In a digital age, the allocation of taxing rights to countries can no longer be driven solely by reference to places where a company has a physical presence. If proof were needed, you need look no further than the continuing tax disputes between companies such as Apple or AirBnB on the one hand and the EU or its member states on the other. Similarly, the US is moving away from a physical presence to an economic nexus following the Wayfair decision in 2018. The OECD recognises that current tax rules dating back to the 1920s are no longer sufficient to ensure a fair allocation of taxing rights in an increasingly globalised world.
Against that background, the OECD has published a new proposal for taxing highly digital business models. This will affect not only the tech giants but will also extend to other consumer-facing businesses such as luxury goods makers and international car companies.
For businesses within the scope of the new rules, taxation will largely depend on where sales occur. This will give countries the right to tax non-resident enterprises which are active within their borders. While some of these rights already exist within double taxation agreements, the OECD is proposing a new set of profit allocation rules which have a three-tier mechanism:
- a share of profits would be taxable in each country where a multinational sells goods or services but has no physical presence;
- for countries in which multinationals have a physical presence, a formula would be used to identify a fixed rate of return on marketing, distribution and administration; and
- a dispute-resolution mechanism which would top up profits allocated to a country, if A and B produced lower revenues than a country would have received using current rules.
There is still a long way to go. While the OECD has made considerable efforts to produce proposals which are reasonably accurate and relatively simple for both companies and tax administrations, there is no hiding the fact that this is a complex issue and much more detailed work will be required before the new rules come into force. At present data has no generally accepted valuation method from an accounting perspective and, as the accounts are the starting place for taxation, this will only acerbate the conundrum they face. Having said that, the OECD is hopeful of implementation in 2020. With the overall effect likely to be the shifting of taxable profits away from tax havens and towards the jurisdictions in which most customers are based, we can be sure that significant political hurdles have yet to be cleared.
In the meantime, a number of countries such as the UK have pressed ahead with their own alternatives. For the UK, these include the diverted profits tax which came into force on 1 April 2015 and the digital services tax which is expected to apply from April 2020. In response to criticisms that, by introducing additional new country-level taxes such as these, the UK threatened to undermine the OECD initiative, Financial Secretary to the Treasury Jesse Norman has confirmed that these taxes will be scrapped once the new OECD rules are ready to come into force.