The unified approach

The tax challenges arising from the digitalisation of the economy were identified as one of the main areas of focus of the BEPS Action Plan, leading to the 2015 BEPS Action 1 Report ('the Action 1 report'). The Action 1 report found that the whole economy was digitalising and, as a result, it would be difficult, if not impossible, to ring-fence the digital economy.

The Action 1 report also observed that, beyond BEPS, the digitalisation of the economy raised a number of broader direct tax challenges chiefly relating to the question of how taxing rights on income generated from cross-border activities in the digital age should be allocated among countries. However, the Action 1 report stopped short of prescribing a solution to the challenges analysed in the report.

In recognition of the growing sense of urgency of the need to reach a solution to these challenges, the G20 finance ministers delivered a mandate to the OECD Inclusive Framework on BEPS, working through its Task Force on the Digital Economy (TFDE), to produce an interim report in 2018, which would provide a further in-depth analysis of value creation across new and changing business models in the context of digitalisation and the tax challenges they presented.

These challenges included risks remaining after BEPS for highly mobile income producing factors that still can be shifted into low-tax environments. However, members of the Inclusive Framework did not converge on the conclusions to be drawn from this analysis, but committed to continue working together towards a final report in 2020 with a view to providing a sustainable, consensus-based solution to these challenges.

This commitment was reflected in the January 2019 policy note, which provided a two-pillar approach to address the challenges identified in the Action 1 report and the interim report. One pillar addresses the broader challenges of the digitalised economy and focuses on nexus issues and the allocation of taxing rights, and a second pillar addresses remaining BEPS issues.

The two-pillar approach also reflected elements of the game-changing developments resulting from the sweeping tax reform enacted in the United States, which resulted in a broadening of the US tax base through the implementation of BEPS measures and the introduction of a minimum tax.

Conscious of the ambitious G20 timeframe and the political salience of the issue, the TFDE further intensified its work after the policy note and produced a detailed Programme of Work in May 2019 relating to both pillars. More specifically, under pillar onethe Programme of Work sought to undertake a coherent and concurrent review of the profit allocation and nexus rules.

Under pillar two, it sought to develop rules that would provide jurisdictions with a right to 'tax back' where other jurisdictions have not exercised their primary taxing rights or the payment is otherwise subject to low levels of effective taxation. While the Programme of Work provided a solid foundational basis, there was a risk that progress would stall in the face of three competing proposals – known as the marketing intangibles, significant economic presence, and user participation proposals – that were put forth by certain members of the Inclusive Framework, and which could not on their own achieve consensus.

Developments at the highest levels of international politics pointedly illustrated why the world could simply not afford to see progress stall on this important issue. The G20 finance ministers, central bank governors and national leaders endorsed the Programme of Work, but they certainly did not endorse a workstream that increasingly appeared to be turning in circles.

Both pillars would reduce the dispersion of effective tax rates and reduce the incentives for multinational companies to engage in profit shifting

Any resulting standstill would engender uncertainty, and risk igniting conflicts similar to the one on display in the lead up to the G7 leaders' meeting in Biarritz, after France enacted its digital services tax (DST) in July 2019 to which the United States responded by initiating a Section 301 investigation. Ultimately, the G7 communiqué stated that "the G7 commits to reaching in 2020 an agreement to simplify regulatory barriers and modernize international taxation within the framework of the OECD" but tensions remain. In such an international context, it is clear that achieving a multilateral, consensus-based solution is of the highest importance.

In recognition of this, the OECD secretariat released its proposed 'unified approach' in October in an effort to unlock the conversation and move the ball forward. In the absence of taking action, time would keep ticking and the discussion within the Inclusive Framework would continue turning in circles. Thus, drawing on the commonalities of the three competing proposals under pillar one, the OECD secretariat put forth a proposal known as the 'unified approach' on which the 130+ members of the Inclusive Framework could build.

The 'unified approach' proposes to focus on 'consumer-facing businesses', which would cover highly digitalised business models and other highly profitable business models that interact with consumers. It proposes a new nexus, distinct and separate from the existing concept of the permanent establishment (PE), which would ensure a company is taxable in a jurisdiction where its sales exceed a certain threshold even if it is not physically present in that market. It is important to note that this new nexus rule would be introduced as a stand-alone rule, on top of the PE rule – to limit any unintended spill-over effect on other existing rules.

In addition to the creation of a new nexus, the OECD secretariat proposal also aims to reallocate to market jurisdictions a portion of deemed residual profit – i.e. profit in excess of a certain threshold – through a formula and based on the consolidated financial accounts of the company. It also proposes to allocate an appropriate fixed return for what are known as distribution activities, which simplify and improve the administrability of existing international tax rules.

