2020 is looming as the most significant year in international tax in a century, as the OECD, the Inclusive Framework (IF) and the G20 address the tax challenges arising from the digitalisation of the economy. The ambitious timetable is to achieve a consensus-based solution by the end of 2020. Despite the project's name, the proposals effectively amount to a disruption of some of the key long-standing principles of international tax, irrespective of the taxpayer's business. We refer to this as the Global Tax Reset II.
While the challenges are large, and time is short, the alternative involves uncoordinated unilateral actions, double taxation and increased uncertainty: additional challenges to an already "fragile global economy", as stated in the OECD Secretary General's tax report to G20 finance ministers and central bank governors in February 2020. Events of late 2019 provided a window into the alternative scenario, as France and the US publicly argued about the French digital services tax (DST) and US tariff responses.
With the OECD based in Paris, and much of the public debate being driven by the EU and the US, the voice of countries in the Asia-Pacific region has been less obvious. The Asian Century concept anticipates that economic trends and demographic shifts will result in an increased importance of Asia-Pacific economies. These emerging multinationals and countries will be operating in an international tax environment shaped by the Global Tax Reset II.
This article considers the responses of Asia-Pacific countries to the emerging tax challenges, their role in the OECD process and some possible impacts in the region.
Pillars one and two in brief
The OECD work involves a two-pillar approach.
Pillar one – new nexus and profit allocation rules
Pillar one proposes to revise existing profit allocation and nexus rules, which are based on a concept of a permanent establishment (PE), requiring a physical presence and arm's-length principles. In January 2020, the IF endorsed the unified approach on pillar on, which consists of:
- Amount A: A new taxing right to allocate a portion of group profit to user/market jurisdictions, irrespective of local physical presence. Two broad groups of business have been identified as relevantly participating in a "sustained and significant manner" in the economic life of a market jurisdiction:
- Businesses that generate revenue from the provision of automated digital services, such as online search engines, social media platforms, digital content streaming companies, online gaming companies, cloud computing services etc.; and
- Consumer-facing businesses that generate revenue from the sale of goods and services of a type commonly sold to consumers, such as personal computing products including mobile phones, luxury goods, branded food, as well as franchise models.
As is evident, Amount A goes well beyond so-called digital companies. Many significant issues are yet to be resolved including scope (which companies are included), carve-outs (which companies are excluded), and various key thresholds affecting the calculation of Amount A.
- Amount B: A fixed return for defined baseline marketing and distribution functions.
- Amount C: Profit based on the arm's-length principle where in-country functions exceed the activity compensated under Amount B.
Pillar two – global anti-base erosion rules
Pillar two, variously referred to as the global anti-base erosion (GloBE) proposal or a minimum tax, seeks to allow countries to "tax back" profits that would otherwise be taxed at a rate below a (yet to be determined) "minimum rate". It comprises four elements:
- An income inclusion rule that would tax certain group income subject to tax at less than a minimum rate;
- A switch-over rule to switch from an exemption to a credit method when the profits attributable to a foreign PE are subject to tax at less than a minimum rate;
- An undertaxed payment rule that would operate by way of a denial of a deduction or imposition of source-based taxation (e.g. withholding tax) for a related party payment not subject to tax at or above a minimum rate; and
- A subject to tax rule that would subject a payment to withholding or other taxes at source and deny treaty benefits on certain items of income where the payment is not subject to tax at a minimum rate.
One of the key open issues with respect to pillar two is the extent, or otherwise that there will be substance-based carve-outs. That is, if a low tax rate is associated with a business activity of substance, will the related income still be exposed to a pillar two response. This is particularly important for jurisdictions offering tax concessions (as occurs in Asia-Pacific), often predicated on a certain level of investment or activity.
The growing importance of Asia-Pacific
Asia-Pacific companies and consumers are increasing in size and significance. Both of those attributes increasingly expose Asia-Pacific companies and countries to various aspects of pillars one and two.
Asia-Pacific based companies accounted for 42% of the world's Fortune 500 (the world's 500 biggest companies by revenue) in 2018, according to the McKinsey Global Institute's report, 'Asia's future is now, July 2019'. The same report noted that, of the world's largest 5,000 companies by revenue, 43% (2,150 groups) were based in Asia-Pacific in 2017 with more than three-quarters of these based in China, Japan, South Korea and Australia. The organisation's 'China and the world' report of July 2019 showed that Chinese companies dominate the Asia-Pacific Fortune Global 500 companies, with a total of 110 companies, almost as many as are based in the US (126).
At the same time, increasing incomes and urbanisation has created an expanding middle class in the region.
Steps taken across Asia-Pacific
While all key countries in Asia-Pacific are involved in the OECD process via the IF, several countries have at the same time taken a range of domestic law steps as a result of base erosion concerns involving, but not limited to, digital-based companies.
