02Direct Tax

February, 2019 – Volume 110

NEWSFLASH

www.nangia.com

Public consultation paper released by OECD to address tax challenges of digitalized economy

Public consultation paper ponders over theproposals discussed by the Inclusive Frameworkat a high level and seek comments from thepublic on a number of policy issues andtechnical aspects. Public comments are soughtto assist members of the Inclusive Frameworkfor developing a solution for its final report tobe issued to the G20 in 2020. Comments on thisconsultation document should be sent by 1March 2019.

The consultation paper talks about proposals toaddress the two major issues identified by theBEPS Action Plan -1 i.e. “Broader taxchallenges” and “remaining BEPS issues”. It setouts proposals that could become part of thelong-term solutions for taxation of digitalizedeconomy.

❖ BROADER TAX CHALLENGES (REVISEDPROFIT ALLOCATION AND NEXUS RULES)

The Inclusive Framework is currently examiningthe following three proposals for revising theprofit allocation and nexus rules in response tothe challenges posed by digitalization of theeconomy:

A. User participation proposal

❑ The proposal seeks to modify currentprofit allocation rules for certainbusinesses to provide that profits shouldbe allocated to jurisdictions in whichthose businesses’ active and participatoryuser bases are located, irrespective oflocal physical presence.

❑ It acknowledges the difficulties in usingtraditional transfer pricing methods fordetermining the amount of profit thatshould be allocated to a user jurisdiction.

❑ It is proposed that the profit allocated to auser jurisdiction in respect of theactivities/participation of users should becalculated through a non-routine orresidual profit split approach. This proposalis most significant to the highly digitizedbusiness models such as social mediaplatforms, search engines and onlinemarket place

B. Marketing intangibles proposal

❑ This proposal has been designed to addressa situation where a multinational group canessentially reach into a jurisdiction, eitherremotely or through a limited localpresence for developing a user/customerbase and other marketing intangibles.

❑ It sees an intrinsic functional link betweenmarketing intangibles and the marketjurisdiction.

❑ The proposal would modify current transferpricing and treaty rules to requiremarketing intangibles and risks associatedwith such intangibles to be allocated to themarket jurisdiction.

❑ The proposal considers that the marketjurisdiction would be entitled to tax someor all of the non-routine income properlyassociated with such intangibles and theirattendant risks, while all other (routine)income would be allocated amongmembers of the group based on existingtransfer pricing principles

❑ The proposal would modify current profitallocation and nexus rules to require thatthe non-routine or residual income of themultinational group attributable tomarketing intangibles and their attendantrisks be allocated to the market jurisdiction.

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NEWSFLASHFebruary, 2019 – Volume 110

Public consultation paper released by OECD to address tax challenges of digitalized economy

❑ The special allocation of some or allnon-routine returns from marketingintangibles, and the related expansionof the market country’s taxation rights,would apply with no exceptions

❑ The allocation of non-routine or residualincome between marketing intangiblesand other income producing factorscould be determined through differentmethods.

C. Significant Economic Proposal

❑ As per this proposal, a non-residententerprise would have a taxablepresence in a jurisdiction if it has asignificant economic presencedetermined on the basis of a purposefuland sustained interaction with thejurisdiction via digital technology andother automatedmeans.

❑ It is based on the view that thedigitalization of the economy and othertechnological advances have involvedbusiness enterprises heavily in theeconomic life of a jurisdiction without asignificant physical presence.

❑ Revenue generation combined withother factors would be used to establishnexus in the form of a significanteconomic presence in the countryconcerned.

❑ Under this approach, profits would beallocated based on a fractionalapportionment method, as discussed inthe Action 1 Report. Also, Othersimplified methods such as the modifieddeemed profits methods described inAction 1 Report would be considered.

❑ Also, imposition of a withholding tax asa collection mechanism andenforcement tool would be considered

September 16- October 15, 2018

Questions for public comments

➢ General view on the proposal to addressremaining BEPS issues have been soughtfrom the public in consideration of theobjectives, policy rationales, andeconomic and behavioral implications ofthe proposal.

