Changes proposed by the OECD and G20 will have a significant impact on the tax and compliance obligations of digital businesses.
The Base Erosion and Profit Shifting (BEPS) project is an ongoing collaborative effort by the Organisation for Economic Co-operation and Development (OECD) and G20 countries to update the international tax system for the 21st century and prevent the shifting of profits to low-tax jurisdictions.
One of the main tax challenges identified as a focus area of the BEPS project is the digital economy and how taxing rights for cross border income generating activities should be allocated to individual countries.
A number of proposals have been put forward by the OECD, grouped into two “Pillars”, and intended to form a framework for achieving a consensus-based solution to cross border taxation by the end of 2020. This solution would then be adopted by OECD member/G20 countries in due course.
However, given the delays in achieving a multilateral agreement, some countries, notably the UK and France, have unilaterally introduced interim measures to counter some of the challenges.
Pillar One: A “unified approach” to taxing multinationals
Pillar One is relevant for “large” consumer facing businesses. Large is likely to be defined as those organisations currently within Country by Country Reporting (CbCR) and with a global turnover exceeding €750 million.
In November 2019 the responses to a consultation document on Pillar One were published, commenting that the proposals were too complex, and too restrictive in applying only to consumer facing businesses.
In summary, the proposals in Pillar One are to:
- Reallocate taxing rights to the jurisdiction where customers or users reside;
- Introduce a new nexus rule based on sales, unrelated to physical presence in a jurisdiction (this moves beyond current taxation models); and
- Depart from the current arm’s length principle for allocating income to the commercial operations carried out in that territory.
Pillar Two: Global Anti-Base Erosion (GloBE) proposal
Pillar Two focuses on the remaining BEPS issues not considered by Pillar One, and is not limited to highly digitised businesses. It seeks to design a system of taxation where multinational enterprises pay a minimum level of tax.
Four components are envisaged:
- An “income inclusion rule” where income of an overseas branch is taxed if that income is subject to less than a minimum tax rate;
- An “undertaxed payment rule”, which denies a deduction (or applies withholding tax) for some payments to a related party where the receipt is not subject to tax at or above a minimum rate;
- A “switch-over rule” to be introduced into tax treaties, which will permit a jurisdiction to switch from exemption to a credit method when profits attributed to a permanent establishment (PE), or derived from immovable property (non-PE), are not subject to a minimum tax rate;
- A “subject to tax rule” that would subject payments to withholding tax where the payment is not subject to a minimum rate of tax in the recipient jurisdiction.
Digital Services Tax
Despite the UK government’s ongoing commitment to a multilateral solution to the taxation of digital services, the October 2018 Budget announced the UK’s own Digital Services Tax (DST) regime, to be introduced from 1 April 2020. Draft legislation was published in July 2019.
The current draft legislation proposes that:
- DST will apply where a group’s worldwide annualised digital services revenue exceeds £500 million and its UK digital services revenue exceeds £25 million;
- A 2% tax will be levied on revenues generated from the provision of an online marketplace, a search engine or a social media platform, where those revenues are attributable to UK users; and
- A £25 million annual allowance will be available, on which no DST is payable; and
- An option is available to use an alternative basis of calculating the charge, which will be beneficial where a digital activity has a low or negative UK operating margin.
These proposals are subject to change, pending the March 2020 Budget.