On 13 February 2019 the OECD’s Inclusive Framework published a consultation document on issues relating to the tax challenges of digitalisation of the economy. This follows the publication on 29 January 2019 of a Policy Note and the agreement of the members of the Inclusive Framework on the proposals to be examined. The aim is to reach consensus on a long-term policy in this area by 2020.

Profit allocation and nexus rules

Digital businesses can create value through activities linked to a jurisdiction without actually having a physical presence there. This occurs because of three characteristics of these businesses – scale without mass, a heavy reliance on intangible assets, and the role of data and user participation. Any solution to this “nexus” issue also needs to find a method for profit allocation, otherwise there will be increased uncertainty for taxpayers and increased tax controversy.

The Inclusive Framework is currently looking a three proposals to deal with the issues – the user participation proposal, the marketing intangible proposal and the concept of significant economic presence.

User participation model

This model looks at the value created by highly digitalised businesses (e.g. social media platforms, search engines or online marketplaces) through an active user base, where the business solicits data and content contributions. Soliciting the engagement and active participation of users is important for value creation for some digitalised businesses. The activities and participation of users contributes to creating of the brand, generating of valuable data, and developing market power through a critical mass of users.

The profit allocation rules could be revised to include the profit creating activities related to the user base, for example using a residual profit split approach; and the nexus rules could be revised to give jurisdictions where users are based the right to tax the profit allocated to them.

Marketing intangibles approach

The marketing intangibles approach would also change the profit allocation and nexus rules but would have a wider scope to address the broader impact of digitalisation.

The approach sees a functional link between marketing intangibles and the market jurisdiction (where users are located). Intangibles such as

brand and trade name arise through users in the market jurisdiction; and other marketing intangibles, such as customer data, lists and relationships and customer lists result from activities targeted at customers and users in the market jurisdiction.

This approach would therefore modify the transfer pricing and tax treaty provisions to allocate marketing intangibles and associated risks to the market jurisdiction. The market jurisdiction could tax some or all of the non-routine income associated with the marketing intangibles and associated risks.

Significant economic presence

If a non-resident has a significant economic presence based on a purposeful and sustained interaction with the jurisdiction via digital technology and other automated means a taxable presence could arise under this proposal. Revenue generated on a sustained basis would need to be combined with other factors establishing a nexus, for example the existence of a user base and associated data input; a certain volume of digital content derived from the jurisdiction; billing and collection in local currency or with a local form of payment; maintenance of a website in a local language; responsibility for the final delivery of goods to customers or the provision by the enterprise of other support services; or sustained marketing and sales promotion activities, either online or otherwise, to attract customers.

There would need to be a link between the revenue generating activity and the significant economic presence. In relation to revenue there would need to be a definition of the types of transactions covered and appropriate thresholds.

Allocation of profit could be done using a fractional apportionment method. This would involve defining the tax base to be divided, for example by applying the global profit rate of the MNE group to the revenue generated in a particular jurisdiction; determining the allocation keys to divide that tax base; and weighting these allocation keys. A withholding tax could be used as a collection mechanism.

Global anti-base erosion proposal

A global anti-base erosion proposal would introduce two inter-related rules to deal with other BEPS challenges. An income inclusion rule would tax the income of a foreign branch or a controlled entity if the income was subject to a low effective tax rate in the residence jurisdiction; and a tax on base eroding payments would deny a deduction or treaty relief for payments unless they were subject to an effective tax rate at or above a minimum rate.

Public consultation

Comments on the consultation document are invited by Friday, 1 March 2019. The Inclusive Framework is to hold a public consultation on the issues on 13 and 14 March 2019 to give external stakeholders an opportunity to provide input at an early stage in the process.