Will governments, hit by slowdown, rush to adopt new OECD taxing rights?

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Digital transformation has changed the way businesses operate, brought in new business models and transformed old ones. The new-age digital companies pose a challenge to taxation as such companies are able to earn significant revenue even from countries where they have virtually no physical presence. Countries are in a dilemma on how to tax revenue earned by companies with no local physical presence as taxation is conventionally linked to entities having physical presence in a particular country.

To address this issue, in 2015, the Organisation for Economic Cooperation and Development (OECD) released its Action Plan highlighting the tax challenges in the digital economy. Then in March 2018, the OECD released an interim report which contained an in-depth analysis of new and changing business models and possible implications for the international tax system primarily in areas of nexus and profit. Post this, the OECD released a policy note exploring two pillars (Pillar One and Pillar Two) for resolving the identified tax challenges of digital economy. OECD and G20 member countries have endorsed that these pillars will be the basis for negotiating and developing a consensus based solution in the future.

Pillar One addresses tax challenges related to nexus and profit-allocation to a country, and under a ’Unified Approach‘ envisages that three types of profits can be attributed to a country (i.e. Amount A, Amount B and Amount C).

Amount A is a new taxing right that will be introduced in countries; it will let a country's tax profits earned by businesses due to their sustained participation in the economy of that country, irrespective of physical presence. Automated digital services and consumer facing businesses are two broad business activities identified as 'in-scope' businesses.

Automated digital service includes businesses operating in online search engines, social media platforms, online intermediation platforms, digital content streaming, online gaming, cloud computing services and online advertising services. One can expect more additions to this list. It is noteworthy that digital content streaming need not be only for entertainment platforms. It can include any activity that requires streaming, for e.g. undertaking a virtual education course or tutorial.

Consumer-facing businesses would seek to cover those companies that are earning profits in a country either by direct sales or through resellers performing routine tasks. For example, sales undertaken by the distributor of a global cosmetics company that has set up a reseller for distributing products in India, would get covered. Typically, the distributor would keep a guaranteed margin and remit the balance payments overseas, as payment for purchase of goods without deducting any taxes. With the introduction of this new taxing right, it is envisaged that the amount remitted towards purchase of goods would be taxed in India by Indian tax authorities.

Amount B and Amount C relate to providing a return to a country for marketing activities carried out in it. Amount B seeks to provide a fixed return to a country for baseline marketing and distribution activities carried out by a Multinational Enterprise (MNE) group in that country. The objective for introducing Amount B is to put at rest the ongoing global litigation for revenues earned by limited risk distributors. As against this, Amount C seeks to cover an additional return for marketing activities carried out over and above the baseline marketing activities envisaged in Amount B.

Pillar Two, commonly referred to as ‘GloBE proposal‘, proposes that MNE groups should be subject to minimum global rate of tax. Pillar Two is aimed at reducing profit shifting by MNEs by reducing tax differentials between countries, thereby reducing the incentive for MNEs to shift profits.

Based on an analysis of data gathered from more than 200 countries and 27,000 firms, it is estimated that the proposals under the two pillars will have extensive impact on companies in digital-oriented and intangible-intensive segments. The combined effect of Pillars One and Two, is expected to increase the global corporate tax revenues by 4 percent, i.e. up to $100 billion per year; the gains are likely to be same / comparable across high, middle and low income group countries. It is also expected that investment hubs would experience loss of revenue.

Further, given the financial situations of many countries because of COVID-19, such countries may seek unilateral implementation of these proposals. This sudden spur in businesses going digital and with recession looming large, may act as a further impetus to introduce the proposals unilaterally even though OECD still has to undertake significant work to finalise them.

Considering on-going evolution of new tax regimes, companies may need to internally assess their processes, analyse whether user participation, value drivers for their products, come within the ambit of the above Pillars. Companies should assess their ability to generate accounting data related to products and geography as this will impact the taxability in a country.

Companies should take a practical approach to develop transparent systems and be agile to adapt to changes envisaged. Businesses should therefore introspect proactively and analyse the applicability of the OECD proposal to ensure preparedness once the law comes in force.

About authors: Bhupendra Kothari is Senior Director, Dhruba Saha is Senior Manager and Urvi Jagirdar is Manager, Deloitte Haskins and Sells LLP

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