In October 2019, the OECD published a discussion draft for a ‘Unified Approach’ under Pillar One. This document was an attempt by the OECD to advance discussion on taxation of the ‘digital economy’, i.e. BEPS Action 1. The objective was to combine the various options previously discussed in this respect into one ‘final’ solution. The OECD wished to receive public commentary on the draft so that it could establish a final document by late 2020. However, because of the Covid-19 pandemic and the US government’s announcement that it is postponing Pillar One negotiations, it would appear highly unlikely that the deadline will be met. Nonetheless, it is interesting to take a closer look at the ‘Unified Approach’, because it appears to at least partially reflect the intentions of various jurisdictions, including the EU, which have announced the introduction of their own (unilateral) digital service tax.
What does the ‘Unified Approach’ suggest?
The OECD acknowledges that, because of the digitalization of the economy, there would appear to be no need for multinational enterprises to be present in every jurisdiction where they trade. For this reason, the current almost 100-year-old allocation keys of corporate income taxing rights can be considered – at least for the larger B2C digital companies – to be obsolete. Based on the current allocation keys, physical presence is required in certain jurisdictions to allow it to execute its taxing rights, whereas under the ‘Unified Approach’, a ‘digital presence’ alone already allows jurisdictions to execute their taxing rights. However, because most multinational enterprises carry out digital activities, it may prove quite burdensome to delineate those enterprises to which the new nexus approach will apply, a fact of which the OECD itself is also aware.
The ‘Unified Approach’ introduces a new ‘nexus’ approach, i.e. having a certain level of ‘digital sales’ in a jurisdiction rather than a physical presence. It is not envisaged, however, that this new ‘nexus’ will replace the old one; it should merely be considered a supplement to the already existing model. Furthermore, the ‘Unified Approach’ suggests a three-tier allocation of profits, i.e. so-called Amount A, Amount B and Amount C.
Of these amounts, Amount B seems the easiest to apply, i.e. remuneration for low-risk marketing and distribution supporting activities. However, to avoid discussions on remuneration, an option might be to set fixed percentages (perhaps for different industries and/or geographical areas). Overall, the remuneration under Amount B, which is based on the arm’s length principle, is taxed according to the ‘old’ nexus approach.
Amount C was created to allow jurisdictions to allocate additional profit to themselves if they can successfully argue that – besides the activities under Amount B – additional activities are performed in their jurisdictions for which remuneration is due. The level of this remuneration should be set, once again, by applying the arm’s length principle, thus being rather straightforward. However, as the overall remuneration under this new nexus approach will not change if one or more jurisdictions wish to apply Amount C, whereas Amount B is already fixed, this would imply a reduction of Amount A. Because this amount is divided over multiple jurisdictions (see below), the application of Amount C will – most likely – result in multiple Mutual Agreement Procedures to mitigate the risk of double taxation.
Finally, Amount A is that which is most important in the ‘Unified Approach’; this amount represents the sum to be allocated to so-called ‘market jurisdictions’. Amount A is considered to reflect the deemed residual profit that should be allocated to ‘market jurisdictions’, whereby the size of the market in each jurisdiction must be considered to arrive at a ‘well-balanced’ allocation. Although at first glance it might seem feasible to accurately calculate Amount A, given the fact that this will probably be based on a pre-set formula, the actual allocation of Amount A (and review of its correctness) might well prove a matter for discussion, since each individual ‘market jurisdiction’ will only represent a quite small part of the puzzle and only the taxpayer itself can provide enough information. The question is whether taxpayers are willing (and able) to share such information, as this will represent a significant administrative burden whereas, in the long term, it might be questionable whether individual taxpayers will have enough information available to provide this information, e.g. the scope of the (global) market and the local market(s), information on what years should be applied etc.
Potential backdrops of the suggested ‘Unified Approach’
Because the ‘Unified Approach’ will be an additional nexus allocation key, local taxing rights and tax treaties must be adjusted to allow tax authorities to apply this new nexus approach. However, if not all jurisdictions apply the new nexus approach (at the same time), a new loophole may well be created in taxation of multinational enterprises, since these enterprises could argue that, based on local legislation, the new nexus approach should be applied, with allocation of part of their profit to another jurisdiction, whereas that other jurisdiction might not yet be able to tax these profits because of legislative constraints. So, instead of solving a problem, the ‘Unified Approach’ may create a new one.
Furthermore, even if only a few jurisdictions apply the ‘Unified Approach’ and the first backdrop as mentioned above is solved, the extensive administrative burden for taxpayers confronted with this new nexus approach will be significant (and even more burdensome if only applicable to a few jurisdictions).
Finally, if a taxpayer is not physically present in a jurisdiction, how will such a jurisdiction be able to actually execute its taxing rights, i.e. who must be contacted for the filing of a tax return, and where should authorities go if such obligations as paying taxes are not correctly met?
The ‘Unified Approach’: still an approach to be considered
As mentioned early in this article, the ‘Unified Approach’ appears to (partially) reflect the intentions of various jurisdictions that have announced a unilateral ‘digital service tax’. If such a new ‘digital service tax’ is introduced unilaterally, this may severely impact taxes due by multinational enterprises, since mechanisms for solving potential double taxation are unlikely to be in place. Because many jurisdictions have made significant expenditures in an attempt to protect their economy from the adverse consequences of the Covid-19 pandemic, unilateral introduction of a ‘digital service tax’ may prove a (relatively easy) path forward for the mitigation of debts incurred.
Final remarks
Although the ‘Unified Approach’ is still a suggestion by the OECD, and the introduction of unilateral ‘digital service taxes’ is still minimal, being aware of these trends can allow you to examine these topics and analyse whether you may eventually be confronted with the new taxing rights. If this is indeed the case, you then have time to consider how to plan for these new taxing rights and/or adjust your financial systems such as to enable you to provide the information that these new taxing rights will demand.
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