Santander backs OECD proposal for significant economic presence

The OECD consultation document has received only a few endorsements from the business community, though most companies recognise the need for change. Spanish bank Santander is one of the dissenting voices that backs proposals made by the organisation’s Task Force on the Digital Economy.

“The [task force] should continue working on the clear definition of new nexus and profit rules that would enable the jurisdictions where value is created by digitalised business models to tax the profits associated with such value,” the company said. “This would contribute to establish a fair level playing field for all businesses.”

“From our point of view, to achieve this objective the [task force] could explore continuing the line of work established by the EU in relation to the ‘significant digital presence’,” the bank added.

By contrast, most financial industry bodies expressed concerns about the proposal. The International Banking Federation (IBFed), the European Banking Federation (EBF), the Swiss Banking Association (SBA) and the Association for Financial Markets in Europe (AFME) all took issue with the lack of clarity on the details.

“We see a substantial risk that any application of the ‘significant economic presence’ proposal would create numerous new permanent establishments which would not generate any actual profits,” said Petrit Ismajli, head of the SBA’s tax department.

However, Santander stressed that the details need to set clear boundaries on the concept and its application to limit any potential negative fallout. The bank was particularly concerned about the increased complexity and uncertainty it would introduce to the international tax system.

Santander suggested that the task force “draw on the concepts of ‘user participation’ and ‘marketing intangibles’” to define those parameters. The company also recommended that the OECD look at the European Commission’s proposal on significant economic presence as a potential model. This is where the bank agrees with industry bodies.

“Any significant economic presence nexus factor based on a digital presence should be focused on actual user interaction and input in a sustained capacity,” said Michael Barbour, chair of the IBFed tax working group.

Many taxpayers see marketing intangibles as the proposal with the strongest basis, though the valuation of such assets is the real difficulty. Significant economic presence, by contrast, is seen as the proposal closest to formulary apportionment – making the possibility of double taxation much more likely.

“The avoidance of double taxation should be a cornerstone of any solution,” the bank said. “The future global consensus-based long-term solution should ideally be implemented by all members of the Inclusive Framework through a multilateral instrument with a mandatory arbitration mechanism.”

Mandatory binding arbitration (MBA) is one of the ways businesses hope to tie up loose ends in a post-BEPS world. It might be possible to imagine a tax system where formulary apportionment is limited to marketing intangibles playing the role of allocation key. But this is all too easy to say.

All of this raises doubts about the future of the arm’s-length principle (ALP). Originally a commercial principle, the concept has been the gold standard of transfer pricing (TP) strategy for decades. The turn towards new ideas might put a lot of TP arrangements in jeopardy.

“The ALP is very precious because it gives every multinational and tax authority the means to look at transactions in a qualitative way. It doesn’t apply a blind key,” one head of TP at a European multinational told TP Week.

“Formulary apportionment could be practical, but you need an allocation key. The number of full time employees is one key you could apply, and probably the first to come to mind given the idea that people are the strongest representative of substance,” the head of TP said. “But it is obvious that in most business models applying it flatly throughout the value chain would distort the reality of what really drives profits.”

Why any company would want to run this risk might be baffling, but it’s possible to limit the damage by insisting on a clearly defined key and restricting its application. It’s even conceivable that the world might move towards a mixed system, halfway between norms old and new.

“Even if you could make formulary apportionment work, it might only be applied to routine transactions while the ALP would still apply to other transactions. This would just create more complexity,” the head of TP said.

“Even the US states that deviate from the federal code on this can’t make it work,” they stressed. “And that’s profit allocation within the same country, with the same language and the same [federal] government.”

The financial sector might find significant economic presence more palatable because the industry would be unlikely to take a hit from it. “The banking industry is highly regulated, with strong capital and licensing requirements, and operates locally in the markets where it does business,” Santander said.

“This, coupled with sound profit allocation rules that were agreed in 2010, results in a good alignment of value creation with the markets where banks operate, meaning our fair share of taxes are paid in those jurisdictions,” the bank said.

This is not the only view in the financial industry. Payment services providers (PSPs) may be much more vulnerable than a global banking group. Significant economic presence should in theory leave out PSPs, but that does not mean the policy would in practice.

As Ken Chan, head of TP at TransferWise, said: “The factors listed could be interpreted in a way that is broader than the intended policy objectives. We would recommend clarifications on the specific definitions of each of the factors and to provide clear exclusions on what they are not.”

Much like Santander, TransferWise is sceptical of user participation and marketing intangibles being used as the basis of tax policy. Though the PSPs are much more concerned that the idea of significant economic presence could be overstretched.

“We feel it is important to highlight the importance of personal recommendations in building a business’s brand image and loyalty,” Chan said. “These do not necessarily require active intervention by a business.”

“Where a business does actively market in a jurisdiction without a local presence, these could be in scenarios where it has partnered with a local business on the basis that it has no regulatory licence to operate in that jurisdiction,” he explained. “In such instances, it would not be reasonable to assign any marketing intangibles to the business given it has no permission to operate in that jurisdiction.”

The OECD has plenty of work to do to build a consensus across so many different interests. The marketing intangibles proposal may have the most support, but it may need to be combined with some version of significant economic presence to become a viable policy and gain the backing of the financial sector.

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