BEPS 2.0: Revolution in international taxation on the horizon
Following up on the Base Erosion and Profit Shifting (BEPS) initiative, the OECD Secretariat published a document containing a new proposal for a unified and global approach to the taxation of the digital economy, BEPS 2.0, introducing a new method for the allocation of profits among states as well as a proposal for the existence of a minimum tax rate. The initiative aims to achieve consensus on the matter among the states before the end of 2020. The proposal in fact departs from the arm’s length principle (i.e. how much would be paid for services or goods between unrelated, independent parties) and attempts to allocate profits by formula.
BEPS 2.0 is a follow-up of the OECD’s Base Erosion and Profit Shifting (BEPS) project of 2015, whose outcome was a set of recommendations of how to reduce aggressive tax planning. Some recommendations were directly implemented by the EU through the Anti-Tax Avoidance Directive (ATAD). The current initiative primarily deals with challenges associated with digitalisation and intends to distribute certain profits of multinational corporations among the states and allocate tax revenue to the countries in which the users and customers of these corporations reside. The new profit taxation principle would thus not derive from the physical presence of companies in individual countries (the existence of permanent establishments), but a certain revenue threshold in a given jurisdiction would be used.
BEPS 2.0 has two main pillars: Pillar 1 describes a unified approach for the allocation of taxing rights and for the revision of profit allocation among the countries; Pillar 2 develops rules giving jurisdictions the taxing rights where primary taxation does not occur in other jurisdictions or where taxation is set at an effective tax rate lower than the minimum tax rate.
The OECD’s recently published document deals with Pillar 1, i.e. applying a unified approach to highly digitalised business models and consumer-facing businesses. Its application to other industries is yet to be discussed; however, it should be restricted by a worldwide annual turnover of EUR 750 million.
In short, this initiative offers a new solution for the re-allocation of taxing rights among jurisdictions in exchange for higher legal certainty for all parties. The unified approach means that a portion of the deemed residual profit, i.e. profit above a certain threshold, is allocated among other jurisdictions using a formulary approach (the profit will be derived from a corporation’s consolidated financial statements). Simultaneously, a fixed return should be established for certain baseline or routine marketing and distribution activities in a jurisdiction in accordance with existing international taxation rules. And, finally, compensation for other functions in a jurisdiction should be determined based on the existing arm’s length principle.
In early November, a public consultation document dealing with Pillar 2 was published. Agreement on the final BEPS 2.0 framework is expected at the end of January 2020, while consensus among the states may become a reality at the end of the same year. We believe that this initiative should be monitored very carefully; it may happen that no consensus among the OECD countries is reached, resulting, as in the digital economy taxation case, in a number of uncoordinated unilateral local initiatives potentially leading to double taxation. On the other hand, if this initiative is successfully implemented, a shift from the arm’s length principle towards the formulary allocation of profits could also affect other international taxation areas.