International Corporate Tax Reform and the 'New Taxing Right'
Negotiations in the BEPS project are now reaching a crucial stage, with an intensification of work to revise the basic principles of international tax. This report aims to analyse the various proposals involved, putting forward our own suggestions, and also to explore some unilateral measures that may be considered by developing countries.
The OECD secretariat has been working to produce a unified approach as a framework for a proposed ‘new taxing right’, following its Consultation document of March 2019 and the Work Programme published in June. This report aims to analyse the various proposals involved, putting forward our own suggestions, and also to explore some unilateral measures that may be considered by developing countries. Our aim is to help inform the debates in various forums from September 2019 to January 2020, after which (if the framework is approved) detailed work is expected to take place to produce a solution for approval in 2020.
The ambitious agenda aims to reform the key elements of international tax: (i) the rules for allocation of income and tax paid by multinational enterprises (MNEs), and (ii) the threshold for taxable presence, as well as (iii) devising a template for a global minimum tax. Particularly welcome is that the new approach now aims at a fairer allocation of MNE profits starting from their total global profits, and there is an emphasis on reducing complexity and adopting methods that are easy to administer especially for developing countries.
A major advance is that allocation would start from consolidated profits, and therefore would take a unitary approach to MNEs. However, the attempt at a unified approach seems based on methods to separate routine from non-routine profits (referred to as residual profits). This is conceptually flawed, since the super-profits or rents of MNEs derive from the synergy due to the combination of their activities in many countries. It would also entail continued use of the current transfer pricing rules based on the arm’s length principle which are complex and difficult to administer. We consider that the approach put forward by India and the G24 developing countries for fractional apportionment is superior. This would allocate profits more fairly, by balancing factors reflecting both supply (assets, employees, users) and demand (sales). We outline how a shift to a new approach could be done in an evolutionary way, combining explicit general principles of allocation with a pragmatic process to devise detailed methodologies for identifying, quantifying and weighting apportionment factors, and building on the existing profit split method (Appendix 1).
A new treaty provision on taxable presence should be based mainly on a minimum sales threshold, but this should be proportionate to the size of each country’s economy. A quicker way to adopt such changes could be if the UN Tax Committee examined the existing provision in its model convention for taxable presence if services are furnished in a country for over 183 days (article 5.3.b), and developed the Commentary to adapt it to the digitalised economy.
A global minimum tax would help developing countries protect their tax base by curbing tax competition. It should be as broad as possible, with no carve-outs and income blending only at country level. On this basis, the minimum rate should be 15%, rising to 20% after a transition period. The dual system currently proposed would entail complex coordination and application rules. We suggest a combined approach based on single substance test using the same multi-factor allocation of profits as for Pillar 1, based on quantifiable and location-specific factors that reflect where real activities take place, and balancing supply-side factors (labour, capital, and users where relevant) with demand-side factors (sales). This would ensure that the measures are non-discriminatory and make the tax simpler and easier to apply.
Our final section outlines and briefly evaluates some measures that developing countries might consider introducing unilaterally or as groups: indirect taxes on digitalised services and transactions (including reforming VAT); withholding taxes on payments for services or royalties; reconsideration of the taxable presence criterion and attribution of profits to the furnishing of services; and alternative methods for allocation of MNE income, including alternative minimum corporate taxes, a shared net margin method, and a shift towards fractional apportionment.