A statement by the Inclusive Framework on base erosion and profit shifting (BEPS) released on 31 January 2020 noted that the international community will continue working on a long-term consensus-based solution to the tax challenges of the digital economy and aim to compete the work by the end of 2020. The statement was issued following a meeting of the inclusive framework on 29 and 30 January 2020. Discussion will continue on a two-pillar solution as previously outlined by the OECD, including new nexus rules to determine where tax should be paid and profit allocation rules.

Pillar One

The basis for the solution will be the Unified Approach on Pillar One along the lines put forward by the OECD in October 2019. The revised Programme of Work under Pillar One aims to deliver a consensus-based solution by the end of 2020 as required by the G20.

The unified approach expands the taxing rights of the market jurisdictions, which are often the jurisdictions where users of the services are located. The approach distinguishes between three types of taxable profit that could be allocated to a market jurisdiction as follows:

Amount A is a share of residual profit that would be allocated to market jurisdictions according to a formula applying at group level and not depending on physical presence in the country. It reflects profits from participation in the economy of the market jurisdiction, through activities taking place in, or remotely directed at, that jurisdiction.

Businesses within the scope of this new taxing right would include automated digital services such as online search engines, social media platforms, online intermediation platforms, digital content streaming and online advertising services; and consumer-facing businesses such as personal computing products, clothes, toiletries, branded foods and automobiles.

Amount B would be a fixed remuneration for the group calculated on the basis of an arm’s length return for defined distribution and marketing functions in the market jurisdiction.

Amount C would cover any additional profit attributable to the market jurisdiction if in-country functions are more than the baseline activity compensated under Amount B. The scope of Amount C is still being discussed but it also includes a requirement for improved dispute resolution processes.

Each of the three types of taxable profit cover different aspects of activity in the market jurisdiction although there could be points of overlap. Amounts B and C do not create any new taxing rights as they are based on existing profit allocation rules, including the physical presence requirement, with improved practical application of the arm’s length principle. Only Amount A relies on a formula-based approach.

Safe Harbour Basis

The Statement notes a proposal by the US to implement Pillar One on a safe harbour basis; but recognises that many Inclusive Framework members have reservations concerning the proposed safe harbour approach. The Statement covers other policy issues that must be agreed under Pillar One, including the safe harbour issue, but a final decision on this issue will be made when the main outline of Pillar One has been agreed upon.

Pillar Two

Progress has also been made on Pillar Two, which is intended to ensure that multinational enterprises pay a minimum level of taxation. Work is continuing on the income inclusion rule; switch-over rule; undertaxed payments rule and subject-to-tax rule. There is also ongoing work on co-ordination and simplification and compatibility with international obligations.