The digitalization of the economy has made it possible for companies to reach and approach customers all around the world without having a physical presence. Instead, sales can be made through websites and other digital platforms. Sales through a website provides an opportunity for companies to sell products or services to customers in different market jurisdictions without having any other tax obligations in that jurisdiction.
Since the digitalization of the economy shows no signs of decreasing, OECD has initiated several projects to adapt the international tax system to these new circumstances; Pillar one is one of these projects.
On the 12th of October 2020, OECD published its latest draft of Pillar one, which after much consultation has taken the project a step further. In this article, we have summarized the report.
Pillar one – what is new and important?
The purpose of Pillar one is to adapt and improve the international tax system with new profit allocation and nexus rules. The intention is to expand the taxable right to ensure taxation is not limited to taxpayers with physical presence in a jurisdiction.
Pillar one consists of three key elements:
- The new taxing right (Amount A)
- Fixed return for defined baseline marketing and distribution activities (Amount B)
- Improved tax certainty processes
The content of Pillar one is still open for discussion and is thus only a draft proposal. The aim is to present a final report in mid-2021.
A new taxing right – Amount A
Scope and exemptions
OECD have expanded the scope in the latest draft compared to the previous draft due to differences between members. Companies which will probably be within the scope is:
- Consumer Facing Businesses (CFB)
- Companies that provide goods or services, directly or indirectly, that are usually sold to customers for private use. This also includes licensing and franchising
- Digital Services (ADS)
- Examples of ADS are social media platforms and online games.
In the previous reports were only CFB included in the scope. Both CFB and ADS are businesses that can have meaningful and extensive interactions with users and customers within a jurisdiction. In the proposal OECD mentions that some businesses will be out of scope of the new taxing right, for example financial services. Another proposed exemption is to exclude groups with a global revenue of less than EUR 750 million, or groups with a global revenue exceeding EUR 750 million but has a limited ADS or CFB income. As mentioned earlier, this is only a proposal and no final decision has been made.
New profit allocation rules
Based on the consolidated accounts, part of the profit of ADS or CFB must be allocated to a market jurisdiction over a certain limit and with a certain de minimis foreign revenue. The calculation and distribution of Amount A is performed through a three-step formula not based on the arm’s length principle (ALP). Similar to previous report, there are requests for segmentation for taxpayers who perform both ADS / CFB and other activities within the same jurisdiction.
As noted in the draft proposal the new rules may lead to double taxation. OECD recommends that the existing methods for eliminating double taxation might be an appropriate solution. Another proposed solution is implementing safe harbors.
A new Nexus
If sales in a market jurisdiction exceed a certain amount, the Group will have a so-called Nexus, i.e. a presence in the jurisdiction where the consumer is located. The new Nexus shall only be used to identify market jurisdictions eligible for amount A and will not lead to any other tax consequences for the Group.
The Nexus rules may be applied differently for ADS and CFB. The very nature of ADS allows them to provide their services remotely and with a substantial and persistent engagement with the market without physical presence, compared to CFB where the opportunity to participate remotely is smaller. The profit margins in CFB are typically lower than those in ADS, which may justify a higher threshold for CFB.
No consensus has been reached regarding the thresholds, but the report gives the impression that the thresholds will be different for ADS and CFB. Furthermore, lower thresholds are considered for developing economies.
Fixed return – Amount B
In order to simplify the management and reduce the number of disputes between companies and tax authorities, the OECD proposes a fixed remuneration, Amount B, for certain activities. Amount B represents a standardized remuneration for certain marketing and distribution activities. To clarify which companies are entitled to a fixed remuneration, Amount B, OECD sets out a number of requirements in a positive list (i.e. positive indications of what such a company does), and a number of requirements of what such company should not do, i.e. a negative list. The company in question should, for example, not perform excessive R&D to be eligible for Amount B. Additional requirements or exceptions may apply.
The remuneration is proposed to be based on benchmark analyzes and a percentage return on sales (varies depending on industry and area).
Dispute resolution mechanisms
Different approaches to prevention and dispute resolution mechanisms are proposed to avoid double taxation with respect to Amount A. In essence, all proposals require government commitments.
Developing a consensus solution for 137 members regarding digital taxation has shown to be both a challenging and extensive task for the OECD. Due to the Covid-19 outbreak during the year, the work has become more difficult and the pressure is now increasing further on the OECD to present a consensus solution in mid-2021 to prevent countries from implementing their own regulations.
However, the report lacks consensus in most areas and much work is needed concerning the scope, the exceptions, thresholds etc. Nevertheless, we would like to emphasize that the extended scope, if it remains in the final report, means that more companies will be affected by the new rules than the previous reports indicated.
Despite all the uncertainties, if the final proposal has any similarities with this draft, it will lead to major changes for tax authorities and multinational companies. The implementation of, and compliance with, Pillar One will be both time and cost consuming and the problems seem to become more complicated the more detailed the reports become.
If you have any thoughts or concerns about how the OECD’s new Pillar One may affect your company, you are welcome to contact us.
We will follow the developments with interest and will post an update when the next report is published.