International tax rules have yet to adapt to modern business. Pascal Saint-Amans, director, Centre for Tax Policy and Administration, Organisation for Economic Co-operation and Development, says a multilateral response is essential if countries are to overcome the tax challenges arising from digitalisation
Globalisation and digitalisation have facilitated the emergence of new business models in which multinational enterprises can create value and generate profits in countries where they are not physically present. Intangible property, which is easy to move around but hard to tax, is also playing an increasingly important role in generating profits for these businesses. Although these developments have changed how and where profits are made, international tax rules, which date back to the 1920s, have yet to
As a result, the current international tax rules are increasingly perceived as unfair and outdated. Growing public pressure has led countries to consider implementing unilateral measures in an effort to tax multinational enterprises that are operating in their markets, but that cannot be taxed based on current ‘nexus’ and ‘profit allocation’ rules. This perception of unfairness is increasing, as highly digitalised companies are generally doing well during the COVID-19 crisis, while traditional businesses have, in general, greatly suffered. In addition, many companies are being bailed out with taxpayer funds. In the wake of this crisis, tolerance for tax avoidance is expected to be at a historic low.
The proliferation of unilateral measures such as digital services taxes in response to growing public pressure actually decreases tax certainty while increasing the likelihood of disputes. Disputes relating to these matters have even arisen among certain G7 members, further highlighting the urgency to develop a solution soon. Despite the tensions at the time, G7 leaders at their summit in August 2019 in Biarritz committed “to reaching in 2020 an agreement to simplify regulatory barriers and modernise international taxation within the framework of the OECD”. There is now widespread agreement – and not just in the G7 – that the international tax rules must be adapted to the 21st-century economy, even if the timeframe has been pushed back to mid-2021.
On equal footing
The OECD has brought together more than 135 countries, including all G7 members, on an equal footing in the G20/OECD Inclusive Framework on Base Erosion and Profit Shifting. Its members have been working on the implementation of a 15-point action plan to tackle tax avoidance by multinationals, developed between 2013 and 2015. The plan aims at improving the coherence and the transparency of the international tax system by, inter alia, eliminating harmful tax regimes and ensuring the exchange of country-by-country reports that provide data on the global operations and taxes of multinationals.
Progress is being made on countering BEPS risks in several areas, yet the tax challenges arising from digitalisation continue to be a vexing problem. In spite of the complexity of these challenges, the Inclusive Framework is making solid progress in this domain. Following a mandate from the G20, countries and jurisdictions are committed to reaching an agreement on a consensus-based solution by the middle of 2021, the implementation of which would improve tax certainty for both businesses and tax authorities. The ongoing work is based on a two-pillar approach, which has been informed by extensive public consultations with many stakeholders, including businesses, academia and civil society.
At its plenary meeting in January 2020, the Inclusive Framework agreed on the parameters to pursue negotiations on the reallocation of some taxing rights to market jurisdictions under Pillar One, by developing new nexus and profit allocation rules. This pillar would ensure that multinational enterprises that conduct sustained and significant business in a given country would be taxed in that country on a portion of their profits, irrespective of having a physical presence. By adopting clear rules, taking a formulaic approach, and designing effective and robust dispute resolution mechanisms, Pillar One seeks to create an international tax system that is both predictable and easy to administer.
Under Pillar Two, the G20/OECD Inclusive Framework on BEPS is working on addressing the remaining BEPS issues by ensuring that multinational enterprises pay a minimum level of tax. Such measures would discourage businesses from shifting their profits to low-tax countries.
Reports on the blueprints for both pillars were delivered to G20 finance ministers in October 2020, in line with their July communiqué. A public consultation on the draft blueprint reports released in October 2020 is currently underway, with comments due by 14 December 2020, and a public meeting is scheduled for mid-January 2021.
Boosted global revenues
The benefits of a global solution arising from this two-pillar approach are clear. An OECD analysis from October 2020 shows the proposed reforms could increase global corporate income tax revenues to $50–80 billion per year. The combined effect of the reforms and the US global intangible low taxed income could represent $60–100 billion per year (i.e., up to 4% of global corporate income tax). For businesses, simpler rules, increased tax certainty and the prevention of double taxation would create an environment that is more conducive to trade and investment.
However, if multilateral efforts fail, and countries increasingly choose to adopt unilateral measures, the risks to the international economy could be grave. The world has already seen tensions aggravated among long-standing allies as a result of tax disputes turning into trade disputes. Should such disputes multiply across the globe, international growth and investment could be negatively affected. G7 members play a critical role in bridging certain differences between them before political agreement can be reached on key policy features of a consensus-based solution by mid-2021. Fragmentation of the international tax system is simply not a viable, sustainable solution. Only a robust multilateral response can truly address the tax challenges arising from digitalisation.