The OECD published major proposals on October 9 to impose income tax on deemed profits of multinational enterprises (MNEs) in each country where they have consumers, even if they have no physical presence in those countries. This would strike hard at e-commerce over the internet.
The current international tax rules date back to the 1920s are not sufficient to tax online trading. Hence the OECD’s reform proposals, which are open for consultation until November 12. After that, assuming the proposals are refined and finalized, many countries are likely to start applying the measures. Israel joined the OECD in 2010.
Know your 123 and ABC
There appear to be a number of steps in the OECD proposals. The amounts and percentages remain to be determined as does implementation and enforcement.
• First, identify in which countries consumers (including users) are located.
• Second, check which entities in the MNE group “own the profit according to their audited consolidated financial statements drawn up according to US GAAP or IFRS accounting principles.
• Third, check whether a carve-out is prescribed, for example extractive industries, commodities and perhaps supplies of goods and services through intermediaries, franchise arrangements or financial services. There may also be a carve-out for MNEs with annual revenues below, for example, €750 million.
• Fourth, ascertain the revenue threshold for each market country. The revenue threshold will be prescribed by reference to the market size, and may also take into account certain activities such as online advertising services directed at non-paying users. This would amount to a new nexus rule supplementing the traditional permanent establishment rules.
• Fifth, if you get there, for each country concerned, calculate amounts called A, B and C. These amounts reallocate profits and taxes between the countries of the world.
Amount A is a deemed residual profit would be the profit that remains after allocating what would be regarded as a deemed routine profit on activities to the countries where the activities are performed. Amount A would be a rate of return to be calculated through a formula based on sales.
Amount B would be a deemed fixed remuneration for assumed baseline activity relating to distribution activity, where applicable, supposedly reflecting existing permanent establishment and transfer pricing rules.
Amount C would be additional remuneration where there are more functions in the market country than have been accounted for by reference to the local entity’s assumed baseline activity (which is subject to the fixed return in B above), and that country seeks to tax an additional profit on those extra functions in accordance with the existing transfer pricing rules.
• Sixth, implementation, perhaps via a withholding tax mechanism. Details remain to be determined.
• Seventh, complaints and double taxation would be resolved by legally binding and effective dispute resolution mechanisms. These remain to be determined.
Comments
These OECD proposals have been highly touted but are only half-baked at present.
These proposals would reallocate billions of dollars profits and taxes each year among the countries of the world, onshore as well as offshore. The winners won’t mind, the losers will. It was generally assumed a big loser may be the United States, but these proposals are actually a compromise which take on board some aspects of the Trump tax reform at the end of 2017.
There are also moral issues. If countries like China and India have large consumer populations, should those countries be entitled to scoop up much of the world tax cake even if those consumers are less affluent and generate lower profit margins in reality? Or should some kind of profitability adjustment be made?
At the more detailed level, it seems that only B2C (Business to Consumers) would be covered by the proposals, apparently not B2B (Business to Business). Why and how this would work are not stated in the proposals.
Double and multiple taxation are not yet adequately addressed. Would there be a foreign tax credit mechanism or an overseas profit exemption? Also, dispute resolution mechanisms should not involve arbitration which can take years. Consideration might be given to a worldwide tax tribunal system which can be faster
The proposals only relate to income tax changes, not VAT/GST/Sales tax, leaving a yawning gap.
It is unclear how consumers (e.g. children) would withhold tax from MNEs.
What about Israel?
The proposals would probably be a net revenue earner for the Israeli treasury. There are probably far more large foreign MNEs with Israeli consumers than large Israeli MNEs with foreign consumers.
As always, consult experienced tax advisers in each country at an early stage in specific cases. The writer is a certified public accountant and tax specialist at Harris Horoviz Consulting & Tax Ltd. leon@h2cat.com.