Back in October, the ink had hardly dried on Paschal Donohoe’s Budget papers when the OECD launched another consultation document on how to tax the digital economy.

The OECD’s new proposals contain two pillars of work. In this article, I will outline the main points we raised in our responses to the consultation papers on Pillar One and Pillar Two.

Unified approach under Pillar One

Pillar One contains a simple concept, which is proving difficult to deliver. It is proposing that companies be taxed everywhere they sell, rather than where they make, do or physically locate. This would allow a share of taxable profits to be allocated to countries where goods are sold, irrespective of whether or not the multinational has a physical presence in the territory.

The proposals move beyond the traditional arm’s length principle for profit attribution and introduce a potentially new approach to profit attribution, which seeks to create a new nexus and place value on the user/marketplace.

International tax rules should not hinder growth or place an undue burden on business based in smaller economies

The proposals in the consultation paper have the potential to have a disproportionately negative impact on small, open exporter economies like Ireland. Although there is an acknowledgement in the consultation paper that smaller economies can also benefit, no detail on how this will be achieved has been included in the consultation paper. It is important that arm’s length principles are respected and form part of the solution to the tax challenges of the digitalised economy. International consensus on the matter is impossible unless the solution gives a fair weighting to the recognition of entrepreneurial profit to the jurisdiction where real and substantive activity is located.

Scope

Significant work needs to be done to clearly define the new ‘nexus standard’ and the threshold level of activity that would create nexus under any new rules. There are also many terms in the consultation paper that are only loosely defined, and these need to be further developed to minimise the possibility of unintended consequences.

The consultation paper suggests that the various elements of the proposals will not apply uniformly and might apply differently between and within companies, according to different segments, business lines, sectors and/or regions. Careful consideration must be given to how this will be achieved. Ringfencing income streams and business lines is a complex and difficult task. Businesses capture data and design financial reporting systems to meet their current reporting requirements. Therefore, businesses may not have the information available to ringfence income streams and business lines. Businesses will therefore need to design new financial reporting systems to accommodate new requirements. Any new rules should not place an undue burden on well-established business models.

Profit allocation

The proposals in the consultation paper seek to redistribute deemed residual profit to market jurisdictions.

There are many challenges that arise from the assumption that value is attributed to jurisdictions based on users/markets. Take a basic example of data. Raw data has no value in itself. It is the creation and use of a data collection system that has value and consideration must be given to where the intellectual property and technology to develop and produce that data collection system is created.

If a member of multinational group gathers data from other companies in the group and turns it into a valuable information resource, then that value is rightfully attributable to the company that did the work rather than the raw data.

Binding dispute resolution

Any fundamental change in the nexus and profit allocation rules will require the establishment of upgraded dispute resolution mechanisms. It is essential that mandatory binding dispute resolution be available for when disputes arise.

Consideration given to losses

The consultation paper outlines that “the new rules should not create distortions and should be effectively applicable to both profits and losses”. However, the substance and detail of how losses will interact with the proposals is lacking within the consultation paper.

Any new rules on nexus and profit allocation should apply equally in situations where the results to be allocated are losses rather than profits. It would be wholly unacceptable to re-allocate profits across jurisdictions globally without also re-allocating losses related to high-risk activities.

Conclusion on Pillar One

We acknowledge that there is merit in finding a straightforward and simple approach that will result in commemorating entrepreneurial investments. In determining fair and sustainable international tax rules for allocating taxable profits, consideration must be given to the investment made by countries to facilitate the talent and capital that brings about entrepreneurial profit, and not to allocate all residual profits of groups trading internationally to countries as mere owners of consumers.

Pillar Two – Global Base Erosion Proposal

Moving on from Pillar One, on 8 November the OECD released the second part of its two-pillar plan for taxing the digital economy. The Pillar Two consultation paper explores design questions for a global minimum tax (GloBE).

The consultation document sets out the four component parts to the GloBE proposal, which envisages an income inclusion rule, an undertaxed payments rule, a switch-over rule as well as a subject to tax rule. These proposals, like Pillar One, pose a substantial change to the international tax architecture by subjecting internationally operating businesses to a minimum rate of tax.

The views that we expressed in our response to the consultation paper are discussed below.

International tax rules should not hinder growth or place an undue burden on business based in smaller economies

By deviating from long-standing principles, the proposal for a global minimum tax would have the effect of creating barriers to investment. The proposals would disrupt genuine investments that lead to real economic activity and the implementation would have real economic effects that need to be carefully evaluated. While the overall impact of these proposals will depend on the level of the minimum tax rate, we are concerned that the proposals target real economic activity.

As work on this project continues, it is important that the assessment of the economic implications of these proposals continues and that the outcomes of these economic assessments be fully reflected in the discussions and decision-making process.

Any potential solution must strike the appropriate balance and not disproportionately prejudice small, open economies that seek to attract – and rely on – substantive foreign direct investment in order to grow their businesses and economies.

Tax competition

The consultation document discusses establishing a floor for tax competition among jurisdictions. We have concerns with the introduction of a floor for tax rate competition. Competition is central to the operation of markets. It fosters innovation, productivity and growth, all of which create wealth and reduce poverty.

Competition is the process of rivalry between firms striving to gain sales and make profits. It is the driving force behind markets, and efficient and fair markets are essential for catalysing private sector development and economic growth. Competition can be harmed by inappropriate government policies and legislation.

We do not agree with the introduction of a floor to international tax competition. In our view, international tax competition is inevitable, and free and fair tax competition is necessary in order to allocate resources efficiently and to maximise global welfare.

Before the international tax rules are re-written again, the impact of the 2015 BEPS initiatives should be allowed more time to ingrain into Inclusive Framework jurisdictions

The consultation document explains how the GloBE proposal is intended to address the remaining Base Erosion and Profit Shifting challenges linked to the digitalisation of the economy. However, it goes even further than the digitalised economy and addresses these challenges more broadly. These proposals are not merely an extension of the BEPS project, but another overhaul of the international tax system.

The consultation document describes the global anti-base erosion proposals as aimed at addressing “the harmful race to the bottom of corporate taxes”. This was the concern at which the BEPS project was aimed. Countries around the world in the Inclusive Framework are in the process of implementing the BEPS recommendations and the results of the BEPS work should be allowed to play out before undertaking an evaluation of whether and where there may be continuing areas of concern.

Countries have the sovereign right to set their own tax rate

We are concerned that the GloBE proposals outlined in the consultation document would erode the sovereign right of countries to choose the corporate tax rate that is best for their particular economic circumstances and their particular tax system. Under long-standing principles, there should be no question that the country where the commercial activities are performed is fully sovereign in deciding whether and how to tax these activities.

Conclusion to Pillar Two

Established international tax rules cannot be disregarded, which risks creating chaos for international businesses and tax authorities alike. Existing international tax rules are backed up by substance and sound economic logic, which should be respected. It is important for policymakers to think long and hard about how a radical rethinking of international tax principles will impact the stability of the global corporate tax yield and the impact on individual countries. Policymakers must also consider how international businesses will cope with another layer of complex and burdensome international tax rules.

If you would like more information, or are interested in reading the Institute’s full responses to the OECD consultation papers, visit www.charteredaccountants.ie

Bríd Heffernan is Tax Technical Manager at Chartered Accountants Ireland.

Email: brid.heffernan@charteredaccountants.ie