Important tax developments for digital economy

Over the past few years, the digital economy has become a hot topic around the world. The international community has made substantial progress towards reaching a consensus-based and long-term solution to prevent tax challenges arising from the digitalisation of the economy. Seeking to keep working towards an agreement by mid-2021, the Organisation for Economic Co-operation and Development (“OECD”) issued on 12 October 2020 a two-pillar approach, under development since 2019, to reach a solid foundation for a future agreement. 

Digital transformation stimulates innovation, generates efficiencies and improves services while boosting more inclusive and sustainable growth and enhancing well-being. At the same time, the breath and speed of these changes introduce new challenges in many different areas; and taxation is also impacted by these evolutions. Considering the current international context, an in-depth reform of the international tax system appears to be necessary to manage the tax challenges arising from the digital economy and to restore stability to the international tax framework.  

This awareness has also been accelerated by the Covid-19 pandemic where most governments affected their overall finances by increasing spending on healthcare and providing unprecedent levels of financial support. There is crucial need to get back on a sustainable footing.

The two-pillar approach released reflects convergent views on key policy features, principles and parameters for a future agreement between the 137 countries and jurisdictions to determine a consensus-based solution to face the new tax challenges arising from the changes of the business models.

Considering the important changes that may significantly impact your business, Mazars’ tax experts have highlighted below the key aspects arising from the latest OECD developments, ahead of the future agreement that should be entered between the 137 countries involved in the determination of a global solution.

Key features

While Pillar One and Pillar Two represent complementary approaches, distinctions need to be considered in terms of scope and objectives.

Pillar One is establishing new rules on where tax should be paid (under the so called “Nexus” rules) and a sustainable taxation framework that would allow allocation of the taxing rights between countries.

Pillar Two is introducing rules that would provide the jurisdictions involved with pragmatic tools to effectively address tax issues in relation to base erosion and profit shifting (“BEPS”), i.e., to apply a right to tax where other jurisdictions have not exercised their primary taxing right or low level of taxation was applied.

Pillar One

While globalisation and digitalisation of the economy can, with or without the presence of an activity, lead to the realisation of profits, the overall existing international tax rules is generally attaching a taxing right to profits deriving from a physical presence in a jurisdiction. In such a context, the allocation of the taxing rights and related taxable profits can no longer be solely limited by reference to local presence.

This illustrates the willingness to relocate the taxing rights to market jurisdictions through a new Nexus approach and profit allocation rules in recognising that the digitalised economy is interacting the consumers and creating value without traditional presence in a located market.

Pillar One is illustrating the taxing right relocation through a three-tier mechanism:

• Revisit of the existing Nexus and profit allocation right in accordance with activity carried out and regardless of physical presence;
• Simplification of administration process with transfer pricing rules for tax administrations through the standardisation of remuneration and related party distributors that perform baseline marketing and distribution activities in market jurisdictions; and
• Implementation of dispute resolution mechanisms to enhance tax certainty and prevent dispute between tax administrations of different jurisdiction.

The scope of application of these new rules remains at this stage under discussion between the countries involved in the development of these new approaches and is also predominantly jeopardised by key pending political issues. Ahead of a future agreement, it will be necessary to agree on the definitive solutions, definitions and period of application as, at the moment, many positions remained unclear.

Pillar Two

The global reflections around Pillar Two are designed to ensure that internationally operating businesses are paying a minimum level of tax regardless of the location of their headquarters or of the jurisdiction they operate in.

Under Pillar Two, the aim is to re-attribute the income being subject to low-tax regime or nil-tax regime to another taxpayer, even though it has not been distributed. The framework for the implementation of these new rules provides for different mechanism to achieve this outcome.

While the impact of some of the tax mechanisms will be exclusively limited to the implementation or amendment of domestic laws, others can only be implemented through the changes of bilateral tax treaties. This is predominantly impacting the decision-making process and slows down the determination of a consensus-based solution.

Our view at this stage

Pillar One and Pillar Two approaches aim to reach a consensus-based approach to manage tax challenges arising from the digitalisation of the economy. 

Overall, the OECD works comes at just the right time considering that the digital economy progresses consistently, and the absence of international framework might lead to a proliferation of unilateral digital tax systems which would adversely impact tax certainty and sustainability of the market.

On the other hand, Pillar One and Pillar Two demonstrate that political decisions and arbitration of some jurisdictions are impacting the conclusion of a consensus-based approach and the determination of a global agreement.

The overall impact of these future rules can already be anticipated and Mazars’ tax experts highly recommend proceeding with early reviews of your businesses to effectively determine the consequences that could potentially arise.