On October 13, 2021, the G20 Finance Ministers and Central Bank Governors issued a Communiqué formally endorsing the political agreement reached by 136 countries of the OECD/G20 Inclusive Framework on Base Erosion and Profit Shifting (IF) on a two-pillar framework to dramatically change the taxation of multinational enterprises (MNEs). The Communiqué calls on the IF
On August 5, 2021, the OECD released updated Peer Review Results for preferential tax regimes reviewed by the OECD Forum on Harmful Tax Practices (“FHTP”) in connection with BEPS Action 5. Of particular interest to Multinational Enterprises (“MNEs”), the Peer Review Results report that the Foreign-Derived Intangible Income (“FDII”) regime is already “in the process of being eliminated” and that “the United States has committed to abolish this regime.”
The possibility that FDII might be repealed should come as no surprise given the Biden Administration’s Green Book proposal to eliminate FDII. And in any event, the repeal cannot actually take effect until and unless FDII is repealed by legislation. Nevertheless, for MNEs that would be adversely affected by the possible repeal, the references in the Peer Review Results send a strong signal that FDII repeal may be a key priority in future tax reform negotiations.
Continue Reading Whither FDII — OECD Discusses FDII in Harmful Tax Practices Update
On April 15, 2020, OECD released the report titled “Tax and Fiscal Policy in Response to the Coronavirus Crisis: Strengthening Confidence and Resilience” (the “COVID-19 Response”). The COVID-19 Response discussed the decisive action many governments have taken to contain and mitigate the spread of the virus and to limit the adverse impacts on their citizens
On July 10, 2021, the G20 endorsed a broad framework to advance Pillars One and Two, which includes an aggressive timetable for bringing the new rules into force in 2023. The endorsement came in a Communiqué, which approved the July 1 statement by the 139-country Inclusive Framework. The G20 agreement represents a political consensus on
For over a decade, countries have been looking for ways to tax the digital economy. On July 1, 130 countries announced an agreement that would provide a new taxing right to enable a country to tax a portion of digital profits even in the absence of traditional taxable nexus with the country. This new taxing right is known as “Amount A”. The quantum of Amount A remained a mystery until the publication of the OECD’s “Statement on a Two-Pillar Solution to Address the Tax Challenges Arising From the Digitalisation of the Economy” on July 1, 2021 (the “Statement”) which quantified Amount A to be “between 20-30% of residual profit defined as profit in excess of 10% of revenue” for in-scope enterprises. Although this quantum of Amount A represents a political compromise, a solid theoretical basis underlying that compromise is essential to sustaining consensus.
The early proposals to modify profit allocation and nexus rules for the digital economy enterprises, which ultimately produced Amount A, strived to be based on certain subjective criteria, including the concepts of user participation, marketing intangibles and/or the concept of significant economic presence. The contemplated methods for profit allocation were the Modified Residual Profit Split method, Fractional Apportionment method, and Distribution-based approaches, along with the options for business line and regional segmentation. However, the criteria and methods of the early proposals are nowhere to be found to found in the OECD July 2021 Statement, leaving many questions about Amount A still unanswered. While the final compromise on Pillar One eliminates the focus on digital economy and shifts instead to high profitability when defining in-scope MNEs, the “digital essence” still surrounds Amount A. For one thing, the introduction to the Statement continues to refer to the “two-pillar solution to address the tax challenges arising from the digitalisation of the economy.” Moreover, a widely accepted assumption in the final Pillar One negotiations is that high profits are generated by intangibles and those are increasingly concentrated with digital businesses. Therefore, an analysis of Amount A cannot be divorced from the analysis of the factors that contribute to the digital economy.
On June 5, 2021, the Finance Ministers and Central Bank Governors of the G7 countries issued a Communiqué announcing their agreement on the conceptual framework for a substantial revision to global tax policy (the “Communiqué”). The Communiqué puts the G7’s stamp of approval on recent efforts by the OECD (supported by a big push by
As discussed in prior blog posts, Amount A will apply as an overlay to the existing profit allocation rules. As the profit of an MNE group is already allocated under the existing profit allocation rules, a mechanism to reconcile the new taxing right (calculated at the level of a group or segment) and the existing profit allocation rules (calculated at an entity basis) is necessary to prevent double taxation. This is the purpose of the mechanism to eliminate double taxation from Amount A. To reconcile the two profit allocation systems, it identifies which entity or entities within an MNE group bears the Amount A tax liability, which effectively determines which jurisdiction or jurisdictions need to relieve the double taxation arising from Amount A. This mechanism is based on two components: (i) the identification of the paying entity or entities within an MNE group or segment; and (ii) the methods to eliminate double taxation.