Finally, it recognises that the facts and circumstances approach under the existing arm's-length principle rules would continue to apply in the market/user jurisdictions, but that effective dispute prevention and binding dispute resolution between member jurisdictions would be needed to limit disputes and improve tax certainty. In short, the 'unified approach' provides a package that reallocates taxing rights to market jurisdictions in certain circumstances in exchange for improved tax certainty.

Not all businesses would be affected by the proposed 'unified approach'. The scope would be limited to large businesses that interact remotely with users in market jurisdictions, even if the business has no or a limited physical presence in that jurisdiction. It would also apply to other businesses that market their products to consumers, and which may use digital technology to develop remotely a consumer base with limited or no physical presence in the jurisdiction where these consumers generally reside.

A public consultation was recently completed on November 12, where input was received from a number of stakeholders on the questions posed in the public consultation document. Similar to the last public consultation in March, interest was intense and the submitted comments extensive.

The OECD secretariat and members of the Inclusive Framework are currently reviewing this input and will draw upon it to answer a number of the key questions that still need to be answered before any agreement is finalised. These include which businesses could be scoped-out and whether the revenue threshold should be set at the €750 million ($825 million) level used for country-by-country reporting (CbCR) or at a higher level.

The scope would be limited to large businesses that interact remotely with users in market jurisdictions

Other key questions relate to the possible use of business line or regional segmentation, options in connection with the treatment of losses and the challenges associated with the determination of the location of sales. All of this, in addition to definitions and quanta, differentiation for business models, elimination of double taxation and other implementation issues, will need to be decided in the coming months by the 135 members of the Inclusive Framework.

In light of recent unfounded criticisms of the 'unified approach', it is important to underscore that the Inclusive Framework, which will be deciding these questions, is composed of both developing and developed countries working on an equal footing, 70% of which are non-OECD and non-G20 countries from every geographic region.

Any final consensus on the outstanding issues mentioned above will be the result of a political agreement that has the support of each and every member of the Inclusive Framework – that is simply the definition of consensus.

International organisations can act as observers within the Inclusive Framework, and regional tax organisation such as the African Tax Administration Forum, which has been vocally supportive of the "unified approach," and the Inter-American Centre of Tax Administrations are also represented. Input from the business community and civil society is also solicited as demonstrated by the recent public consultation.

In order to inform this ongoing work moving forward, an ongoing economic analysis and impact assessment is being conducted and extensive outreach is being undertaken with both developing and developed countries to model specific country revenue effects under a variety of assumptions.

Preliminary results thus far show that both pillars would reduce the dispersion of effective tax rates and reduce the incentives for multinational companies to engage in profit shifting. Furthermore, given that the counterfactual to a consensus-based solution would be a proliferation of uncoordinated and unilateral measures and an increase in tax disputes, the package would not adversely affect the investment environment, but would instead provide greater tax certainty.

In the coming weeks and months, the 135 members of the Inclusive Framework will be meeting regularly to advance work on the details of the 'unified approach' under pillar one. Ideally, the outline of a consensus-based solution would be ready for agreement in time for the Inclusive Framework's plenary meeting in January 2020.

If agreed, the key political parameters of the unified approach would then need to be established and agreed – hopefully by July 2020 – after which the heavy lifting on the technical parameters would really begin with a view to reach a detailed, full-fledged solution by year-end. The Inclusive Framework will of course draw upon the expertise of the OECD's Committee on Fiscal Affairs, which consists of Working Party 1, Working Party 6, and the Forum on Tax Administration,. This will help inform the work going forward.

Any agreement turns on the critical discussions that are scheduled to take place during the remainder of 2019 and throughout 2020. And ultimately, the success or failure of this project lies in the hands of the 135 countries and jurisdictions of the Inclusive Framework. It is also important to note that even if such an agreement is achieved in 2020, it will then be necessary to answer further questions surrounding implementation and administration. More work remains to be done, even in light of an agreement next year.

One must be clear-eyed when evaluating the enormous challenges that lay ahead, but there is cause for optimism. More than two thirds of the world, including countries and jurisdictions from every region, are actively participating on an equal footing, in addition to business, civil society and academia.

In an era where multilateralism is being challenged, the Inclusive Framework has a golden opportunity to deliver a major success story in the history of international cooperation. The OECD will continue to do everything it can to make this success possible by helping the Inclusive Framework deliver on its G20 mandate to reach a sustainable, consensus-based solution to the tax challenges arising from the digitalisation of the economy.

Pascal Saint-Amans, director of the OECD's Centre for Tax Policy and Administration.