OECD on track to reach agreement in 2020 on tax and digitalisation

Pascal Saint Amans, director of the OECD's Centre of Tax Policy and Administration acknowledged, however, that this timeline will be "extremely challenging".  

An OECD statement said that an outline of the architecture of a unified approach to its 'Pillar One' proposal has been agreed, although US demands for a 'safe harbour', remain unresolved.

Eloise Walker, a corporate tax expert at Pinsent Masons, the law firm behind Out-Law, said: "It is not surprising to see the OECD pushing forward in the face of US aggression, although it is somewhat surprising that the timetable has not slipped, given the number of issues yet to be resolved – not just the US demand for a safe harbour and the reaction of other countries to that idea, but also fundamental difficulties around double taxation in bringing these new rules forward."

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. The current international tax system is based on the concept of tax being paid where an organisation derives profits from a permanent establishment in that country. Digitalisation means that substantial profits can be derived from a jurisdiction, without the need for a fixed base there.

Pillar One of the OECD's programme of work 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.

In December 2019, US treasury secretary Steve Mnuchin said in a letter to the OECD that the US supported a multilateral solution to the tax challenges arising from digitalisation, but proposed a 'safe harbour' which would allow companies to elect out of Pillar One.

"Many [OECD Inclusive Framework] members express concerns that implementing Pillar One on a ‘safe harbour’ basis could raise major difficulties, increase uncertainty and fail to meet all of the policy objectives of the overall process", according to a statement by the OECD.

The statement said that a possible safe harbour will be added to the programme of work, but a final decision will be taken on a safe harbour only after all the other elements of the solution have been agreed upon. It notes that resolution of this issue is "crucial to reaching consensus".

The OECD's statement also set out details of the agreed framework for the Pillar One proposals. Pillar One will give all the countries where multinational enterprises (MNEs) operate – so-called 'market jurisdictions' – a new taxing right over a portion of each MNE's 'residual profit'. This new taxing right would apply irrespective of the existence of a physical presence, and so would apply particularly to digital services.

The OECD expects 'automated digital services' within the scope of the rules will include online search engines, social media platforms, digital content streaming, online gaming, cloud computing services and online advertising services. It will also potentially apply to online intermediation platforms, including online marketplaces, whether used by businesses or consumers.

However, Pillar One will not just apply to digital businesses. It will also apply to more traditional businesses that engage heavily with their customers through digital technologies. These 'consumer-facing businesses' would be businesses that generate revenue from the sale of goods and services of a type commonly sold to individuals purchasing items for personal use and not for business purposes.

The OECD said that the businesses covered are expected to include those selling personal computing products such as software, home appliances and mobile phones. It will also apply to customer-facing businesses selling clothes, toiletries, cosmetics, luxury goods, cars or branded foods and refreshments. Franchise models, such as licensing arrangements involving the restaurant and hotel sector, are also expected to be caught.

Extractive industries and other producers and sellers of raw materials and commodities will be carved out. The OECD is also considering exempting retail banks and insurance companies, as well as airline and shipping businesses.

The rules will be limited to large MNE groups meeting a gross revenue threshold test. The OECD said this could be the same as the €750m threshold used for country by country reporting. Businesses would only be caught by the rules if they have a 'significant and sustained' engagement with a market over a period of years. This will involve some sort of revenue test which will be "commensurate with the market" and for consumer facing businesses some other factors. The OECD said the other factors are to recognise the fact that the cross-border sale of tangible goods into a market jurisdiction does not in itself amount to a significant and sustained engagement in that jurisdiction. It is not yet clear what these other factors will be, but the OECD said they could include the existence of a physical presence of the MNE in the market jurisdiction or targeted advertising directed at the market jurisdiction.

"Boundary control will be the big issue in applying these rules to all consumer facing industries" said Eloise Walker. "Mere sales are not supposed to be caught, but how to judge what are mere sales and what are sales that amount to a significant and sustained engagement in a market jurisdiction is the tricky question the OECD has been dancing around since this process began."

The OECD statement highlighted that concerns have been expressed by some jurisdictions and businesses about the continued application of unilateral digital service taxes (DSTs) which have been or are being introduced by countries such as France and the UK. Last week the UK said it would be pressing ahead with its new tax in April, although France agreed to postpone collection of its new tax which is already in force.

The OECD said that it expects that any agreement to implement the OECD proposals on digitalisation will include an agreement to withdraw relevant unilateral actions.

At the same time the OECD gave a short update on its progress in relation to Pillar Two.

It is hoped that the OECD's Inclusive Framework will reach agreement on the key policy features of the solution for taxing the digital economy at its meeting in early July.

If agreement cannot be reached, Pascal Saint-Amans said, on a webinar giving a progress update, "We do not have a plan B". He warned that there would then be a "big risk" of a trade war based on tax disputes.