This content is from: European Union

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.

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