OECD Policy Note - Addressing the Tax Challenges of the Digitalisation of the Economy

The release of this OECD Policy Note on 23 January 2019 “Addressing the Tax Challenges of the Digitalisation of the Economy” builds on an Interim Report dating from March 2018 called “Tax Challenges Arising from Digitalisation”, which provided an in-depth analysis of value creation across new and changing business models in the context of digitalisation and the tax challenges they presented.

Background

The challenges identified include the risks remaining after BEPS, for highly mobile income producing factors which can still be shifted into low-tax environments. Members of the framework did not converge on the conclusions to be drawn from this analysis, they committed to continue working together towards a final report in 2020 aimed at providing a consensus-based long-term solution, with an update later in 2019.

The framework will address two aspects of the BEPS project, namely:

  • Pillar one - the broader challenges of the digitalised economy and the allocation of taxing rights,
  • Pillar two – the remaining BEPS issues.

Most notably, the framework has undertaken the analysis of the above on a “without prejudice” basis.

Pillar One

Pillar One looks at the present allocation of taxing rights including nexus or “country” issues. Multiple proposals have been submitted in this area, that would allocate more taxing rights to market or user jurisdictions in situations where the value is created by a business activity through participation in the user or market jurisdiction that is not recognised in the framework for allocating profits.

The framework recognises that the implications of these proposals may reach into fundamental aspects of the current international tax architecture.

Some of the proposals would require reconsideration of the current transfer pricing rules as they relate to non-routine returns, and other proposals would entail modifications potentially going beyond non-routine returns.

The framework also goes beyond the limitations on taxing rights principally determined by reference to a physical presence, which is accepted as the present corner stone of the current rules and have identified three characteristics not linked to a physical location, notably;

  • scale without mass;
  • a heavy reliance on intangible assets; and  
  • the role of data and user participation.

These characteristics of a highly digitalised businesses act together to create value by activities closely linked with a jurisdiction without needing to establish a physical presence.

The framework indicates that issues of profit attribution and nexus would need to be developed contemporaneously with each playing a key role in any solution ultimately adopted, noting that they may require changes to tax treaties. On nexus, the framework proposes to explore different concepts, including changes to the permanent establishment threshold, such as the concept of “significant economic presence” which was discussed in the Action 1 Report or the concept of “significant digital presence”, as well as special treaty rules.

In all cases, the proposals should lead to solutions that go beyond the arm’s length principle. However, any solution that seeks to address nexus must also address the closely related issue of profit allocation, or it is bound to fail.

Pillar Two

The second pillar will primarily look at an income rule and a tax on base eroding payments. Through these two key aspects the framework proposes to explore taxing rights that would strengthen the ability of jurisdictions to tax profits where the other jurisdiction, with taxing rights, applies a low effective rate of tax  to those profits.

The proposal recognises the fact that countries remain free to set their own tax rates or not to have a corporate income tax system at all. Instead, the proposal considers that in the absence of multilateral action there is the risk of un-coordinated, unilateral action, seeking to attract and protect tax bases, with adverse consequences for all countries, large and small, developed and developing.

Follow Up

A 32 page public consultation document has also been issued which seeks comments on several policy issues and technical aspects, setting out the “Revised Profit allocation and nexus rules” and the breakdown of the potential solutions along with in-depth analysis. While the second part of the note continues to set out proposals to address the continued risk of profit shifting to entities subject to no or very low taxation through the development of two interrelated rules: an income inclusion rule and a tax on base eroding payments.

Given the intention for the consultation to inform policy makers, the consultation is open for three weeks and interested parties are invited to send their comments to the OECD no later than 1 March 2019

Summary

A dual approach recognises that the digitalisation of the economy is extensive, raises broader issues, and is most evident in, though not limited to, highly digitalised businesses. Questions raised of where tax should be paid, and if so in what amount, remain unanswered.

Further features of the digitalising economy magnify the BEPS risks and enable business models that shift profits to entities that escape taxation or are taxed at only very low rates.

Any proposed solution would require broad-based work that covers the overall allocation of taxing rights through revised profit allocation rules and revised nexus rules, as well as anti-BEPS rules.

If you have any questions in relation to the above, or if you would like to discuss this topic further, please contact a member of the Mazars corporate tax team below:

Staff Member

Position

Email

Telephone

Cormac Kelleher

Tax Partner

ckelleher@mazars.ie

01 449 4456

Claire Healy

Tax Director

chealy@mazars.ie

01 449 6477

       

February 2019

February 2019 Tax Newsletter

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February 2019 Tax Newsletter

This series of articles will provide you with an update on tax developments that impact organisations in Ireland and those that do business with Ireland.