With the EU and the rest of the G20 at its back, the OECD remains adamant that the implementation of two of the most ambitious projects yet to be conceived in the sphere of international taxation are on the fast-approaching horizon.
Although it has been less than a decade since the BEPS Action Plan was put into effect in 2013, the OECD/G20 Inclusive Framework on BEPS (the ‘Inclusive Framework’) has already devised and executed a number of tentative solutions to some of the 15 problem areas which were identified.
Of all of these, however, it is the challenges arising from digitalisation under Action 1 which, many would agree, have been the most testing, as the changes proposed in pursuance of a solution are by far the most radical, requiring an unprecedented degree of harmonisation in tax matters around the globe.
To understand how arduous a task indeed this is, one need only consider that even within the EU, some members have thus far resisted the most meaningful attempts to harmonise tax matters inter se, giving the sense that retaining sovereignty in this respect remains important.
One of the most recent updates with regards to Action 1 was the release of a ‘Statement on a Two-Pillar Solution to Address the Tax Challenges Arising from the Digitalisation of the Economy’ by the OECD in October 2021 (the ‘statement’). This document sets out what had been discussed in the OECD/G20 Inclusive Framework. It is noted that not all Inclusive Framework members had agreed to it as of November 4 2021.
As the statement re-iterates, so-called pillar one aims to re-allocate profits of the of the largest and most profitable multinational enterprises (MNEs) to the jurisdictions where the customers and users of those MNEs are located and to remove and standstill the patchwork of sui generis national digital services taxes (DSTs) (and other relevant or similar measures) which are being promulgated in an ever-increasing number of jurisdictions. The OECD claims that the ultimate aim remains to bring an end to trade tensions resulting from the instability of the international tax system.
In more practical terms, pillar one places MNEs with a global turnover above €20 billion and profitability above 10% (i.e. profit before tax/revenue) in-scope. It functions by creating a new ‘special purpose’ nexus rule which results in the allocation of what is referred to as ‘Amount A’ to any market jurisdictions in which that MNE derives at least €1 million in revenue. Extractives and regulated financial services are excluded from the scope of pillar one.
The threshold for the special purpose nexus rule (which applies strictly to determine whether a jurisdiction qualifies for the Amount A allocation) is lower for smaller jurisdictions with GDP lower than €40 billion, such as Malta, for which it has been set at €250,000.
By using a revenue-based allocation key, 25% of the ‘residual profits’ (defined as profit in excess of 10% of revenue) are to be allocated to market jurisdictions which fall within the parameters of the special purpose nexus.
Rules still need to be developed in relation to revenue sourcing, tax base determination and possible segmentation and mechanisms are also still to be included for the capping of residual profits to be allocated to market jurisdictions which already have a right to tax a given MNE. The exemption or credit method will remain the principal method of eliminating double taxation of profits which have been allocated to market jurisdictions, though MNEs are to benefit from mandatory and binding dispute prevention and resolution mechanisms in this regard.
A second amount (‘Amount B’) aims to use the arm's-length principle to standardise remuneration received by related party distributors engaged to perform baseline marketing and distribution activities for those MNEs.
Malta is one of the 137 members of the Inclusive Framework that agreed to the statement, though it would appear that it falls far outside the intended radar of pillar one with a GDP of around €15 billion.
Four countries, namely Sri Lanka, Pakistan, Nigeria, and Kenya have not agreed to the statement as of November 4 2021. Of those who currently have a DST in place, one of the primary concerns in this regard is that, following the implementation of pillar one, they will be forced to abandon their current regime, thus surrendering taxing rights over many of the MNEs which they are currently taxing, given that these do not fall within pillar one’s scope.
The detailed implementation plan contained in the two-page annex to the statement announced that the multilateral instrument through which Amount A is implemented will be developed and opened for signature in 2022 with an aim to bring it into effect in 2023. Work on Amount B “will be completed by the end of 2022”.
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