OECD/G20 Inclusive Framework on BEPS: Tax and Digitalization

by Matilde Serena

As of October 2021, more than 135 States joined a new plan to reform international taxation rules set out by the OECD/G20 Inclusive Framework in BEPS (“Inclusive Framework”) working-group. This reform aims at ensuring that a fair share of taxes is levied on multinational enterprises (“MNEs”) worldwide. Technology is constantly shaping today’s global economy. However, phenomena such as scale without mass, reliance on intangible assets and centrality of data threaten the erosion of the global tax base. On the one hand, intangible assets have contributed to the creation of new business models and fostering cross-border activity, which requires special rules to allocate profits and distribute taxing rights.

On the other hand, technology is deemed to gace facilitated tax avoidance by shifting corporate profits from MNEs to tax havens i.e. low or no tax jurisdictions. This paves the way for the following questions: (1) What are the main challenges of tax and digitalization?, (2) What is the Two-Pillar Solution set out in the Inclusive Framework?, (3) How does the Two-Pillar Solution set out in the Inclusive Framework tackle these challenges?

What are the main challenges of tax and digitalization?

To answer this question it is necessary to distinguish between (1) broader direct tax challenges raised by digitalization, (2) base erosion and profit shifting (“BEPS”) issues exacerbated by digitalization, and (3) Value Added Tax (“VAT”) challenges of digitalization.

Firstly, in the context of direct taxes e.g. corporate income tax, the main question is how to allocate taxing rights on income generated from cross-border transactions involving the trading of digital assets. This is particularly relevant in light of the growing discontent among developing countries calling for more mechanical and predictable rules and redistribute taxing rights based on the users’ location. This paves the way to argue for removal of the physical presence requirement to levy a tax on a legal person. It is in the best interest of developing countries to raise more revenue by offering tax-incentives on real economic activities to attract genuine foreign direct investment, rather than offering wasteful tax-incentives and tax holidays which allow MNEs to shift profits outside of their territory.

Secondly, with regards to other BEPS issues exacerbated by digitalization, there is a risk of uncoordinated, unilateral action by different States with different policy goals. In absence of multilateral action, some States prioritize protection of the existing tax base and other States focus on attracting more tax base by setting up favorable tax regimes. To remedy this imbalance and to limit the distortive impact of taxes on investments and business location, new rules are needed. An example could be the introduction of a a global minimum level of tax.

Thirdly, when dealing with indirect taxes i.e. taxes where fiscal and economic burden do not coincide such as VAT and Service Taxes, the main issue is to establish where should VAT or Service Taxes be paid in online business to consumers transactions. Nowadays, there is the risk that consumers will turn to suppliers established in countries where e.g. VAT is not levied to escape indirect taxation of digital goods supplied by local providers. This would give an unfair advantage to the supplier located in a no-VAT jurisdiction over the domestic retailer. Therefore, to level the playing field it is advisable that indirect taxes are efficiently collected in the country where the consumer lives.

What is the Two-Pillar Solution set out in the Inclusive Framework?

Since the 1990s the OECD has been leading international efforts to prevent tax evasion and corporate tax avoidance in its contracting states. OECD’s early work in this field started in the 2000s with the objective of identifying common standards and establishing a global level playing field to crack down on tax evasion by individuals. In 2013, the focus of the OECD turned to corporate tax avoidance with the launch of the BEPS project. The latter addresses issues of international taxation (with a particular focus on digitalization) in the Two-Pillar Solution agreed upon by members of the Inclusive Framework on 8 October 2021.

How does the Two-Pillar Solution set out in the Inclusive Framework tackle these challenges?

Each pillar addresses a different gap in the existing tax law regime.

On the one hand, Pillar One re-allocates taxing rights over 25% of the residual profit of the most profitable and largest MNEs to jurisdictions where their customers and users are located. Moreover, tax certainty is ensured through mandatory and binding dispute resolution setting up an elective regime to accommodate low-capacity countries. Another core point of Pillar One is removing Digital Service Taxes and other similar measures to establish a simplified and streamlined approach to the application of the arm’s length principle in specific circumstances.

On the other hand, Pillar Two establishes a global minimum tax of 15% on all MNEs with an annual revenue exceeding 750 million euros. Furthermore, it requires all countries applying a corporate income tax rate below 9% to certain payments e.g. royalties and interest to implement a “Subject to Tax Rule” in their bilateral treaties with developing members of the Inclusive Framework to make sure that the tax treaties in question are not abused for tax avoidance purposes. Pillar Two, finally, leaves room for tax incentives for substantial business activities to stimulate legitimate investments in developing members of the Inclusive Framework.

To conclude, this post outlined several challenges relating to direct and indirect taxation of digital taxes and presented the Two-Pillar Solution introduced in 2021 by the Inclusive Framework members. The latter addresses the aforementioned challenges by focusing on the reallocation of taxing rights and establishing a minimum global corporate income tax. On this note, in 2023, the OECD published administrative guidance to implement the Two-Pillar Solution. This is definitely a milestone in the tax regulation of digital markets and paves the way for further international efforts in the tax law field.

Sources:

OECD (2018), ‘Tax and Digitalization’ OECD Going Digital Policy Note, OECD, Paris <https://www.oecd.org/tax/beps/tax-and-digitalisation-policy-note.pdf> accessed 27 February 2023.

OECD, Action 1 ‘Tax Challenges Arising from Digitalization’ (oecd.org, February 2023) <https://www.oecd.org/tax/beps/beps-actions/action1/> accessed 27 February 2023.

OECD/G20 Base Erosion and Profit Shifting Project (2021), ‘Statement on a Two-Pillar Solution to Address the Tax Challenges Arising from the Digitalization of the Economy’ <https://www.oecd.org/tax/beps/statement-on-a-two-pillar-solution-to-address-the-tax-challenges-arising-from-the-digitalisation-of-the-economy-october-2021.pdf> accessed 27 february 2023.

OECD, ‘International community strikes a ground-breaking tax deal for the digital age’ (oecd.org, 8 October 2021) <https://www.oecd.org/tax/beps/international-community-strikes-a-ground-breaking-tax-deal-for-the-digital-age.htm> accessed 27 February 2023.

OECD (2022), ‘ Two-Pillar Solution to Address the Tax Challenges Arising from Digitalization of the Economy: Frequently Asked Questions’ <https://www.oecd.org/tax/beps/faqs-two-pillar-solution-to-address-the-tax-challenges-arising-from-the-digitalisation-of-the-economy-july-2022.pdf> accessed 27 February 2023.

OECD/G20 Base Erosion and Profit Shifting Project (2021), ‘Two-Pillar Solution to Address the Tax Challenges Arising from the Digitalization of the Economy’ <https://www.oecd.org/tax/beps/brochure-two-pillar-solution-to-address-the-tax-challenges-arising-from-the-digitalisation-of-the-economy-october-2021.pdf> accessed 27 February 2023.

OECD (2023), ‘Tax Challenges Arising from the Digitalisation of the Economy – Administrative Guidance on the Global Anti-Base Erosion Model Rules (Pillar Two)’, OECD/G20 Inclusive Framework on BEPS, OECD, Paris <www.oecd.org/tax/beps/administrative-guidance-global-anti-base-erosion-rules-pillar- two.pdf> accessed 27 February 2023.