On February 4, the OECD published a public consultation document entitled “Pillar One – Amount A: Draft Model Rules for Nexus and Revenue Sourcing” (the initial Amount A rules), which represents a small step in the negotiation process. ongoing intensive effort through which the OECD/G20 “Inclusive Framework” has sought to reform international tax rules. The multi-year effort culminated in “A two-pillar solution to address the tax challenges arising from the digitalization of the economy”, published in October 2021 (discussed in more detail in our previous alert). The reference to the digital economy, however, is a bit of a misnomer as Pillar 1 has morphed into a set of rules that broadly apply to very large, highly profitable businesses, rather than being limited to high-tech digital businesses. .
With the publication of the Initial Amount A rules, the OECD noted that it will publish the Pillar 1 rules in stages and plans to consult with stakeholders over the coming months on Pillars 1 and 2, for which most elements are intended to be implemented. in 2023. With respect to the second element of Pillar 1 (referred to as “Amount B”), which provides a fixed return for basic distribution and marketing activities that occur in the market jurisdiction, the OECD expects to publish a public consultation document in mid-2023. -year. With regard to Pillar 2, which would establish a global minimum tax of 15%, the OECD published model rules in December 2021 that address the Global Anti-Base Erosion (GloBE) rules designed to ensure that multinationals are “paying their fair share” (highlighted in our previous alert.) Meanwhile, the timing of U.S. plans to overhaul global low-taxed intangible income (GILTI) rules, which would align more pillar 2 of the OECD, remains uncertain, apparently being linked to the fate of a country slimmed down from the proposed Build Back Better Act which has stalled in Congress.
As noted below, the initial amount A rules for Pillar 1, not yet approved by the inclusive framework of nearly 140 countries, could have financial consequences and impose an excessive burden on companies in the scope, which are large multinational companies whose worldwide turnover exceeds €20. billion ($22.8 billion) and double-digit profitability (i.e., profit/revenue before tax). At a minimum, companies should be aware of this “work in progress” and may want to take advantage of the public comment period, which runs until February 18, to identify issues and recommend alternative approaches that could be considered in the development of the final rules of link and source of income.
The remainder of this alert discusses the Pillar 1 nexus rules for identifying eligible tax jurisdictions and initial observations on the detailed revenue source rules, which take a transaction-by-transaction approach.
Eligible Tax Jurisdictions
Pillar 1 would create a new nexus rule that would allow participating countries to impose net income tax on their attributable share of a portion of the profits (known as “amount A”) of scope companies that are not otherwise not subject to tax in the country of origin based on traditional tax jurisdiction rules under tax treaties and well-established international standards. Thus, a portion of a scope company’s business profits could be taxed by a country even if the profits were not attributable to a permanent establishment of the business in that country, and countries that currently tax such profits should make a corresponding reduction in their corporate income taxes that they currently impose.
The proposed nexus rules relate to income of a covered business deemed to arise from the market jurisdiction. This is the starting point for determining whether part of Amount A can be allocated to a specific jurisdiction and, if so, would most likely be the basis for determining each eligible jurisdiction’s proportional share. The nexus threshold is set at €250,000 (approximately $285,000) for jurisdictions with an annual GDP of less than €40 billion and at €1 million (approximately $1.14 million) for all other jurisdictions. The income threshold is currently denominated in a single currency, which, as stated in the rules on the initial amount A, “raises a number of coordination problems related to currency fluctuations” which must be resolved for the purposes of the multilateral convention. and will likely require “a rebasing mechanism” for national legislation in jurisdictions that would denominate the threshold in another currency.
Observations regarding source of income rules
The Initial Amount A rules provide an approach for determining Amount A allocations for “participating jurisdictions” – those countries that adopt national legislation and sign one or more multinational agreements to implement the two-pillar solution. Amount A was previously, and some would say arbitrarily, determined by the Inclusive Framework to be 25% of “residual profit,” defined as profit greater than 10% of revenue. Since only participating jurisdictions will receive an allocation, Amount A will not necessarily be allocated to all countries in which an in-scope company has a connection under the new rule.
