Global tax systems are based on concepts of trade that are more than 100 years old, when the digital economy, intangibles and trademarks played a much smaller role in international business.
The OECD recognises that, if the problem is not fixed soon, many jurisdictions will take action independently. France is already doing so, the UK are ready to go from 1 April 2020 and other territories have digital services tax in the works. The United States is the wildcard here, with many governments keen to avoid retaliation from the country where many of the affected businesses are domiciled.
The OECD wants to fix the problem by looking at the market places in which large companies operate but have little taxable presence, and allocating profits to those territories. Larger economies with big populations would benefit, while smaller countries would lose out. With an eye on the realpolitik, the OECD knows that their more influential members will have the most to gain.
Some commentators have challenged the emphasis on the end users, suggesting that the approach will disadvantage those countries further up the supply chain, where goods may be manufactured or services are managed.
Included in the detail of the proposals is a way of dealing with the vexed issue of coproduction, where consumers create value for digital companies by creating valuable data, but there is no taxable presence. Again, the OECD plans to do this by looking at the consumer base and allocating profits accordingly.
Who is affected?
Essentially, the OECD is targeting companies that deal with consumers and make ‘above normal’ profits. It seems likely that there will need to be a threshold of profits before the proposals impact a company –where that will sit is unclear – but UK tax advisors will be aware of the variety of thresholds in which tax law applies to larger companies.
A new concept of nexus is created, one largely based on sales rather than physical presence. Although the ‘traditional’ approach to permanent establishment will not be abolished.
Interestingly, only above average profits will be reallocated – routine returns being calculated by reference to existing transfer pricing rules. The issue of many large digital businesses being loss making (it famously took Amazon five years from IPO to generate a quarterly profit) is not well addressed. The OECD will not win much support for significant losses being allocated to businesses with no taxable presence. The document says it applies to losses as well as profits – but there may be ‘special rules for losses’, which may mollify some countries.
The good news is that there seems to be a sensible formulaic approach to the profit reallocation, which reduces the opportunity for uncertainty. For example, in the UK, while the Corporate Interest Restrictions may be complex, their formulaic approach lets businesses find out where they stand quite quickly. The starting point for profitability appears to be the profits for financial reporting which, of course, places accounting standards firmly in the spotlight at a time where standards setters and auditors are under some pressure.
A way forward?
The OECD wants to start a debate, one outside the control of governments, with a view to trying to find consensus that will lead to action. They are looking for public input and have posed four questions that they would like addressed. The questions are around the scope (larger consumer businesses?), nexus (does it only benefit larger territories?) and the calculations and the definition of routine profits.
For the tax world, it is quite a radical proposal, so interested parties should definitely look to respond.
Laurence Field is a partner in Corporate Tax at national audit, tax, advisory and risk firm, Crowe