International Tax Review is part of the Delinian Group, Delinian Limited, 8 Bouverie Street, London, EC4Y 8AX, Registered in England & Wales, Company number 00954730
Copyright © Delinian Limited and its affiliated companies 2023

Accessibility | Terms of Use | Privacy Policy | Modern Slavery Statement

Residual profit splits will worsen tax competition


The residual profit split method (RPSM) is one possible solution to the dilemmas of digital tax, but businesses and NGOs fear the division of income will lead to more fights over tax revenue.

One panel of tax professionals at ITR’s Leading Women in Tax Forum discussed the strengths and weaknesses of the OECD proposals on digital tax. One head of tax at an e-commerce platform explained the risks of the RPSM without clear guidelines.

“If we applied a residual profit split, we would have to allocate income where we have engineers, developers and analysts, as well as users,” she told delegates at the Pullman Hotel in London.

“Our users play a different role than they do for Facebook or Amazon… Users are not key contributors to our business model,” the head of tax said. “We’re really an exchange platform between individuals.”

Many businesses will have to rewrite their TP arrangements to make profit splits work. Some companies fear they will be ‘collateral damage’ in the battles over taxing rights. The OECD wants to tip the balance in favour of market jurisdictions.

“The number of users and sales figures are not a precise way of measuring business activity,” the head of tax said. “We have the same number of active users in Germany as we have in France, yet we run on a loss in France and in Germany we make a profit.”

There is a mismatch between the number of users and streams of revenue for some business models. It’s also possible for an e-commerce platform to exploit the local infrastructure of the market jurisdiction and contribute to its economy.

It seems likely that there will be a compromise that will involve segmented rules for different countries. This is the only way for businesses to get proportionate treatment for loss-making operations despite their user bases. However, some observers fear this will lead to more problems.

“Once we get into special rules, if Germany and France get segmented rules, I can’t even begin to think about what would happen in Africa,” one NGO official said.

“The amount of rules, thresholds and carve-outs is already very complex,” she said. “Once we go to further complexity, I fear that the level of double taxation and non-taxation will rise because the rules are confusing and unclear.”

One TP director, who represented an energy company at the conference, was not happy with the direction of the global tax debate. “We’ve gone from technical and economic approaches to more political discussions about making everyone happy,” she said.

“It’s a shame from an economist’s perspective,” the TP director said. “We’re moving towards formulary apportionment.”

This is the crux of the matter for business leaders. International tax reform could well cost a business its competitive advantage in the global economy. One head of transfer pricing at a pharmaceutical company stressed the risks of moving away from the arm’s-length principle.

“We have concerns about the future of the arm’s-length principle,” the head of TP said. “We are concerned about the emphasis on allocating more profits to market jurisdictions and to marketing intangibles.”

“The key value driver for pharmaceutical companies is R&D investment,” she said. “There is a risk of ignoring the key drivers of value and this does not just affect pharmaceutical companies but other industries as well.”

Many companies would prefer to keep the existing system for the ease of doing business. Even though NGOs tend to favour formulary apportionment, some have found common ground with businesses on the profit split.

“What we could agree on was that the profit split could get messy,” the NGO official said. “We’re concerned about the risk of double non-taxation and businesses are concerned about double taxation.”

This is a rare moment of unity. Business leaders have an obligation to their shareholders, and the cost of international tax reform may be too much to bear for some companies. Nevertheless, the reform process continues.

more across site & bottom lb ros

More from across our site

ITR’s latest quarterly PDF is going live today, leading on the EU’s BEFIT initiative and wider tax reforms in the bloc.
COVID-19 and an overworked HMRC may have created the ‘perfect storm’ for reduced prosecutions, according to tax professionals.
Participants in the consultation on the UN secretary-general’s report into international tax cooperation are divided – some believe UN-led structures are the way forward, while others want to improve existing ones. Ralph Cunningham reports.
The German government unveils plans to implement pillar two, while EY is reportedly still divided over ‘Project Everest’.
With the M&A market booming, ITR has partnered with correspondents from firms around the globe to provide a guide to the deal structures being employed and tax authorities' responses.
Xing Hu, partner at Hui Ye Law Firm in Shanghai, looks at the implications of the US Uyghur Forced Labor Protection Act for TP comparability analysis of China.
Karl Berlin talks to Josh White about meeting the Fair Tax standard, the changing burden of country-by-country reporting, and how windfall taxes may hit renewable energy.
Sandy Markwick, head of the Tax Director Network (TDN) at Winmark, looks at the challenges of global mobility for tax management.
Taxpayers should look beyond the headline criteria of the simplification regime to ensure that their arrangements meet the arm’s-length standard, say Alejandro Ces and Mark Seddon of the EY New Zealand transfer pricing team.
In a recent webinar hosted by law firms Greenberg Traurig and Clayton Utz, officials at the IRS and ATO outlined their visions for 2023.