On 12 October 2020, the OECD released over 900 pages of documents related to its years-long effort to address the challenges of taxing the digital economy. The impetus for this effort was the recognition that existing tax systems do not adequately address the digital world in which economic activity is independent of physical presence. The primary focus of the OECD work is the development of a blueprint for taxing the digital economy through two pillars – Pillar 1, which introduces a new taxing right for jurisdictions in which users or consumers reside, even when the taxpayer has no physical presence in the country, and Pillar 2, a global minimum tax, which would apply to all large multinational groups, regardless of industry. Other aspects of the OECD work include an economic assessment of the effects of Pillars 1 and 2, and a survey of the landscape related to taxing virtual currencies.
Yet despite the significant effort of the OECD, the 137 members of the Inclusive Framework did not reach agreement on a specific, implementable plan. So we must ask: What has been accomplished? Is there anything that we should be doing now that these reports have been released? And, what can we expect over the next months and into 2021?
What has been accomplished?
As the OECD noted, the glass can be viewed as half full or half empty. The Pillar 1 report contains a detailed proposal for the mechanics of a new taxing right that attempts to address some of the inadequacies of current taxing systems with respect to the digital economy. In broad terms, this taxing right is based on a profit split model, in which a portion of a multinational group’s consolidated profit not associated with routine activities is re-allocated to market jurisdictions where there is active and sustained participation without a physical presence. The Pillar 2 report provides guidance for ensuring that multinational groups pay a minimum level of tax regardless of the jurisdictions where they are headquartered or operate.
While the reports are comprehensive in their scope, they lack specificity in many key areas, particularly those that relate to policy rather than structure. The Pillar 1 proposal, for example, reflects a lack of consensus on the most basic question of what types of businesses will be included in the new taxing regime. The current OECD proposal includes both digital businesses (automated digital services) and consumer-facing businesses within the scope of the new taxing right, but many questions remain. Without resolving the question of scope, further development of Pillar 1 cannot proceed. And, even when this question is resolved, other open items remain, including revenue and profitability thresholds, requirements for business line segmentation, the treatment of losses and the portion of profit subject to reallocation, among others.
In addition, Pillar 1 contains proposals for simplifying the transfer pricing of certain routine marketing and distribution functions, and for dispute prevention and resolution mechanisms. Disagreement and unresolved issues remain in both areas. In Pillar 2, again, while the structure of the minimum tax has been developed, fundamental questions remain unanswered, including how to implement the proposal without undue complexity, and how to prevent double taxation of income.
What should we be doing?
Although many of the key details of the proposals remain unresolved, there is much to do. First, the OECD has requested feedback from stakeholders, and is accepting written comments through 14 December 2020. In particular, the OECD has asked for proposals as to how both Pillars 1 and 2 could be simplified while still achieving their specified goals. BDO will be submitting comments as part of this process.
Second, multinational groups should be working to determine how the proposals would affect their global tax positions. Those within the scope of Pillar 1 should ensure that they have the data necessary to apply it. Even with the unresolved details in the plans, modeling can provide insight into the magnitude of the effects under a variety of scenarios, including one in which thresholds for inclusion are lowered over time to include smaller enterprises.
Finally, companies should consider the alternative if the Inclusive Framework cannot reach agreement. The OECD has stated that although Pillars 1 and 2 are technically free-standing or independent of one another, they are politically linked and can only proceed together. So, while in theory a minimum tax regime such as Pillar 2 could be implemented on its own and in one country at a time (e.g., the U.S. GILTI tax), it is unlikely that the Inclusive Framework will adopt Pillar 2 without reaching an agreement on Pillar 1. (In fact, one open issue in Pillar 2 is whether the U.S. GILTI regime would qualify as a Pillar 2 tax. If so, U.S. multinationals would not be further subject to Pillar 2.) On the other hand, should the OECD effort fail, both the European Union and many individual countries have vowed to move forward with unilateral measures, including digital services taxes, to address the taxation of the digital economy. Some countries, in fact, have already enacted digital services taxes and several more are under consideration around the world. Companies should be carefully monitoring these developments to understand the potential effects of such taxes on their businesses. BDO’s Taxation of the Digital Economy Tool is designed to help navigate this emerging landscape.
What happens next?
After the OECD receives written comments on the Pillar 1 and Pillar 2 proposals, a public consultation will be held, likely in early January 2021. Beyond that, the OECD expects to resolve all of the remaining technical and political issues by mid-2021, and to develop model draft legislation, guidelines, and other rules as needed for implementation. While nothing is certain, even if all the open issues are resolved by mid-2021, we would not expect to see implementation until late 2021 or early 2022.
Ultimately, no one can say with confidence when, how or even if a comprehensive plan to address the taxation of the digital economy will be enacted in 2021. On the other hand, taking a “wait and see” approach is imprudent. Companies can provide needed input to the OECD, understand and develop preliminary plans to address the potential effects of the OECD proposals (and their alternatives) on businesses, and monitor relevant developments closely as these efforts progress.