Scale without mass, reliance on intangibles, use of information and communication technologies and multi-sided business models are key characteristics of new-age businesses. Digitalisation of businesses has exposed vulnerabilities in the existing tax framework, designed over a hundred years ago, and prone to base erosion and profit shifting. Governments globally have recognised the need to revisit the concepts of source and residence or the characterisation of income for tax purposes. The BEPS project, initiated by the OECD and the G20 in 2013, was a major step in resolving this conundrum.
OECD Inclusive Framework
The OECD has been working towards developing a global consensus on an inclusive framework. It has released an elaborate blueprint for the Two-Pillar Approach. The proposals under Pillar One seek to reallocate taxing rights to market jurisdictions in case of automated digital services (ADS) and consumer-facing businesses (CFB). Pillar Two recommends a set of rules to ensure that profits of internationally-operating businesses are subject to a minimum rate of effective tax.
The UN alternative
The UN has proposed a simplified alternative by releasing a draft of Article 12B, which could be included in tax treaties between countries through a multilateral convention. The draft proposes to allocate partial taxing rights on income from ADS (excluding royalties and fees for technical services) to market jurisdictions. It allows an option for taxpayers to choose between gross and net basis taxation and accordingly subject to tax/withholding at specified rates.
Consensus on resolution
While the final reports from the OECD on the Two-Pillar Approach are expected in mid-2021, it would be a daunting task to have a global/political consensus. The biggest impediment is garnering agreement on the ‘one size fits all’ approach under Pillar One. Uncertainties exist on the applicability of Pillar One (agreement to thresholds; classification of profits into routine and non-routine before arriving at the share of profits to market jurisdictions; quantum of incremental tax revenue that would be collected vis-à-vis the efforts involved). Regarding Pillar Two, setting a global minimum tax rate may allow economically stronger countries to force a minimum rate agenda on smaller economies, which may have an economic impact on them.
Assuming consensus is reached, absence of harmonised adoption would give rise to mismatches. Early this year, the US withdrew from discussions on Inclusive Framework. As against this, the acceptability and time to implement the UN alternative provides no immediate redressal; the resolution may be farther than it appears.
Triggered by the desire to protect tax base and uncertainty about a mutually-accepted solution, several countries introduced unilateral measures like equalisation levy, withholding tax, digital services tax, VAT/GST, etc. With the pandemic and the resulting economic slump causing deficit in tax revenues of governments, it is likely more countries may implement such measures. While these measures may/may not fill coffers of governments, they add to the complexity of doing business for a global corporation. Besides additional compliance and tax cost, they add to risks from non-compliance, unintended litigation, increased efforts and ultimately increased cost of doing business.
While these developments from the OECD and the UN are steps to resolve tax challenges on digital economy, businesses should assess the impact of digital taxes in their main operating jurisdictions. All global businesses should relook at their existing business models considering current tax laws, interim measures and resolution propositions. The key is to have a holistic perspective on local and international developments. It is important to maintain consistency in positions, documentation, reporting and compliances across regulations and countries. Businesses must gather adequate technical and tech support to implement the imminent changes in their infrastructure to effectively identify, track and manage complex computations and compliances. It would be worthwhile to assess capabilities of existing ERP systems to track and map the digital activities and resulting revenues/costs. Resourcing, trainings and reskilling of tax teams will be necessary to cater to additional compliance requirements. Rethinking tax functions is imperative, as taxation complexities are likely to stay.