Continue Reading OECD’s Pillar One Blueprint: Elimination of Double Taxation
In February 2021, the Organisation for Economic Co-operation and Development (“OECD”) issued a handbook linked with the official roll-out of its International Compliance Assurance Programme (“ICAP”). ICAP was first introduced as a pilot in January 2018 (“ICAP 1.0”) as a voluntary program where MNE groups may receive “comfort and assurance” from multiple tax administrations as to the veracity of the MNE group’s transfer pricing allocations and numerous types of international transactions. While some notable countries did not participate in ICAP 1.0 (for example, Germany), the pilot program received positive reviews by a number of MNE groups. In March 2020, the OECD enhanced the pilot program (“ICAP 2.0”) to encourage more countries to join. On March 22, 2021, the OECD announced an initial list of twenty countries that are participating in the official program.[1]
Continue Reading ICAP, a New Tool in the Multiverse of Multinational Tax Dispute Management
Amount B aims to standardize the remuneration of related party distributors that perform baseline marketing and distribution activities in a manner that is aligned with the arm’s length principle. Its purpose is two-fold: First, Amount B is intended to simplify the administration of transfer pricing rules for tax administrations and reduce compliance costs for taxpayers. Second, Amount B is intended to enhance tax certainty and reduce controversy between tax administrations and taxpayers.
Pillar One assumes that distribution and marketing activities would be identified as in-scope based on a narrow scope of activities, set by reference to a defined “positive list” and “negative list” of activities that should and should not be performed to be considered in scope. Quantitative indicators would then be applied to further support and validate the identification of in-scope distributors. It is anticipated that amount B could be based on return on sales, with potentially differentiated fixed returns to account for the different geographic locations and/or industries of the in-scope distributors. Given the narrow scope of Amount B, there is currently no provision for Amount B to increase with the functional intensity of the activities of in-scope distributors. Amount B would not supersede advance pricing agreements or mutual agreement proceeding settlements agreed before the implementation of Amount B.
Under one proposal, the implementation of Amount B would operate under a rebuttable presumption, namely, that an entity that acts as a buy/sell distributor and performs the defined baseline marketing and distribution activities qualifying for the Amount B return would render it in scope, but that it will be possible to rebut the application of Amount B by providing evidence that another transfer pricing method would be the most appropriate to use under the arm’s length principle. While one group of OECD members prefers a narrow approach, another group prefers a broader approach that would also provide standardized remuneration for commissionaires or sales agents, or for distribution entities whose profile differs from the baseline marketing and distribution activities discussed below.
Overview. As discussed in prior blog posts, Amount A is a proposed new taxing right over a share of residual profit of MNE groups that fall within its defined scope. The calculation and allocation of Amount A will be determined through a formula that is not based on the Arm’s Length Principle (ALP). The formula will apply to the tax base of a group (or segment where relevant) and will involve three components: Step 1: a profitability threshold to isolate the residual profit potentially subject to reallocation; Step 2: a reallocation percentage to identify an appropriate share of residual profit that can be allocated to market jurisdictions under Amount A (the “allocable tax base”); and Step 3: an allocation key to distribute the allocable tax base amongst the eligible market jurisdictions (i.e. where nexus is established for Amount A). This three-step formula to determining the Amount A quantum could be delivered through two approaches: a profit-based approach or a profit margin-based approach. A profit-based approach would start the calculation with the Amount A tax base determined as a profit amount (e.g. an absolute profit of EUR 10 million) whereas a profit-margin approach would start the calculation with the Amount A tax base determined as a profit margin (e.g. a PBT to revenue of 15%). Both approaches would apply the three steps of the allocation formula similarly, and hence would deliver the same quantum of Amount A taxable in each market jurisdiction.
Continue Reading OECD’s Pillar One Blueprint: Profit Allocation