Action 1 Tax Challenges Arising from Digitalisation

The world has changed significantly in the last 100 years, and particularly over the last decades as a result of the digital transformation. This has a wide range of tax implications cutting across direct and indirect taxation, impacting tax policy and tax administration alike. But one of the implications that has been at the centre of the recent global debate is whether or not the international income tax rules continue to be ‘fit for purpose’ in the modern global economy where new and often intangible value drivers come to the fore, and physical distances are losing their relevance.

One aspect of this debate relates to how taxing rights on income generated from cross-border activities should be allocated among countries, and the suggestion that the changes caused or facilitated by digitalisation – notably scale without mass, heavy reliance on intangible assets, and the importance of data – require to revisit some fundamental aspects of the international tax system (so-called ‘profit allocation’ and ‘nexus’ rules). Another aspect of this debate relates to BEPS, and the suggestion that digitalisation has facilitated tax avoidance and the shift of profit to MNE entities subject to no or very low taxation.

The stakes are high. Notwithstanding the progress achieved in tackling double non-taxation with the implementation of the BEPS package, growing discontent with the taxation outcomes produced by an international tax system that was developed in a “brick and mortar” economic environment has led an increasing number of countries to adopt (or consider adopting) uncoordinated and unilateral measures. Failure to deliver a comprehensive and consensus-based solution to these issues – i.e. BEPS and the allocation of taxing rights – could thus lead to a proliferation of unilateral actions which would not only undermine the relevance and sustainability of the international income tax system, but also more broadly damage global investment and economic growth. This work of the Inclusive Framework is thus about ensuring that the international tax framework for MNEs remains relevant for today and the future, thereby promoting economic efficiency and global welfare. It will also ensure that governments continue to efficiently raise revenues not only from traditional but also from digital businesses, both for direct tax and indirect tax purposes. 

The timeline agreed in the G20 is to develop a consensus-based solution by the end of 2020. This is extremely ambitious given the need to revisit fundamental aspects of the international tax system, but is reflective of the political imperative that all members of the Inclusive Framework attach to finding a timely resolution of the issues at stake.

After the delivery of the Interim Report in March 2018, the Inclusive Framework continued its work and delivered a Policy Note in January 2019 including concrete proposals made by members framed within two complementary pillars.

• Pilar 1 - Re-allocation of profit and revised nexus rules: this pillar will explore potential solutions for determining where tax should be paid and on what basis ("nexus"), as well as what portion of profits could or should be taxed in the jurisdictions where clients or users are located ("profit allocation").
• Pillar 2 - Global anti-base erosion mechanism: this pillar will explore the design of a system to ensure that multinational enterprises – in the digital economy and beyond – pay a minimum level of tax. This pillar is intended to address remaining issues identified by the OECD/G20 BEPS initiative by providing countries with new tools to protect their tax base from profit shifting to jurisdictions which tax these profits at below the minimum rate.

A public consultation document describing the two pillars in more detail was also published in February 2019, followed by a public consultation meeting in March with over 400 participants attending from business, academia and civil society. 

The result of these efforts are now reflected in the Programme of Work to Develop a Consensus Solution to the Tax Challenges Arising from the Digitalisation of the Economy adopted in May 2019, which contains a plan to explore the technical design and implementation issues that must be worked out to develop a comprehensive and consensus-based solution within the agreed 2020 timeframe.

The OECD is also providing support to developing countries on this work, through a set of regional events on digitalisation, carried out in partnership with regional organisations and development banks. 

Change the allocation of taxing rights through a coherent and concurrent review of the profit allocation and nexus rules (Pillar 1)

The 2015 Action 1 Report identified a number of broader tax challenges raised by digitalisation which it identified as “nexus, data and characterisation”, and that relate to the question of how taxing rights on income generated from cross-border activities in the digital age should be allocated among countries. While some options to address these concerns were discussed, no consensus emerged and decision was made to continue working in this area. This continued work led to the delivery of an Interim Report in March 2018 analysing the impact of digitalisation on business models and the relevance of this for the international income tax system. Members of the Inclusive Framework did not converge however on the conclusions to be drawn from this analysis, and committed instead to continue working together to deliver a final report in 2020 aimed at providing a consensus-based long-term solution. Consistent with that mandate, recent work of the Inclusive Framework has focused on the examination of a number of proposals that seek to revise contemporaneously the existing profit allocation and nexus rules, with a view to allocate more taxing rights to the country where the customers and/or users are located (so-called “market country”). The implications of these proposed solutions reach into fundamental aspects of the current international tax architecture, as they entail modifications potentially going beyond the arm’s length principle and no longer contrained by physical presence requirements.

Remaining BEPS issues and minimum taxation (Pillar 2)

The second pillar identified in the Programme of Work will explore the design of a system to ensure that multinational enterprises – in the digital economy and beyond – pay a minimum level of tax. This pillar would provide countries with a new tool to protect their tax base from profit shifting to low/no-tax jurisdictions, and is intended to address remaining issues identified by the OECD/G20 BEPS initiative.

The approach would leave jurisdictions free to determine their own corporate tax rates (including whether they have a corporate income tax) but allow other jurisdictions to tax income that would otherwise be subject to low levels of effective taxation thereby ensuring that all internationally operating businesses pay a minimum level of tax.

The work on this approach is based on the premise that, in the absence of multilateral action, there is a risk of uncoordinated, unilateral action, both to attract more tax base and to protect existing tax base, with adverse consequences for all countries. The approach therefore seeks to advance a multilateral framework to achieve a balanced outcome which limits the distortive impact of direct taxes on investment and business location decision and provides a backstop to the first pillar for situations where the relevant profit is booked in a tax rate environment below a minimum rate.

In the area of Value-Added Taxes and Goods and Services Taxes (VAT/GST), the BEPS Action 1 Report identified that digitalisation created both BEPS risks and broader challenges.  BEPS risks arise from highly digitalised businesses structuring their affairs to pay little or no VAT on remotely delivered services and intangibles, while the broader tax challenges were associated with the collection of VAT on cross-border supplies of goods, services and intangibles from online sales, particularly cross-border B2C sales.

The recommendations in BEPS Action 1 have been integrated into the 2016 International VAT Guidelines and complemented by the 2017 report on Mechanisms for the effective collection of VAT/GST where the supplier is not located in the jurisdiction of taxation and the 2019 report on The role of digital platforms in the collection of VAT/GST on online sales which provide guidance on implementation to jurisdictions.

Implementation of the BEPS Action 1 VAT recommendations has been very encouraging. Over 50 jurisdictions have adopted rules for the application of VAT to B2C supplies of services and intangibles from online sales by foreign vendors. Of these, 40 have implemented simplified registration and collection regimes for the collection of VAT on the cross-border B2C supplies of services and intangibles.

The BEPS Implementation Report confirms the assessment that implementation has greatly enhanced compliance levels and yielded substantial tax revenues for market jurisdictions, and has levelled the playing field between domestic suppliers and foreign vendors. Jurisdictions are now increasingly turning their attention to the collection of VAT on imports of low-value goods, which has the potential to yield significant revenues for jurisdictions and importantly also address competitive distortions.