The OECD introduced in February 2022 two sets of draft model rules for public consultation. The draft rules focus on aspects of “Amount A,” the share of a business’s residual profits that will be subject to the new taxing right created under Pillar One of the October 2021 two-pillar agreement endorsed by 137 members of the OECD/G-20 Inclusive Framework on BEPS to address the issues brought about by the digitalisation of the economy (for an analysis of the October agreement, see the article in the November 2021 issue of Corporate Tax News).
The OECD’s introduction of the draft model rules represents the next step in the process of implementing the two-pillar framework’s plan to reallocate some taxing rights to market jurisdictions into domestic legislation.
The first set of draft model rules, released on 4 February, addresses two aspects of Amount A -- nexus and revenue sourcing. The draft rules do not represent a consensus view among Inclusive Framework members; rather, the rules are a “working version” issued for public comment. Input on the discussion draft had to be submitted to the Inclusive Framework’s Task Force on the Digital Economy before 18 February. BDO submitted comments on these draft rules.
Under the October 2021 agreement, an in-scope multinational entity (MNE) -- one with global turnover above EUR 20 billion and profitability above 10% -- would be deemed to have sufficient nexus in a market jurisdiction if it derives at least EUR 1 million in revenue from that jurisdiction, or EUR 250,000 for smaller jurisdictions with GDP lower than EUR 40 billion. For an in-scope MNE, 25% of residual profit -- defined as profit in excess of 10% of revenue -- would be allocated to market jurisdictions with nexus using an allocation key.
To determine whether an MNE meets the nexus test, it would have to apply the revenue sourcing rules provided in the OECD draft to identify the jurisdiction in which revenue arises for purposes of Amount A. The newly released model rules create a special-purpose nexus rule that applies solely for this purpose.
The public consultation document’s proposed revenue sourcing rules provide that revenues must be sourced on a transaction-by-transaction basis, a concept that will be explained in more detail in the commentary the OECD plans to release soon. In principle, MNEs would be required to determine the source of revenue for each item that generates revenue; for example, each individual item of inventory or each “click” on an online advertisement.
To determine the source of revenue, covered MNEs would use a “reliable method,” defined as a method that identifies where revenues arise using a “reliable indicator” or, in some specific instances, an allocation key. An “indicator” is, in turn, defined as information that identifies the source of revenue.
Under the draft model rules, in-scope MNEs would have to source all revenue according to the category of revenue earned from each transaction. The draft rules provide guidance on seven types of transactions:
The second public consultation document, released on 18 February, sets out draft model rules for tax base determinations under Amount A of Pillar One.
The tax base determinations rules will be used to establish the profit (or loss) of an in-scope MNE that will be used for the Amount A calculations to reallocate a portion of the MNE’s profits to market jurisdictions. Under the proposed model rules, profit (or loss) would be calculated on the basis of the consolidated group financial accounts, with a limited number of book-to-tax adjustments. The draft rules also include provisions addressing the carryforward of losses.
As was the case with the draft revenue and sourcing rules, the tax base determination draft rules do not reflect consensus among the drafters regarding the substance of the document. Rather, the stakeholder input received will help guide the OECD in revising and finalising the rules. Comments on these draft rules had to be submitted no later than 4 March. BDO submitted comments on these draft rules.
As explained above, “Amount A” refers to the share of a business’s residual profits that will be subject to the new taxing right created under Pillar One. The tax base is the measure of profit that forms the basis for partial reallocation under Amount A rules.
Because Amount A is determined based on the profits of a group (rather than on a separate-entity basis), the model rules prescribe the use of consolidated group financial accounts as the starting point for computing the Amount A tax base. More specifically, the draft model rules call for the use of “Qualifying Financial Accounting Standards” to ensure that the profit that is applied for Amount A purposes is not impacted by accounting practices that do not align with common practice.
The draft model rules provide that the computation of the Amount A tax base would start from the bottom-line figure of the profit and loss statement (that is, the MNE’s total profit or loss). That number would then be subject to some book-to-tax adjustments, such as the deduction of certain items of income and the addition of certain expenses, to arrive at a standardised adjusted profit before tax.
The adjustments the draft model rules adopt reflect instances where the goals of accounting standards and Amount A may differ in some points, including occasions where the adjustment is required to prevent potential double counting of income or to prevent the deduction of specified expenses for policy reasons.
The proposed model rules state that, for ease of administration and compliance, the proposed adjustments will be kept to a minimum to limit complexity.
The draft tax base determination rules also include provisions allowing the carryforward of losses.