Tax and the digital economy: Significant concerns over OECD proposals

The Organisation for Economic Co-operation and Development (OECD) consulted the international tax community on proposals for taxing digital transactions, and CPA Canada contributed our suggestions. Find out how the OECD responded in its latest statement.

The OECD is leading the way toward a global agreement on common principles for taxing the digital economy, and it has set a tight timetable for achieving consensus on final proposals before the end of 2020. The OECD is developing these rules in consultation with over 135 countries that are part of the OECD’s Inclusive Framework on Base Erosion and Profit Shifting.

As we discussed in our recent tax blog, the OECD is working to establish uniform rules for taxing transactions that are done across borders virtually and online with little or no physical presence. The OECD is tackling these issues through two separate pillars:

  • Pillar 1 examines new ways of determining nexus and allocating profits among countries
  • Pillar 2 looks at a broad global proposal for preventing base erosion

In the fall of 2019, the OECD released detailed proposals on both pillars for public consultation. The three-month consultation period gave stakeholders little time to examine the proposals in detail. Less than a month was available to actually consider the proposals for each pillar. CPA Canada responded with brief submissions on both pillars that address the OECD’s questions and highlight our concerns at a high level.

The OECD gained plenty of feedback from the many submissions it received and during the Inclusive Framework’s recent plenary meeting. On January 31, 2020, the OECD released a statement affirming the member countries’ commitment to agree to a solution by the end of 2020. The statement also allays some of the concerns we raised in our submissions on Pillar 1 and Pillar 2.

PILLAR 1: A UNIFIED APPROACH TO NEXUS AND PROFIT ALLOCATION

For Pillar 1, the OECD has proposed a unified approach that combines elements from three proposals previously outlined in the OECD’s May 2019 Programme of Work.

Some high-level concerns we highlighted in our submission and how the OECD’s recent statement responds to these concerns are as follows:

1. Scope test

The OECD initially proposed that these rules should apply to any large business with a consumer-facing element. We think this application would be overly broad and somewhat unclear. For example, would the proposals apply only to businesses that sell products or digital services directly to consumers, or would they also apply to businesses that sell to intermediate customers who then sell directly to consumers (ignoring distributors)? How would they apply to companies that do not separate their consumer-facing and non-consumer-facing businesses?

Statement update
The OECD clarified that the proposed rules are intended to target automated digital services (e.g., online search engines, social media platforms) and consumer-facing businesses (e.g. franchises, luxury goods).

The OECD also expects the rule to apply to large consumer-facing businesses that sell consumer products indirectly through intermediaries. The rule will not apply to those selling intermediate goods that are incorporated into a finished product. 

Finally, the OECD suggests that businesses with more than one business line will likely need to segment affected business lines from those unaffected when applying the rules. However, the OECD did not specify how this would be done.

3. Complexity

Aspects of the proposals — such as a new nexus rule and the use of country-specific sales thresholds – may be too complicated, and how they would operate is uncertain. For example, would the country-specific sales thresholds take into account the relative size of each country’s economy to ensure smaller countries benefit from the rules? How would the tax authorities of each country receive data on local sales to determine whether the rules apply to the business in question?

Statement update
The OECD remains committed to making the rules and compliance requirements as simple as possible but did not say how this would be achieved. Although complexity is still a concern, more clarity was provided about the new taxing right and the use of sales thresholds. The OECD suggests using various sales thresholds to ensure compliance burdens are proportionate to the intended benefits. One of these thresholds includes the existing €750 million sales threshold used for country-by-country reporting. The statement also included various sector carve-outs for, among others, extractive industries and many financial services. 

4. Need for accounting standards experts

The proposed profit allocation methods use financial information based on generally accepted accounting principles (GAAP). The OECD should therefore work with a panel that includes both tax experts and accounting standards experts to ensure the methods proposed work effectively. It was not clear to us whether this analysis had been done.

Statement update
In its revised Programme of Work, the OECD will apparently seek technical expertise on these issues.

5. Need for a dispute resolution mechanism

The proposals go beyond traditional international tax rules, requiring a new approach to eliminating double taxation and an effective dispute resolution mechanism will be needed for several aspects of the proposals.

Statement update
The OECD acknowledges the importance of eliminating double taxation and implementing an effective dispute resolution mechanism. In tackling double taxation, the OECD is proposing to come up with a new multilateral process that will be mandatory and binding. The statement highlights various methods that it is exploring, including foreign tax credits, deductions and income exemptions.

The OECD also announced that an elective safe harbor approach suggested by the U.S. will be considered. Under such an approach, companies could elect to be subject to Pillar 1. This does present a number of issues which may make reaching a consensus difficult.

PILLAR 2: GLOBAL ANTI-BASE EROSION (GLOBE) PROPOSAL

This set of proposals seeks to curb the risk that global companies may shift profits to jurisdictions with the lowest rates of tax. Some general concerns we highlighted in our submission are as follows.

1. Using GAAP financial statements to determine the tax base determination

For Pillar 2, GAAP is used for computing the tax base, which heightened general concerns we raised for Pillar 1. We question whether this method is suited to its intended purpose. Whether financial statements are based on IFRS or other forms of GAAP, they are designed primarily to meet the needs of investors, lenders and other creditors to facilitate capital allocation decisions, and not to help governments determine taxable profits.

2. Verification

It is uncertain how tax authorities would confirm amounts of taxable profits. In particular, they may not have the accounting expertise they would need to confirm whether global profits were calculated correctly under GAAP. This would be especially true if the GAAP being used is that of a foreign country.

3. Compliance costs

The OECD will need to carefully select a threshold level to ensure the proposals only apply to entities that can manage the resulting increase in compliance costs.

In its statement, the OECD briefly discussed its progress on its work related to Pillar Two, noting significant progress toward reaching a consensus. However, based on the OECD’s list of open issues, significant work is still required on major design elements of the proposed rules.

OECD’S NEXT STEPS

The OECD’s statement also provides an update on next steps and timing for its work to gain global agreement on a final set of rules. These next steps include the following:

  • Throughout 2020, OECD subsidiary bodies will deliver technical analysis and input on the feasibility and implications of the proposed rules, conduct economic analysis and perform impact assessments.
  • The Inclusive Framework Steering Group and subsidiary bodies will work to reach an agreement among the inclusive framework on the key policy features of a solution to Pillar One by July 2020. An agreement on the remaining policy features will be completed by November 2020.
  • Subsidiary bodies will continue to work on resolving the key issues listed in the statement on the Pillar Two proposals.
  • Countries in the inclusive framework will work to agree a final consensus-based solution by the end of 2020, when the steering group will release a report with all technical details.

CPA Canada will continue monitoring the OECD’s work and contributing to the global debate on the most efficient, effective and fair principles for taxing the digital economy. We also look forward to providing insight and advice to the Department of Finance Canada and the Canada Revenue Agency when it comes to adopting the OECD’s ultimate recommendations in Canada.

KEEP THE CONVERSATION GOING

What other practical concerns do you have with the proposals and their potential impact on global businesses with a Canadian presence? Post a comment below.

 

CPA Canada’s Tax Blog is designed to create an exchange of ideas on tax policy and practice issues, and their impact on those who practice tax. Your comments can provide helpful input into the public interest advocacy positions developed by CPA Canada.

About the Author

Bruce Ball, FCPA, FCA, CFP

Vice-president, Taxation, CPA Canada