom' in terms of corporate tax rates and to stop the perceived opportunities for profit shifting that remain after the previous BEPS changes," said Eloise Walker, a corporate tax expert at Pinsent Masons, the law firm behind Out-law.

Under pillar two, the OECD is seeking to develop a coordinated set of rules to implement a minimum rate of tax. An 'income inclusion' rule would tax the income of a foreign branch or a controlled entity if that income was subject to tax at an effective rate that is below a minimum rate. There is no indication yet of what the minimum tax rate could be. This decision will be made once the design of the rules is settled. 

An 'undertaxed payments' rule would deny a deduction for a payment to a related party if that payment was not subject to tax at or above a minimum rate. A 'subject to tax' rule would complement the undertaxed payment rule by subjecting a payment to withholding or other taxes at source and adjusting eligibility for treaty benefits where the payment is not subject to tax at a minimum rate.

It is also proposed that a 'switch-over rule' be introduced into tax treaties that would permit a residence jurisdiction to switch from an exemption to a credit method where the profits attributable to a permanent establishment (PE) or derived from immovable property, which is not part of a PE, are subject to an effective rate below the minimum rate.

These rules would be implemented by changes to domestic law and tax treaties and would incorporate a co-ordination or ordering rule to avoid the risk of double taxation that might otherwise arise where more than one jurisdiction sought to apply these rules to the same structure or arrangement.

Although the OECD says that comments are welcome on all aspects of the programme of work on pillar two, it has specifically requested comments on three technical design aspects of the GloBE proposal. These are how the tax base should be calculated; the extent to which groups should be able to combine income and taxes from different sources in determining an effective blended tax rate; and whether there should be any carve-outs and thresholds.

Walker said: "It is frustrating, although not that surprising that the OECD has not made greater progress before throwing the matter open to public consultation. Academically speaking the easiest way to stop profit shifting is to have a truly common consolidated corporate tax base where worldwide profits are calculated and subject to tax at the same rate worldwide, then divided up between the relevant countries."

"That, of course, isn't going to happen given the socio-economic and political drivers of the real world. But having opened Pandora's Box by suggesting GloBE they find themselves unable to work out how to tackle the perceived problem and hope someone else can suggest a way forward. It remains to be seen which country will win the resulting tug-of-war," she said.

Comments are requested by 2 December 2019 and there will be a public consultation meeting on 9 December.

The OECD work has come about because a growing number of countries are not content with the current international tax system and in particular with the way the rules work as the economy becomes more digitised. The OECD has committed to producing proposals to change the international tax system by the end of 2020 and has said that to do this the outline architecture of the changes will need to be agreed internationally by January 2020. The OECD is keen to reach international consensus on any solutions and wants to avoid countries taking unilateral action to address the shortcomings of the present system.

However, many countries are already taking unilateral action. The UK is proposing to introduce a 2% digital services tax in April 2020 on the UK revenues of providers of social media platforms, search engines and online marketplaces. France has already introduced a 3% tax on revenues deemed to have been generated in France by digital companies, as has Hungary. Austria, Italy, Spain, the Czech Republic, Slovenia, Poland, Turkey, Canada and Uganda are among the countries which have also been considering a digital services tax.