India is the only country in the region that has implemented a DST-type tax. India's 6% equalisation levy applies to specified services including online advertisements, the provision for digital advertising space or any other facility or service for the purpose of online advertising. India also has an expanded PE concept of a significant economic presence (SEP) where there is sustained engagement with Indian users or systematic or continuous soliciting of business activities without any physical presence in India. The 2020 Indian budget proposes to expand the attribution of income for operations carried out in India to include any income from the data generated by Indian users of digital services. However, the effective date of the proposal on the SEP has been deferred pending the consensus-based approach.
In June 2019, New Zealand issued a discussion document regarding proposed options for a DST. That process is still ongoing with no final decision made. In October 2018, the Australian government released a discussion paper seeking views on pursuing an interim and unilateral approach, such as a DST. However, in March 2019, the government announced that it had decided not to proceed with any such interim measure and, instead, recommitted to engaging in the OECD multilateral process.
In April 2019, Indonesia expanded its definition of a PE to include a computer, electronic agent or automatic equipment owned, rented or used by a foreign taxpayer to perform business activity through the internet. A further regulation addressing e-commerce transactions was issued in November 2019, stipulating that all foreign companies that actively trade in goods or services electronically in Indonesia are treated as having a taxable physical presence in Indonesia if specific criteria (generally indicative of large transaction value) is met.
Vietnam has introduced a tax administration law that requires foreign suppliers engaged in 'e-commerce business activities' without a PE to file and pay Vietnamese taxes (or authorise other parties for such tax filing), beginning July 2020. Commercial banks would be required to participate in the tax collection/withholding process. The law is unclear (detailed implementation awaits further guidance), but the intention for taxing e-commerce activities/digital operations seems quite clear.
In March 2018, a practice note was issued by the Malaysian revenue authority stipulating that payments made to non-residents for digital advertising services without the presence of a PE would be treated as being a royalty that is subject to 10% withholding tax if the payment is for the purchase or use of applications (apps) by the payer that allows the payer to create their own advertisement campaign.
Australia and New Zealand also have in place broader domestic anti-avoidance and anti-BEPS rules including PE avoidance rules. Australia's "targeted integrity rule" acts as a supplement to the anti-hybrid provisions and can deny tax deductions for interest payments made to low tax foreign affiliates. Conceptually, it is similar to the undertaxed payment rule in pillar two.
All of these various measures create additional complexity and potential double taxation.
A feature of the OECD proposal is that any consensus-based agreement must include a commitment by members of the IF to withdraw "relevant unilateral actions". It would be expected that many of the above measures would fall away when pillars one and two are implemented.
Asia's voice in the OECD debate
The OECD/G20 IF is made up of 137 countries, 15% of which comprise countries in Asia-Pacific (OECD/G20 Inclusive Framework on BEPS, June 2019).
At a government level, Asia-Pacific countries are well represented in the debate and decision-making process. According to the OECD Composition of the Steering Group on the Inclusive Framework on BEPS, January 2020, China is deputy-chair of the BEPS steering group, and Australia, India, Japan, South Korea and Singapore are also members, giving the region six positions among the 24 members of this key body. Australia, China, Singapore, Malaysia, Japan and India also have roles as vice-chairs or bureau members in the IF/OECD's Task Force on the Digital Economy Administrative Body.
India is also active in the debate through its membership in the G24.
In the opening address delivered in October 2019 at the Tax Academy 2019 Digital Tax Conference on October 4 2019, a senior Singapore government minister laid out two principles on which the global consensus solution should be based: being a framework that continues to support global economic growth and innovation, while also allowing jurisdictions to pursue their own tax policy mix. The OECD approach was described as moving from a "value creation approach", in which profits should be taxed where value is created, to a "destination-based approach", in which taxing rights and corporate profits are allocated based on the size of consumers' markets.
Asia-Pacific companies lodged only four submissions or approximately 9% of the November 2019 submissions from companies in respect of pillar one. For pillar two, Asia-Pacific companies lodged four submissions or approximately 22% of taxpayer submissions (OECD public comments received on the proposal for a unified approach under pillar one, and on the global anti-base erosion proposal under pillar two).
According to the OECD regional meetings of the Inclusive Framework on BEPS, a number of regional outreach and consultation events have been held in the region in 2019, including the study group on Asian tax administration and research (SGATAR) annual meeting in Indonesia in October, a regional meeting and consultation on digitalisation for Asia-Pacific countries in Manila in November and a development forum of OECD Multilateral tax centres in China in December.
Possible impacts of the OECD's proposals in Asia-Pacific
The emerging size and significance of Asia-Pacific companies and the increasing wealth and power of Asia-Pacific consumers are highly relevant to the key levers of pillars one and two, and indicate that the proposed reforms will have significant impacts for Asia-Pacific companies and countries.
