On February 13, the OECD issued far-reaching proposals for addressing the challenges of digitizing the economy and invited comments from the public by March 1. A version of this article will be submitted to the OECD.
Governments around the world are concerned that multinationals have exploited loopholes to park profits in low tax locations. In 2015, the OECD initiated a campaign addressing base erosion and profit shifting (BEPS). This was meant to end abuse of existing tax rules. Now the OECD wants to change the tax rules altogether, especially in the digital area. There is no international consensus, so the OECD is inching along with its proposals and hopes to conclude something by 2020.
New OECD digital taxability proposals
Until now, a company from country A was taxable in country B if it does business in country B. The OECD proposes three new taxability and profit allocation bases:
• Based on user participation in a country
• Based on marketing intangibles in a country
• If there is a “significant economic presence” in a country
Taxation based on user participation is aimed at “certain highly digitalized businesses” where such enables advertising revenues to be generated, irrespective of whether those businesses have a local physical presence. So-called “non-routine” profits would be allocated between countries based on the activities of users.
Taxation based on marketing intangibles may reflect, for example, trademarks, trade names, customer lists, customer relationships, proprietary marketing and customer data. It has broader application than taxation based on user participation, and is not weakened by modest decision-making in low-tax jurisdictions. But it reflects “state of mind” of customers, not demand. “Non-routine” income would be allocated based on marketing intangibles contribution or a functional analysis – but approximations may be necessary.
The “significant economic presence” approach (favored in Israel) allocates income to a country if there are revenues and at least one other factor, e.g., users, volume of digital content, local billing or currency, local language website, local final delivery or after-sales support, or sustained marketing.
Global anti-base erosion proposals
Anti-base erosion means preventing the shifting offshore of profits. The OECD proposes two alternatives:
• Tax in the home country of a company if the profits of a foreign branch or affiliated company are not taxed at a minimum tax rate. This would reflect US GILTI (global intangible low taxed income) principles, and/or
• Tax in the payment country on “undertaxed payments” not taxed at a minimum tax rate elsewhere.
We have a number of comments on these proposals.
First, it is all about America. The US is known to object to proposals that appear to narrowly discriminate against successful US hi-tech firms. Therefore, the user participation proposal is probably a non-starter, whereas the US itself uses the marketing intangible approach (e.g., in the GlaxoSmithKline pharmaceuticals case of 2006) which is of broader application. Physical goods, professional services and digital products and services may all be covered.
Second, the proposals appear to relate only to income tax, and overlook sales Tax/VAT/Goods & Service Tax. This is a major omission given the Wayfair case (South Dakota v. Wayfair, June 21, 2018, 17-494), in which the US Supreme Court ruled that US states can impose sales tax, e.g., if there are annual revenues over $100,000 or more that 200 shipments into the state concerned. The EU taxes electronic service supplies.
Third, companies fear multiple taxation. The OECD proposals do not say how income will be totaled and taxes will be coordinated globally. They merely say that if more than 100% of profits are taxed, or if there are losses, the excess or loss will have to be re-allocated somehow.
Fourth, the proposals also call for strong dispute resolution procedures. Practitioners know that this may take years and may not arrive at agreement.
Fifth, the proposals do not distinguish between B2B (business to business) and B2C (business to consumer. There is a risk of double or multiple taxation, e.g., if there are marketing intangibles in both countries. And if the trade passes down a line of companies (B2B2B, e.g., goods made in China sold to a Hong Kong company and on to affiliates around the world) will multiple taxation emerge?
To address the above issues, we recommend a global database, a global companies registry and a global tax tribunal system.
As for base erosion, there should be an exception for payments to locations where the nexus approach (people and expenditure) is upheld per existing BEPS rules and recent “resumed substantial activities” recommendations.
As always, consult experienced tax advisers in each country at an early stage in specific cases.