Taxation of the digital economy – continuing progress

20 November 2020

On 12 October 2020 , the OECD published its reports on the pillar one and pillar two blueprints on the taxation of the digital economy. Whilst the OECD also acknowledged that it would now not meet its stated objective of securing consensus on this subject by the end of 2020, the pressure to achieve a consensus amongst the 137 members of the Inclusive Framework on base erosion and profit shifting (BEPS) is, perhaps, now stronger than ever in the context of the global economic slowdown being driven by the coronavirus pandemic. It is now the aim of the OECD to bring the process to a successful conclusion by mid-2021 and it has stated that ‘political agreement could and should be reached soon’.  

Pillars one and two – a summary

Pillars one and two are approaches intended to provide a global framework for taxing the digital economy. The blueprints reflect what the OECD considers to be broadly agreed views on many of the key policy features and identify the remaining policy, technical, and administrative issues where further work is needed.  

The two pillars are structured as follows.

Pillar one

At high level, the focus of this pillar is on new nexus rules and new rules to determine the allocation of taxable profits between tax jurisdictions. However, the scope of pillar one is broad - it comprises what the OECD describes as 11 separate building blocks which include three major areas, being:  

  1. a new taxing right for market jurisdictions over a share of residual profit calculated for a multi-national group; 
  2. a fixed return for certain baseline marketing and distribution activities taking place physically in a market jurisdiction, in line with the arm’s length principle; and
  3. processes to improve tax certainty through effective dispute prevention and resolution mechanisms.

Pillar one would involve a significant change to the way taxing rights are allocated among jurisdictions. The OECD estimates that this could result in the reallocation of taxing rights on about US$100bn of profit per year, on the basis of assumed but reasonably realistic profitability thresholds and reallocation percentages. The OECD anticipates that all economies with market activities are likely to benefit from revenue gains, while ‘investment hubs’ would lose tax revenues.  

Pillar two

Pillar two would introduce a global anti-base erosion (GloBE) proposal, that is broadly in the form of a minimum level of tax payable by businesses operating internationally. The OECD predicts that pillar two is likely to yield a significant increase in corporate income tax revenues and also reduce the incentive for multi-national enterprises to shift profits to low-tax jurisdictions   .  

Current climate

Many governments will be looking to raise additional funding to repay debts arising during and rebuild domestic economies that have suffered as a result of the coronavirus pandemic. The commitment to tax the digital tech giants arguably brings together an increasing awareness of the potential additional tax revenues that could be raised with a growing intolerance from voters for businesses that are perceived to not be paying their fair share of taxes. 

In addition, the ongoing absence of an agreed international framework for the taxation of the digital economy carries the risk of further uncoordinated unilateral tax measures. Examples here include the digital services tax already in effect in the UK and elsewhere and the recent announcement by the EU Commission that the EU will act unilaterally in early 2021 in the absence of global agreement by that time.

Consensus may therefore promote global economic recovery if measures are implemented consistently around the globe, but if there is continuing disagreement regarding key aspects of pillars one and two, it may be even more likely that we see the kinds of trade disputes and sanctions that are becoming increasingly common and are likely to only hinder worldwide economic growth. As a result, the occupancy of the White House in 2021 and the views of the new regime, coupled with the trajectory of the economic impact of the coronavirus pandemic, will clearly be significant global influencing factors.  

The pillar one and pillar two blueprints are open for consultation until 14 December 2020 and the OECD then plans to hold public consultation meetings in January 2021. 

For more information please get in touch with Suze McDonald.