Addressing the tax challenges of digitalisation

By Elinor Kasapidis

The OECD/G20 Inclusive Framework on base erosion and profit shifting (BEPS) is undertaking work to address the tax challenges raised by digitalisation.

As of July 2021, more than 130 Inclusive Framework member jurisdictions have committed to a two-pillar solution, with a detailed implementation plan to be finalised by October 2021.

According to the statement by the Organisation for Economic Co-operation and Development (OECD), under Pillar One, the largest profitable multinational enterprises (MNEs) will have a percentage of their residual profit allocated to the market jurisdictions where their goods and services are used or consumed.

This will make those profits subject to tax in the market jurisdiction. However, enterprises operating in extractive and regulated financial services industries will be excluded.

Further, there will be a simplification and streamlining of baseline marketing and distribution activities, as well as the removal of all digital services taxes and other similar and relevant measures.

Pillar Two comprises the Global Anti-Base Erosion (GloBE) rules and a Subject to Tax Rule (STTR).

The GloBE rules will impose a top-up tax on a parent entity, where its constituent entities are taxed at a low rate (the Income Inclusion Rule) and will deny deductions or require adjustments in relation to the low tax income that is not subject to the top-up tax (the Undertaxed Payment Rule).

The STTR will allow source jurisdictions to impose tax on certain related party payments that are taxed below a minimum rate via treaties.

The GloBE rules will apply to MNEs meeting the country-by-country reporting thresholds and impose a top-up tax based on the effective tax rate test in each jurisdiction. The minimum effective tax rate will be at least 15 per cent.

A unified approach

The OECD estimates that taxing rights on over US$100 billion (A$136 billion) of profits will be reallocated to market jurisdictions, while the global minimum tax will generate an additional US$150 billion (A$203 billion) each year.

In addition, the OECD states that the replacement of unilateral and uncoordinated tax measures with a unified approach provides greater tax certainty and a reduction in compliance and administration costs, leading to a more favorable global investment environment.

While the progress to an agreed commitment is a positive step, many details remain to be sorted out. For MNEs and their advisers, significant uncertainty remains in terms of the formulas, carve-outs, simplifications, exemptions, adjustments and dispute resolution processes.

With the rules expected to be implemented by 2023, the ambitious timeframe places significant pressure on lawmakers, policy advisers and tax administrators to understand the impacts of the proposed plan on their jurisdictions and determine their approach to implementation.

Jurisdictions that currently offer corporate tax rates lower than the yet-to-be-determined minimum effective tax rate, or whose exemptions and incentives reduce the effective tax rate below the threshold, will need to consider the implications for their economic and fiscal policy settings.

Opportunities to address challenges

The intention to reduce administration and compliance costs has been welcomed. However, experience with transfer pricing and country-by-country reporting requirements suggests that there will be challenges.

The implementation of Pillars One and Two may also provide an opportunity to address existing difficulties with the timely and efficient resolution of cross-border tax disputes, and the proposal to include dispute prevention and resolution mechanisms will be critical to avoid double taxation.

As the two-pillar solution progresses, tax administrations will need to engage with affected MNEs and their advisers to ensure that the new rules are understood and adopted.

It is also likely that there will be an increased use of and dependence on multilateral advance pricing agreements, mutual agreement procedures (MAPs) and perhaps even joint audits to provide certainty.

This is likely to place pressure on tax administrators to enhance their engagement with other jurisdictions and seek to resolve disputes in a more timely manner, with the Inclusive Framework also monitoring MAP provisions under BEPS Action 14.

After the detailed plan is released in October, there remain further steps, including the ratification of a multilateral instrument, which would underpin Pillar One and the passage of the rules through each jurisdiction.

The extent to which there will be unanimity and agreement upon the details remains to be seen.