➢ The extent to which businesses, as aresult of the digitalization of theeconomy, have an active presence orparticipation in a jurisdiction that is notrecognized by the current profitallocation and nexus rules has beenasked. Further, in answering above, ithas been requested to consider thefollowing points:

▪ Which businesses have this type ofapplicability, and how the assessmentmay change over time?

▪ What are the merits of using aresidual profit split method, afractional apportionment method, orother method to allocate income inrespect of such activities?

➢ Suggestions are requested on the bestapproaches to reduce complexity, ensureearly tax certainty and to avoid orresolve multi-jurisdictional disputes

➢ Comments have been requested on thedesign considerations in developing newprofit allocation and nexus rulesconsistent with the proposals describedabove, including with respect to scope,thresholds, the treatment of losses, andthe factors to be used in connection withprofit allocationmethods

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❖ GLOBAL ANTI-BASE EROSION PROPOSAL

The BEPS issues are being considered to beaddressed through the development of thefollowing two inter-related rules:

A. Income inclusion rule

❑ The rule will seek to tax the income of aforeign branch or a controlled entity if thatincome was subject to a low effective taxrate in the jurisdiction of establishment orresidence.

❑ The income inclusion rule would operate asa minimum tax by requiring a shareholderin a corporation to bring into account aproportionate share of the income of thatcorporation if that income was not subjectto tax at a minimum rate.

❑ The rule would apply to any shareholderwith a significant direct or indirectownership interest in that company andwould be applied on a per jurisdiction basis.

❑ The amount of income to be includedwould be calculated under domestic lawrules and shareholders would be entitled toclaim a credit for any underlying tax paid onthe attributed income, with such creditsalso being calculated on a jurisdiction-by-jurisdiction basis.

❑ This rule would supplement rather thanreplace a jurisdiction’s CFC rules.

❑ In the case of exempt foreign branches, theincome inclusion rule would operate by wayof switch-over rule that would turn off thebenefit of an exemption for income of abranch and replace it with the creditmethod where that income was subject to alow effective rate of tax in the foreignjurisdiction.

September 16- October 15, 2018

❖ Tax on base eroding payments

This measure would deny a deduction ortreaty relief for certain payments unlessthat payment was subject to an effective taxrate at or above a minimum rate. It furtherincludes:

1. Undertaxed payments rule

❑ The undertaxed payments rule woulddeny a deduction for certain definedcategories of payments made to arelated party unless those paymentswere subject to a minimum effectiverate of tax.

❑ The effective tax rate test would takeinto account any withholding taximposed on the payment. The test forwhether a payment was to a relatedparty could be based on a 25%common ownership test

❑ The rule should apply to a broadrange of payments and should cover“conduit” or “imported”arrangements, where the effect of anundertaxed payment is “imported”into the payer jurisdiction through apayment that is otherwise outside thescope of the rule

2. Subject to tax rule

This rule would apply to undertaxedpayments that would otherwise be eligiblefor relief under a double tax treaty. Taxtreaty benefits provided by the followingArticles shall be denied by this rule:

o Article 7 (Business profits);o Article 9 (Associated enterprises);o Article 10 (Dividends)o Article 11 - 13 (Interest, Royalties and

Capital Gains)o Article 21 (Other income)

NEWSFLASHFebruary, 2019 – Volume 110

Other considerations

Though, a rule-based approach is being considered to develop, the members of task force ondigital economy are exploring the technical issues that may arise in between the designing ofthe rule.

These rules would be implemented by way of changes to domestic law and double taxtreaties and would incorporate a co-ordination or ordering rule to avoid the risk of economicdouble taxation.

Questions for public comment

1. General view on the proposal to address remaining BEPS issues have been sought fromthe public in consideration of the objectives, policy rationales, and economic andbehavioral implications of the proposal.

2. Design considerations have been sought for the both the rules from the public. Further,separate view has been requested on undertaxed payments and subject to tax proposalsalong with practical, administrative and compliance issues.

3. Suggestions are requested on the best approaches to reduce complexity, ensure early taxcertainty and to avoid or resolve multi-jurisdictional disputes

4. Also, comments on scope limitations of the proposals and best way to coordinate the rulehave also been asked.

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NEWSFLASHFebruary, 2019 – Volume 110

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