On February 13 2020, the OECD held a preliminary and high-level webcast to update stakeholders on their economic analysis and impact assessment work. The work is based on a number of significant assumptions and does not seek to prejudge decisions of the IF. The publicly released work does not identify impacts on particular countries, but rather identifies impacts for certain country groupings. These groupings are high, middle, and low-income jurisdictions (World Bank classifications), and investment hubs (jurisdictions with inward foreign direct investment above 150% of GDP). A common feature of investment hubs, albeit not formally part of the relevant definition, is a relatively low corporate income tax (CIT) rate.
The analysis indicates that the two-pillar approach could increase global CIT revenue by up to 4% or $100 billion annually. Most of this additional CIT revenue is expected to be raised under pillar two because of profits (subject to no or low CIT) becoming subject to a 'top up' tax in another jurisdiction. This has the result of increasing effective tax rates on multinationals, and providing additional tax revenues to one or other country, by virtue of one of the four responses contemplated by pillar two.
To put this expected annual revenue gain in some context, when the OECD released the BEPS reports in October 2015, it was estimated that BEPS resulted in a CIT loss of between $100-$240 billion. The revenue impacts of pillars one and two above would be incremental to the revenue impacts which have already resulted from the measures implemented since October 2015.
The OECD analysis also makes the point that estimated impacts on companies and countries under pillars one and two ought not to be compared to the existing position, but rather to the unpredictable world of further unilateral measures and greater uncertainty, in the event of a failure to reach a consensus-based solution.
Specifically in relation to pillar one, the OECD estimates that most economies would experience a small CIT revenue gain, with low and middle-income economies gaining relatively more revenue than advanced economies. However, investment hubs are estimated to be exposed to a loss in CIT revenues, potentially up to 5% in some of the modelled scenarios.
In respect of Amount A under pillar one, the OECD work to date suggests that this could apply to in-scope groups with gross revenues exceeding €750 million. The growing pool of large Asia-Pacific multinationals indicates that many regional groups would exceed that threshold, and become exposed to paying Amount A tax in various market jurisdictions. However, some Asia-Pacific companies will be expected to benefit from the carve-outs for extractive industries, raw materials and commodities and certain aspects of the financial services sector.
It is also noted that many large companies are still relatively domestically focused compared to the US – for example, the McKinsey Global Institute's China and the world report of July 2019 states that 19% of China's corporate revenue was earned overseas in 2017, as compared to 44% of revenue earned outside the US by US firms. To that extent, the reallocation of Amount A profits to market jurisdictions may be less significant for Asia-Pacific multinationals, as compared to the case for multinationals generally.
Where Asia-Pacific multinationals become liable to tax on Amount A, this would involve a reallocation of the tax base to market countries (whether within the region or elsewhere), with other countries to give an exemption or credit for such foreign tax. This could increase effective tax rates of companies to the extent that profits attributable to Amount A are taxed at higher rates than is presently the case.
Conversely, the increasing wealth and scale of the consumers in Asia-Pacific would be expected to result in a new source of tax collections for those countries, as that consumer power attracts Amount A tax liabilities of foreign companies.
It is less easy to forecast the potential impacts of pillar two in the region, as a key driver of where the tax revenue will fall under pillar two depends upon whether the consensus creates a taxing right in the parent jurisdiction or the market jurisdictions.
The significant reshaping of the global tax system is coinciding with the significant reshaping of the Asia-Pacific economies. The international tax rules that emerge from this process will govern the tax exposure of Asia-Pacific companies and tax collections of Asia-Pacific countries as the region continues to grow in size, importance and wealth.
The authors acknowledge the contributions of the Deloitte Asia-Pacific Tax Policy Group in the writing of this article.
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David Watkins is the leader of the Deloitte Australia's Tax Insights & Policy group and the leader of the Deloitte Asia-Pacific Tax Policy group. David has over 30 years of experience in corporate income tax and international tax covering a wide range of tax issues across various industry sectors. David has worked in Malaysia, Singapore and New York.
In his current role, David's focus is on emerging tax policy and law developments including base erosion and profit shifting (BEPS). The Tax Insights & Policy group is involved at various stages in these emerging issues including consultation and submissions, publications, presentations and assessing the impacts of tax law changes.
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Daljit Kaur is a manager in Deloitte Australia's Tax Insights & Policy group. Daljit's experience covers corporate income tax and international tax, including BEPS. Daljit's responsibilities include tax policy and tax treaty research and analysis, for the purposes of Deloitte's internal and external tax publications and forums.
Prior to joining Deloitte, Daljit worked with the International Bureau of Fiscal Documentation (IBFD) in Malaysia.
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