The G20 leaders' summit in Osaka next month represents a significant juncture in digital economy tax reform – a summit that will test the OECD's previously-expressed optimism that they will be able to show that good progress has been made on the "what" and the "how" of a long-term solution to be delivered in 2020. Until the summit, we can only speculate on what these will be – albeit such speculation can be much more informed given the significant progress that has been made in the past six months by the OECD and the BEPS Inclusive Framework on the path to a consensus solution.
How will the long-term solution likely look?
Let's speculate on the "how" first. It is clear, from the OECD's and a number of other key players' perspectives, that unilateral measures are not the answer, although many countries have announced their intention to introduce their own digital services tax, and the French version is already in force. Despite this, a consensus solution appears more likely following the OECD's 13 February 2019 Public Consultation Document (OECD ConDoc). With members of the Inclusive Framework having generally lent their support to a "two-pillar approach" – involving a new nexus-based approach to allocate taxing rights and a minimum tax on profits of related party investors and under-taxed payments – the question now is how soon agreement can be reached.
The aim of a nexus-based approach would be to allocate more taxing rights to market or user jurisdictions where value is created through user participation. Achieving this requires two fundamental changes to the international tax system as follows:
- Firstly, a new form of taxable presence needs to be created. Under traditional permanent establishment (PE) concepts, user participation does not, of itself, create a taxable presence. So the OECD is exploring new nexus concepts, including changes to the PE threshold, potentially modelled on India's significant economic presence test;
- Secondly, once a user-based nexus is established, it is necessary to consider how profit attribution rules can be changed to take into account, as the OECD describes it, value "created by a business activity through participation in the user or market jurisdiction that is not recognized in the framework for allocating profits".
So, what value is it that current profit allocation rules – namely, transfer pricing (TP) methods based on the arm's length principle – are currently not recognizing? The OECD ConDoc refers to proposals from the Inclusive Framework to reconsider current TP rules as they relate to "non-routine returns" being, very broadly, returns for unique functions that typically could not be outsourced to a third party. In particular, an alternative proposal to the user participation model "involving the concept of marketing intangibles" has attracted support, including, significantly, from the US, and many are describing this as a likely way forward. Like the user participation model, the PE and TP rules would be modified to allow market jurisdictions to tax non-routine income associated with marketing intangibles, even in the absence of a taxable presence. Currently, under the OECD TP Guidelines (Guidelines), a "marketing intangible" is an intangible that relates to marketing activities, aids in the commercial exploitation of a product or service, or has an important promotional value for the product concerned. It may include trademarks, trade names, customer lists, customer relationships, and proprietary market and customer data that is used or aids in marketing and selling of goods or services to customers.
For example, a data center company has developed a centralized strategy to target key customers, who in turn attract other customers who are able to benefit from being able to locate in close proximity to those key customers. The company has data centers located in key financial hubs that focus on financial services clients. Other customers can take advantage of the interconnection offered in these data centers and reap benefits such as being able to execute trades faster. This creates profits that are substantially higher than traditional data center companies without this strategy. Under the OECD proposal, each country where the financial services clients are based would have the right to tax non-routine returns linked to the marketing intangible, which in this case is the company's network of interconnected users.
If the OECD adopts a "marketing intangibles" concept to allocate non-routine returns to a user jurisdiction, then the precise amount of such a non-routine return (and, related to this, the taxable income in that jurisdiction) will clearly pivot on how broad the definition of "marketing intangible" is for such an allocation. If the objective is to tax value created by a business's activity or participation in market or user jurisdictions, it would seem that the definition of "marketing intangibles" should focus on "customer"-type intangibles, such as relationships and data, however what will be adopted remains to be seen.
The likely scope of any new rules
The other big question, exactly "what" will be within the scope of any new rules also remains to be answered in Osaka. The OECD ConDoc was silent as to whether any measures should be confined to just "digital economy" companies. Such silence may indicate that there is no intention to target specific sectors, but rather, to include everything, such as bricks and mortar businesses that may have digitalized elements to their supply chain.
Reasons for optimism
The path from the BEPS Action 1 report (Addressing the Tax Challenges of the Digital Economy) to Osaka has been littered with potholes, in the form of a proliferation of unilateral measures and rival initiatives such as that proposed by the European Commission. Many stakeholders in international taxation will share the OECD's justified optimism for a solution to be agreed in the near future. The alternative scenario would be likely to mean further unilateral measures, prolonging the uncertainty for businesses.