There is growing consensus to support a U.S. proposal for the reform of global corporate tax rules, which would limit the ability of multinational companies to shift profits to low-tax jurisdictions, according to the Organisation for Economic Co-operation and Development.
In January, the OECD presented four different proposals to redesign corporate tax rules to address issues raised by the digital economy. One of the four plans, developed by the U.S., would significantly change how countries share the right to tax multinational companies, Pascal Saint-Amans, head of tax at the OECD, told the Financial Times.
“It needs to be refined but the philosophy of the U.S. tax proposal is pretty strong,” Saint-Amans said. “They have the U.S., Brazil, China, India and other emerging economies lined up.”
He suggested Washington’s position on digital tax reform had undergone “a fundamental change” and now aims to protect the U.S. tax base after the tax reform cut rates in 2017.
The OECD released a policy note that was approved by the 127 member countries of the Inclusive Framework on BEPS, an OECD initiative aimed at tackling the erosion of tax bases and the shifting of profits to low-tax jurisdictions.
The Inclusive Framework member countries, including the Cayman Islands, agreed to examine the proposals to address the tax challenges caused by the digitalization of the economy involving two pillars.
The first pillar considers the broad challenges of the digitalized economy and focuses on the allocation of taxing rights and the second pillar examines the remaining BEPS issues.
Some of the proposals are taking a fresh look at taxing rights and the issue of nexus – the connection a business has with a given jurisdiction, often based on sufficient physical presence – by considering new theories around where value is created.
“The international community has taken a significant step forward toward resolving the tax challenges arising from digitalization,” Saint Amans said. “Countries have agreed to explore potential solutions that would update fundamental tax principles for a twenty-first century economy, when firms can be heavily involved in the economic life of different jurisdictions without any significant physical presence and where new and often intangible drivers of value become more and more important.”
In addition, Saint-Amans said the features of the digitalized economy exacerbate risks and enable structures that shift profits to entities that escape taxation or are taxed at only very low rates.
In a previous report, the OECD summarized the core elements of digitalization as the ability to scale without mass, a higher reliance on intellectual property and the role of users in the value creation.
One of the proposals now discussed would revise existing rules on nexus and on profit allocation by referring to the active contribution of service users. The aim is to attract taxing rights to the territory, where the active user base is located. This is based on the premise that a significant part of the value generated by a business is created by the users, for example by providing their data to a search engine or social media platform. This personal information is then monetized by selling it to advertisers.
Another broader approach focuses on the so-called “marketing intangible.” This approach suggests that a company generates value and makes profit by engineering, marketing and selling its product and that when considering both the nexus and transfer pricing rules, the value created by the “marketing intangible” should be recognized in the jurisdiction where the product is marketed.
A third proposal aims to simplify the provision of taxing rights to jurisdictions where a digitalized product is marketed by focusing on sales, in addition to the idea of significant economic presence. This approach would transcend digital companies and also encompass more traditional businesses.
The fourth proposal focuses on the remaining issues after the implementation of BEPS and targets instances where profits can still be shifted to low tax jurisdictions. It aims to provide both the resident’s country and the source country with a right to tax profits that are subject only to a low or very low level of taxation.
Most of the proposed reforms would entail a significant departure from the current approach where nexus and taxing rights depend largely on economic activity and substance in terms of where the employees, offices and assets are located.
“The Inclusive Framework recognizes that the implications of these proposals may reach into fundamental aspects of the current international tax architecture,” the OECD said in its policy note.
While some member countries of the BEPS Inclusive Framework want to concentrate solely on digital businesses, the OECD is convinced that the “digitalization of the economy is pervasive, raises broader issues, and is most evident in, but not limited to, highly digitalized businesses.”
Any new regime would therefore apply to all multinational companies and not just digital firms.
The proposed reform would move taxable profits of multinationals from offshore financial centers and export nations to countries that have a large number of consumers.
Bruno Le Maire, the French finance minister, called the OECD announcement important.
“We have been fighting for months to advance the topic of fair taxation of the digital giants, and we are starting to see the results: 127 countries are committed to changing tax rules,” he said.
The OECD aims to reach a consensus-based, long-term solution in 2020, with an update to be presented to the G-20 during 2019.
Given the significance of the new proposals for the international tax system, the Inclusive Framework will issue a consultation document that describes the two pillars in more detail, and a public consultation will be held on March 13 and 14, 2019 in Paris as part of the meeting of the Task Force on the Digital Economy.
Further details on the consultation process, including how stakeholders can provide input and most effectively participate, along with the consultation document, will be published in the coming weeks, the OECD said.