The initial amount rules A propose a transaction-by-transaction approach with specific revenue source rules for finished goods and their components, services (location-specific, advertising, online intermediation and transport), rewards programs for customers, the provision of financing, consumer services, business-to-consumer and business-to-business services, the licensing or sale of intangible property, income from real estate and other types of income.
A preliminary review of the proposed revenue source rules reveals potential consequences and unintended results. First, since many of these proposed rules do not conform to the US source rules, taxes on Amount A would likely not be creditable under the final Foreign Tax Credit Rules released in December 2021 or the double taxation article of many US tax treaties. Second, the resulting allocation process seems just as arbitrary as the amount allocated. One example, though not the only one, is how source rules apply to transport services. For passenger air transport, revenue comes from the place of landing; while for cargo air transport, the revenue comes from the place of take-off or the place of landing. Finally, the detailed source rules apply to virtually all types of income and suggest that affected companies would be required to apply them to identify market jurisdiction for each item of global income. Theoretically, this would require scope companies to trace the trade chain of all their products and services, of which they could not reasonably be expected to have any knowledge. For example, an in-scope US company that manufactures equipment in the US that is sold to an unrelated UK distributor who resells the equipment to unrelated retailers around the world, would be required to determine where the customers of these retailers take delivery of the equipment.
Fortunately, the proposed rules recognize that in many (and perhaps most) cases affected companies will not have access to information to reliably determine the market jurisdiction(s) for their products or services. The proposed approach would impose an obligation on scope businesses to obtain all the reliable information they can, within reasonable limits (for example, by requesting information from other businesses in the market chain for their products or services). However, in the absence of such reliable information, scope companies would be required to determine market jurisdictions using one of the arbitrary allocation keys provided by the Model Rules. Perhaps the best example of arbitrariness is the so-called “global allocation key”, which could apply to several types of transactions and would generate income according to the proportionate share of “final consumption expenditure of each applicable jurisdiction, as published by the United Nations Conference on Trade and Development. If a final consumption expenditure figure is not available, an approximation would be determined based on the “population of the jurisdiction and the average ratio of final consumption expenditure to population for all jurisdictions for which final consumption expenditure were available”. Under the opt-out rule, certain jurisdictions would be excluded from the sourcing rules, such as when applying the global allocation key, if a scoped business can prove that its revenue is not derived from a or more of the jurisdictions identified by the allocation key.
A&M Taxand says
Uncertainty remains as to whether either pillar of the two-part solution will materialize and whether the United States, given the current state of flows, would adopt the OECD approach. so nearly 140 other jurisdictions applied the rules. Without US participation, the model rules proposed for Pillar 1 would lack cohesion and inevitably lead to higher levels of double taxation. Apart from this, even if Pillar 1 results in model rules and a multilateral convention, the rules for allocating Amount A may differ significantly from those of the original Amount A Rules. Thus, the companies involved should keep abreast of ongoing developments, but it may not be worth immediately delving into the many complex source rules. Suffice it to say that affected companies would be saddled with an extremely onerous, complex and costly compliance obligation, which is contrary to an earlier version of the Inclusive Framework which stated that “compliance costs ([including for] trace small amounts of sales) will be kept to a minimum. Although the rules “have been designed to balance the need for accuracy with the need to limit compliance costs”, it is not clear what “reasonable steps” affected companies should take to identify a reliable indicator. In order to provide useful feedback and recommendations, affected companies may wish to perform high-level analysis to assess the feasibility of applying the procurement rules and the possible implications. Companies might prefer an approach less dependent on reliable data and more dependent on arbitrary allocation keys to reduce compliance costs. As always, we are available to help our clients understand ongoing OECD developments and the potential implications for their businesses.