G20 Finance Ministers push global tax reform

by | Mar 5, 2020

Alarmed at plans by individual countries to unilaterally introduce digital services taxes, G20 Finance Ministers recently stepped up momentum to global consensus for fundamental reforms to the international tax system (NY Times article).

At stake, is the sustainability of the international tax framework – the concern is about unilateral digital taxes and retaliatory tariffs further escalating international trade tensions, damaging global investment and growth.

Conceived in the OECD plan to address tax challenges in the digital economy, the proposed reforms reach further than purely digital businesses.

The reforms are founded on two “pillars” which would see the re- allocation of taxing rights between jurisdictions together with re-allocations of profits to be taxed across such jurisdictions (Pillar One); and new internationally coordinated rules to neutralise the risks of ongoing profit-shifting by MNEs by the imposition of an effective global minimum tax rate (Pillar Two).

Concerted pressure by the G20 and OECD is likely to see broad international political consensus for these reforms achieved in 2020.

Contact Don Green or Chris Gibbs at ICGTAX to discuss how your company may be affected by these reforms –

+612 8599 8320

don.green@ICGTAXGlobal.com

chris.gibbs@ICGTAXGlobal.com

Read more . . .

G20 Finance Ministers recently expressed alarm at plans by individual countries to unilaterally impose digital services taxes (corporate income tax), the New York Times reported recently (see article). Some nine European countries already have proposed, announced or implemented such taxes.

The G20 Finance Ministers alarm is that such unilateral taxes will incite retaliatory tariffs by adversely affected countries and lead to an escalation of international trade tensions significantly more serious than those of recent times. At stake, is the sustainability of the international tax framework. Absent a consensus solution, more uncoordinated unilateral taxes on gross sales revenues will ensue, damaging global investment and growth.

These unilateral moves fly in the face of concerted efforts by the OECD, especially in the last 12 months, toward global consensus for new and fundamental reforms to the international tax system.

The proposed reforms are the work of the 130 member countries of the OECD-inspired Inclusive Framework (IF) on Base Erosion and Profit Shifting (BEPS). The reform proposals have their genesis in Action 1 of the BEPS Project: to address the challenges of the digital economy, but have a broader scope than purely digital businesses.

On 30 January, the IF issued an important statement on the reform which confirms its commitment to agree on a consensus-based solution by the end of 2020.

The reforms are founded on two “pillars”, which seek to address continuing challenges faced by the global community of nations as a result of the (legitimate) tax planning activities of Multi-National Enterprises (NME’s). If implemented, the Two Pillars reforms will dramatically reform the architecture of the present international taxation system.

The proposals were released by the OECD for public consultation in October (Pillar One) and November (Pillar Two) last year. The initiative for these reforms was one of the main foci of the BEPS Action Plan, the tax challenges of the digitalisation of the economy. The Two Pillars proposals however look wider, focussing broadly on consumer-facing businesses and, in some respects, to all internationally operating businesses.

At this stage, the proposals are just that, and there is some way to go before there is sufficient consensus and, importantly political agreement, to make them a reality. Nevertheless, there appears to be considerable pressure by the OECD and G20 to achieve a consensus solution by the end of this year.

In summary, the Two Pillars proposals would see:

  • The allocation of taxing rights over profits of consumer-facing businesses to market jurisdictions in which the business has a sustained and significant involvement (say through consumer interaction and engagement) in the economy, rather than physical presence in the jurisdiction. Such involvement would be primarily indicated by sales revenue above a defined threshold, including revenues from activity (eg online advertising) directed at free users in the market jurisdiction but booked elsewhere. This allocation is called the “new nexus rule”
  • The allocation of profits under new rules adopting a three-tier mechanism (the “Unified Approach”):
    • A MNE group’s deemed ‘non-routine profits’ wholly or partly taxed by new nexus rule market jurisdictions, apportioned among them on a sales based formula, with percentages to be agreed multilaterally – called “Amount A”. The ‘non-routine profit” is broadly the total profit less the deemed ‘routine profits’ allocated to the countries in which activities are actually performed
    • Baseline activities in market jurisdictions taxed under existing rules, but taxed on the basis of appropriate and negotiated fixed remunerations, reflecting assumed baseline activity­ – called “Amount B
    • A further profit amount, in excess of the fixed remuneration based Amount B, where the taxpayer or tax authority can justify it under the arm’s length principle administered under robust dispute and anti-double taxation measures – called “Amount C”.
  • Foreign (ie ex-home country) income or profits of internationally operating businesses taxed effectively at a set minimum global corporate tax rate. This would be achieved by a combination of measures:
    • Income inclusion rule: imposition of an additional tax in the home jurisdiction on foreign controlled entity of branch income taxed offshore at below the global minimum rate, by to cover the rate shortfall;
    • Switch-over rule; home country relief of double taxation, under tax treaties, by way of credit for foreign tax on foreign branch profits or income from foreign immovable property, rather than by exemption, where such profit or income is taxed in the foreign jurisdiction at below the global minimum rate;
    • Undertaxed payments rule: home country taxation of home country payments to foreign related parties, where the payments are do not suffer foreign tax at or above the global minimum rate. The home country taxation would be achieved by either denial of home country deductions or imposition of a home country withholding tax on the payments.
    • Subject to tax rule: taxation at source at full source country rates (ie with denial of treaty benefits including withholding rate limitations) on related party interest and royalty payments, and potentially on other types of payments or income, whether or not related party, currently attracting treaty benefits and are structured to achieve outcomes inconsistent with the global minimum rate intent.

Implementation of the reforms will require domestic law changes in all relevant jurisdictions and renegotiation of bilateral tax treaties, possibly by way of another multilateral instrument. They will require the development of extensive provisions for coordination, prioritisation of jurisdictional interests and dispute resolution mechanisms to gain the necessary universal political acceptance and to avoid debilitating double taxation.

The Communiqué of the G20 Finance Ministers meeting revealed an important milestone achieved in this process by endorsing the “architecture” of the Pillar One unified approach “as a basis for negotiation” and welcoming the progress on Pillar Two (see Communiqué). Significantly, the Communiqué stressed the importance of the IF “agreeing on the key policy features of a global and consensus-based solution by July 2020, which would form the basis of a political agreement.”

There is clearly a long road ahead before these transformational changes to the international tax system are realised. Nevertheless, the statements and actions to date of the OECD, G20 and the 130 country members of the IF, evidence a strong resolve to achieve a political consensus for these reforms in 2020.

Contact Don Green or Chris Gibbs at ICGTAX to discuss how your company may be affected by these reforms –

+612 8599 8320

don.green@ICGTAXGlobal.com

chris.gibbs@ICGTAXGlobal.com

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