A Tax Talk held by the OECD on 9 October 2019 summarised developments on dealing with the tax challenges of the digital economy.

Pillar One

On 9 October 2019 the OECD Secretariat published a Secretariat Proposal for a “Unified Approach” to taxing certain digital activities. This includes a new nexus rule and profit allocation rules, a three-tier mechanism for taxing the profits and rules for eliminating double taxation and dispute resolution.

Comments on the paper are invite by 12 November 2019 and a public consultation meeting will be held on 21 and 22 November 2019.

Ongoing work on Pillar One includes work on the definitions and thresholds that are still to be decided; the tax treatment of certain business models; business line segmentation; treatment of losses; administration; and elimination of double taxation.

Pillar Two

Pillar Two is the Global Anti-Base Erosion (GloBE) proposal that aims to ensure that international businesses pay a minimum level of tax. The OECD consultation document of February 2019 set out plans for inter-related rules that could help jurisdictions to resolve situations where income is subject to no or very low taxation. Work is continuing on aspects of the proposal including an income inclusion rule; an undertaxed payments rule; and switch-over and subject to tax rules. There also needs to be coordination of the order in which the rules are applied.

Income Inclusion Rule and Subject To Tax Rule

The 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. The 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.

Undertaxed payments rule

Ongoing work on this rule is looking at the types of related party payments to be covered by the rule and at the test to decide if a payment is undertaxed. The nature of the resulting adjustment based on the rule must be determined.

Blending

Still under discussion is the scope to be allowed for blending. This refers to the ability of taxpayers to mix high-tax and low-tax income to arrive at a blended rate of tax on income that is above the minimum rate.

Carve outs

There may need to be some exclusions (carve outs) from the rules, possibly involving an exclusion for regimes compliant with BEPS Action 5 on harmful.

Switch over rule

The switch-over rule for tax treaties would permit the residence state to apply the credit method instead of the exemption method where profits attributable to a permanent establishment (PE), or derived from immovable property that is not part of a PE, are subject to tax at an effective rate that is below the minimum rate. The design of the switch over rule needs to be simple to implement and administer.

Rationale for Pillar Two

The multilateral approach would help to avoid the proliferation of unilateral rules. The minimum tax would decrease pressure on developing countries to introduce tax incentives to attract investment, and the proposal would address the issue of profit shifting from the use of intangibles, without the need to ring fence proposals to apply only to the digital economy.

Consultation

A public consultation on Pillar Two will be held in December 2019.