OECD Framework set to regulate taxation of digital companies
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OECD Framework set to regulate taxation of digital companies

The taxation of the digital economy has been a frequently discussed topic for many years. The OECD Framework is designed to regulate the taxation of digital companies and should be finalized by the end of 2020. In this article we provide you with an overview on the two pillar taxation of digital companies. Additionally we will discuss future challenges, a timetable of the OECD Inclusive Framework and the issue of digital company taxation as a political issue.

The pressure was high from the very beginning. As the Organization for Economic Cooperation and Development (OECD) finalized its Base Erosion and Profit Shifting Action Plan (BEPS Action Plan) in October 2015, the OECD simultaneously began to initiate another and even more far-reaching project: an Inclusive Framework (IF) for the taxation of the digital economy, due to be completed by the end of 2020.

The OECD framework for taxation of digital companies is based on two pillars

How come Amazon hardly pays any taxes in Germany? This is a recurring question in the public debate. The OECD Inclusive Framework approaches the low-taxation of digital companies with a two-pillar model.

The first pillar of the OECD Inclusive Framework creates a new nexus

The fundamental problem with the taxation of the digital economy is that, in the absence of traditional physical links such as residency or permanent establishments, the state in which the market is established has no right of taxation. Consequently, the first pillar of the Inclusive Framework (IF) proposes to link the right of taxation for companies that are considered „consumer facing“ or „highly digitalised“ to non-physical factors, thus creating a new nexus.

Once this nexus is in place, part of the residual profit will be considered taxable in the market state. For this purpose, after remuneration for routine activities in accordance with the arm’s length principle, the residual profit will be divided between the resident and the market state on a formula basis. The formula should be based on factors such as the estimated value contributions of the market states, for example ten percent of the EBIT over ten percent (10 over 10).

The second pillar of the OECD Inclusive Framework creates a global minimum tax through GLoBE

The second Pillar of the Inclusive Framework (IF) focuses less on digitisation but rather on more general BEPS issues in the context of a Global Anti-Base Erosion Proposal – GloBE. According to GloBE, taxation rights should be granted to one of the participating countries if the other participating country – and this is the crux of the matter – has sovereignly decided not to tax the profits at all or not to tax them “ at a sufficiently high level“. Not only does this effectively lead to a global minimum tax, it also involves fiscal sovereignty. In terms of taxation, GloBE is to be implemented either through controlled foreign corporation rules (inclusion and switch-over rule) or through deduction restrictions (undertaxed payments and subject to tax rule).

The challenge of the taxation of digital companies

Criticism raised in the public debate so far focuses mainly on the lack of definitions and interpretations of the approach. In addition, a seemingly unrealistic basic trust is placed in existing conflict resolution mechanisms.

  • What exactly does consumer facing mean and how is it measured?
  • Can it really be assumed that if one state considers the other state’s tax rate to be too low, thus calling into question its tax sovereignty, the states will compromise to avoid double taxation?
  • Should the only internationally recognised consensus on transfer pricing, the arm’s length principle, be abandoned in favour of the transfer of taxing rights?

Not to mention new questions arising in relation to tax bases and consolidation rules.

European taxation of digital companies

Besides, it is currently still unclear whether and to what extent the Inclusive Framework (IF) interacts with other proposals on the taxation of the digital economy. France, for example, has already introduced a digital tax in 2019, but immediately suspended it until the end of 2020. Specific national laws have also been adopted or announced in Austria, Italy, Spain, the Czech Republic, the United Kingdom and Turkey as well.

Final report on the taxation of digital companies set for the end of 2020

The OECD’s envisaged schedule is tight. But despite a plenary session postponed from early July to October regarding the OECD Inclusive Framework, the final report is still announced for the end of 2020.

Will the international tax system fall into chaos on 1 January 2021? No. Because just as the publication of the final BEPS reports was not implemented overnight (and in some cases has not been implemented to date), the final report on the Inclusive Framework is only an intermediate goal.

Much more time will pass until the Inclusive Framework is fully implemented at a national basis. Considering the global Corona crisis, it will probably take longer than anticipated so far. After all, many countries have invested billions to finance economic emergency aid and economic growth packages during the ongoing crisis. These states are unlikely to easily give up or relinquish taxation rights.

Taxation of digital companies as a political issue

In early June, the US government demanded a break in negotiations (due to the Corona pandemic) and simultaneously threatened countermeasures if countries should implement their own digital taxes. However, France, at least, was unimpressed by this threat and announced that it would reintroduce its digital tax if the US did not re-join negotiations.

This announcement was renewed by the French Finance Minister Bruno Le Maire at the beginning of September. He called for a European solution by 2021 if the negotiations on the Inclusive Framework failed. German Finance Minister Olaf Scholz added that he would consider using any revenue from a European digital tax to finance an EU reconstruction fund. This way the EU will have its own income source.

Our evaluation

At its core, the Inclusive Framework is based on two emerging trends in international taxation. For example, GloBE displays a conceptual similarity with the Common Consolidated Corporate Tax Base (CCCTB). This proposal is intended to combat intra-European tax competition, but has been rejected on several occasions. The first pillar can be traced back to the wording used in the draft BEPS papers. It reads: Profits should be taxed where they arise. The IF can therefore be seen as an indicator for the direction in the international tax system is taking.

Due to the unclear schedule and pending important decisions, there currently is no concrete need for action. Nevertheless, the OECD Inclusive Framework should not be ignored, as it has broad support within the G20 and the OECD and is likely to be adopted, despite corona-related delays.

Therefore we will keep you informed on the latest developments. You should review existing business and transfer pricing models at an early stage and anticipate foreseeable changes when introducing new models. Our experts will be happy to support you in this. Please do not hesitate to contact us.

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