On July 1 2021, when the 130 countries which are members of the OECD/G20 Inclusive Framework on BEPS (called the ‘IF countries’) approved the statement on international tax reform, two pillars were pre-agreed for implementation: pillar one covers the new tax rules for reallocation of profits, and pillar two covers new tax rules for a mechanism to introduce a global minimum tax.
In this article, there is a focus on a part of the global minimum tax set of rules which may be expected to develop further and be applied in countries such as Romania. Apart from the minimum 15% corporate tax rule, for multinationals exceeding the global revenues threshold, the IF member jurisdictions must agree to the application by any other IF member of any agreed safe harbour rules for taxation (level of profit margins deemed as acceptable by local tax authorities).
The context is that, in an attempt to ensure that a fair share of profits derived from the business are taxed in countries other than those with the lowest corporate tax rates, based on economic principles set out in anti-BEPS publications, countries such as Romania may require a certain level, or even range of levels of profit margin, which would be seen by the tax authorities as acceptable. Moreover, if companies carry out routine, low-value-added operations, such as distribution and marketing, in jurisdictions such as Romania, they may pay tax in these jurisdictions based on fixed return for defined baseline distribution and marketing activities.
The interaction between pillar one and pillar two is not fully clear and clarifications will be made once the package of new tax rules is ready in October 2021. One of the measures which is planned to be put in place as part of the international package of new tax rules is for countries to receive a proportion of taxable profit from each multinational enterprise, in cases where the countries qualify as end market jurisdictions where goods or services are used or consumed. This is one of the layers, and the other one refers to the remuneration for routine activities.
Pillar two regulates corporate income tax, by the introduction of a global minimum corporate tax rate, (15% has been suggested), so that countries can protect their tax base. Romania has a corporate tax rate of 16%, so it appears already to be aligned to the proposed global tax rate. Thus, the issues to be addressed mainly relate to the tax base.
The concept of ‘routine’ activity is much spoken about, but less frequently differentiated and defined. The definition suggested for routine activities is that of an activity which does not contain research and development and is not typically capital intensive.
The OECD blueprint (July 2021) states that marketing and distribution represent routine functions and that companies should apply an “arm’s-length standard to routine marketing and distribution activities”.
Questions to answer
Such routine activities take place to a large extent in Romania’s economy. Are they all routine activities, as long as the research and development (R&D) function is not present and the financing of the business generally comes from abroad?
What about marketing services? It is known that groups generally develop their own marketing strategy and select the tools for promoting their products, while the companies in each country follow the plan to market and to go to market. However, any team has an intrinsic level of know-how. A sense of creativity is often found in any local company. As such, marketing would probably not mean, automatically, a routine function. Therefore, the OECD needs to clarify the definitions of routine functions better than it has done in the past.
A question may arise as to whether one can expect that countries will introduce into their domestic legislation also a set of levels of margins which would be seen as acceptable for the local tax authorities, for routine activities. There is currently a lack of information about the level of detail per activity and how each tax authority will assess the level of acceptable mark-ups for routine activities. For example, distribution may involve many products or products from several sectors, such as shoes, books and so on.
A question may arise as to whether Romania will implement into its legislation levels of profit margins which will be seen as acceptable per se during a tax audit, for types of distribution activity, say between 3% and 4% for distribution of textiles, or whether a single set of margins will be acceptable for all types of distribution activities, as long as they qualify as routine activities. It is reasonable to think that a differentiation will be made for sectors of activity, which means quite a lot of work and responsibility on the part of the tax authorities; this may prove a valid reason for continuing to rely on benchmarking studies.
Advance pricing agreements (APAs) will remain in force and will continue to be issued. This is an important issue, especially as taxpayers tend to reach an agreement with the tax authorities based on their specific situation. If we link this tax instrument with potential safe harbour profit margins, another question arises: will the margins required be increased or even a level of 10% will be targeted?
The application of such potential safe harbour levels of profit margins may look simple, a way to standardise taxation, but in practice, almost every company’s management considers that the business managed has specific characteristics which do not allow it to be put in a generic box, and most of the time there are explainable deviations from the profit margin from a standard benchmark study.
The new era of taxation
Romania is a country where other services are performed, as well as the distribution of goods. While distribution is likely to be considered as a routine function, it will be more difficult to assess whether IT services are routine activities. The variety of IT business is so big that, in the near future, specialists will probably split the sector into several sub-sectors, when determining the arm’s-length profile.
There is a long way to go to put in place a sufficiently detailed mechanism, but the new era of international taxation has begun. Some member states will push the EU to implement the new package and the EU will obviously agree to the new set of rules, since it replaces the long discussed common consolidated corporate tax base (CCCTB), with which it has some common elements.
© 2021 Euromoney Institutional Investor PLC. For help please see our FAQ.