OECD tax proposal (BEPS 2.0)

Context

OECD has proposed a new multilateral framework on taxation of new-age companies such as Netflix, Uber, Google and Facebook, which have a large customer base in developing countries like India as well as the EU.

About

  • The OECD tax proposal aims to prevent digital Multinational Enterprises (MNEs) artificially showing profits in low-tax countries instead of where deal happens.
  • The proposal requires them to pay tax wherever they have significant consumer-facing activities (market) and where they generate their profits, and not based on jurisdiction of their physical presence.
  • The new OECD proposal brings together common elements of three competing proposals from member countries:
    • A user participation proposal;
    • A marketing intangibles proposal and;
    • A significant economic presence proposal (as proposed by India).
  • OECD tax proposal: The proposal would re-allocate some profits and corresponding taxing rights to countries and jurisdictions where MNCs have their markets. It would ensure that MNEs conducting significant business in places where they do not have a physical presence, are taxed as per the following new unified rules:
    • Where tax should be paid (“nexus” rules; which are largely dependent on sales)
    • What portion of profits should be taxed (“profit allocation” rules)
  • The proposal is based on the work of OECD/G20 Inclusive Framework on Base Erosion and Profit Sharing (BEPS).
  • Discussions on the new proposal are in pipeline (as of November 2019) and all countries must agree for the rules to be enforced.

Base Erosion and Profit Sharing (BEPS):

Base erosion and profit shifting (BEPS) refers to tax planning strategies used by multinational enterprises that exploit gaps and mismatches in tax rules to avoid paying tax. Developing countries’ higher reliance on corporate income tax means they suffer from BEPS disproportionately.

BEPS practices cost countries USD 100-240 billion in lost revenue annually. Working together within OECD/G20 Inclusive Framework on BEPS, over 130 countries and jurisdictions are collaborating on the implementation of 15 measures to tackle tax avoidance, improve the coherence of international tax rules and ensure a more transparent tax environment, fit for purpose for the global economy of the 21st Century.

Objectives of the new OECD tax proposal

  • The idea of the proposal is to address the tax challenges arising from digitalisation of the economy and the rise of complex, global corporate tax structures.
  • Changing nature of work, including automation, artificial intelligence and the rise of the gig economy, can erode tax revenues so severely that it may difficult to provide essential state services by 2040.
  • The initiative aims to advance toward a consensus-based solution to overhaul the rules-based international tax system by 2020.
  • The ultimate goal is to ensure that all MNEs pay their fair share of tax.
  • The proposal aims to balance adherence to the arm's-length principle with formula based solutions.
  • Failure to reach agreement by 2020 would greatly increase the risk that countries will act unilaterally, with negative consequences on an already fragile global economy.
  • The proposal is part of wider efforts to restore stability and certainty in the international tax system, address possible overlaps with existing rules and mitigate the risks of double taxation.
  • Beyond the specific elements on reallocating taxing rights, a second pillar of the work aims to resolve remaining BEPS issues, ensuring a minimum corporate income tax on MNE profits.
  • Together, the OECD anticipates that these proposals will lead to a significant increase in global tax revenues.

Why is India’s take on the OECD tax proposal?

  • India had sought changes in the proposal on digital taxation, saying it would deny the country its proper share of taxes from multinationals such as and Netflix, which generate substantial revenues locally.
  • The proposed OECD formulation meant India getting little revenue despite the large digital and business presence of companies. This is because only “residual profit” will be apportioned among the countries where a company has its markets.
  • Government is of the view that MNEs derive large revenues from countries such as India via their digital presence, without having a physical one, and has questioned the distinction between “routine profits”— which accrue due to physical presence — and “residual profits”.
  • For example, a cab aggregator (like Uber) operating via a mobile app has its core technology base in one country and software base in another but makes money in countries such as India. Hence the Indian method focuses on place of revenue generation.
  • 28 developing nations backed India on its objection to the OECD tax proposal.
  • Grouping believes new global rules to tax tech giants give undue taxation rights to United States.
  • India's draft report on profit attribution gives weightage to sales and users as a factor for profit attribution. If finalised, it would result in higher revenues for countries like India having a large user base but a very low share in the value chain. This would be a vastly increased tax base.
  • Most importantly the scope of the new proposal extends now from just digital business to all consumer-facing business. This is a very significant expansion as market is an important component and deserves to be a factor for profit allocation.

Arm’s-length principle:

The "arm's-length principle" of transfer pricing states that the amount charged by one related party to another for a given product must be the same as if the parties were not related. An arm's-length price for a transaction is therefore what the price of that transaction would be on the open market. For commodities, determining the arm's-length price can sometimes be as simple a matter as looking up comparable pricing from non-related party transactions, but when dealing with proprietary goods and services or intangibles, arriving at an arm's length price can be a much more complicated matter.

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