The OECD presses on with BEPS 2.0 in today’s distressed times

It has been over a year since the OECD initiated the bold project that seeks to address the tax challenges of the digitalisation of the economy, better known as the base erosion and profit shifting (BEPS) 2.0 project. Following a public consultation in March 2019 on the initial document outlining the two-pillar concept, the BEPS 2.0 project took shape with the publication of the Programme of Work (PoW) to Develop a Consensus Solution to the Tax Challenges Arising from the Digitalisation of the Economy on May 31 2019. With a powerful agenda, ambitious timeline and multiple stakeholder interests, BEPS 2.0, which is intended to provide a coordinated approach to the re-allocation of taxing rights (under pillar one) and the introduction of global minimum tax rules (under pillar two), has taken the tax world by storm at a time when numerous countries are considering unilateral measures that would likely trigger double taxation.

The OECD had been working towards an interim target of agreement on some key policy features by an early July meeting of the Inclusive Framework, but the circumstances of COVID-19 have required the postponement of that meeting to early October. With key policy decisions planned for October, the OECD continues to target a consensus-based agreement by the end of 2020. As countries are dealing with other domestic priorities and continue to have differing interests with respect to pillars one and two, many speculate whether the BEPS 2.0 initiative will proceed as planned.

Correspondence among five of the key countries participating in the project – France, Italy, Spain, the UK and the US – has highlighted the significant political differences and heightened the uncertainty regarding how the project will unfold going forward.

The OECD has taken the following actions over the past year in connection with the BEPS 2.0 project:

• May 2019: The OECD released its PoW on the process for achieving a consensus-based solution (subsequently endorsed by the G20 and G7 in June and July 2019 respectively);

• October 2019: The OECD released for public consultation the secretariat proposal for a "unified approach" under pillar one;

• November 2019: The OECD issued a public consultation document for the global anti-base erosion proposal (GloBE) under pillar two and hosted the public consultation on the pillar one consultation paper;

• December 2019: The OECD hosted the public consultation on the pillar two consultation paper; and

• January 2020: The OECD released a statement on the two-pillar approach to address the tax challenges arising from the digitalisation of the economy, announcing that the Inclusive Framework members had renewed their commitment to the BEPS 2.0 project and providing a revised pillar one PoW and an update on pillar two, which was also endorsed by the G20.

The January 2020 statement advances the work on both pillars:

• In respect of pillar one, the statement organises the remaining work to be undertaken into 11 workstreams and identifies two milestones for achieving consensus: (i) an interim target for agreement on certain key policy features of a consensus-based solution at the next Inclusive Framework meeting planned for July 2020; and (ii) production of a final report laying out a consensus-based solution by the end of 2020; and

• In respect of pillar two, the statement describes progress that has been made and identifies key areas where work will continue to achieve a solution by the end of 2020.

Despite the travel restrictions arising from COVID-19 containment measures, the OECD is continuing its work on BEPS 2.0 through virtual meetings and has announced the intention to deliver an agreement on key policy features in October 2020, which is the revised date for the next Inclusive Framework meeting. While this represents a slight delay necessitated by the inability to have the 137 member jurisdictions of the Inclusive Framework meet in July as planned, the project has been proceeding toward the overall goal of agreement in 2020.

However, recent correspondence between the US Treasury Secretary and his counterparts in France, Italy, Spain and the UK underscores a major political disagreement with respect to pillar one. In response to a proposal from the four European finance ministers for a phased implementation of pillar one that would involve covering only digital businesses in the first phase, in a June 12 2020 letter, the US Treasury Secretary reiterated the US position that any new rules must apply on a broad basis and must not predominately burden a single industry. The US letter calls for a pause in the discussions of pillar one, with a view towards resuming later this year and the hope that agreement can be reached on pillar one in 2020. The US letter further notes that the discussions of pillar two have progressed more rapidly and are closer to agreement and indicates that the US fully supports continuing those discussions to reach agreement this year.

On June 18 2020, the OECD released a statement from the Secretary-General expressing concern about the negative implications of unilateral measures related to taxation of digital activity and describing a multilateral solution through the Inclusive Framework as the best way forward. The OECD release indicates the intention to maintain the schedule of working group meetings leading up to the planned October 2020 decision-making meeting of the Inclusive Framework. While there certainly is substantial technical and design work to still be done on both pillars, exactly how this work will progress in light of these political developments remains to be seen.

The OECD recognises that with the far-reaching revised nexus and allocation rules, implementation of pillar one would require precise coordination among countries. The OECD is aware that the rules to be developed will need to provide improved tax certainty and minimise complexity. The January 2020 statement acknowledges that there are technical challenges involved in developing workable rules and highlights the critical policy differences among countries that must be resolved, including:

• The December 2019 US proposal for implementation of pillar one on a safe harbour basis, which has since been rejected by other Inclusive Framework members;

• The extent and scope of the binding nature of dispute prevention and resolution mechanisms; and

• Key technical elements to pillar one (including scope of application, treaty considerations, tax base determinations, sourcing and double tax relief rules and the interactions both among the elements of pillar one and between pillar one and existing transfer pricing guidelines).

Below, several key developments reflected in the January 2020 statement are discussed:

Pillar one is to be delivered through a three-tier mechanism where (i) Amount A provides a share of deemed residual profit allocated to market jurisdictions using a formulaic approach (i.e., the new taxing right); (ii) Amount B provides a fixed remuneration for baseline marketing and distribution functions that take place in the market jurisdiction; and (iii) Amount C provides for binding and effective dispute prevention and resolution mechanisms relating to all elements of the proposal, including any additional profit where in-country functions exceed the baseline activity compensated under Amount B.

Amid calls for clarity regarding which businesses and revenues are in or out of scope, the January 2020 statement sets out some tests and thresholds to determine in-scope businesses in the case of Amount A:

• Business activity test – automated digital services (ADS) and consumer facing businesses (CFB);

• Revenue thresholds; and

• Other profitability tests, specific business carve-outs (and whether purely domestic businesses should be excluded) and other minimum materiality tests.

With the January 2020 statement, the OECD has set out some principles and examples of the businesses that constitute ADS and CFB. ADS is proposed to be businesses that generate revenue from the provision of automated digital services on a standardised basis to a large population of customers or users across multiple jurisdictions (e.g., online search engines, social media platforms, online intermediation platforms such as operation of online marketplaces, etc.). CFB is proposed to be businesses that generate revenue from the sale of goods and services of a type commonly sold to individuals purchasing items for personal use (e.g., personal computing products, clothes, toiletries, cosmetics, luxury goods, branded foods and refreshments, franchise models, automobiles, etc.) and also covers businesses that sell indirectly through third party resellers or intermediaries.

The OECD also describes potential minimum revenue and profitability thresholds for the application of Amount A, including whether these thresholds should be applied on a 'whole of group' basis or only based on affected business segments. The exact application and level of these thresholds are still subject to discussion in the Inclusive Framework, including how to address the concerns of smaller countries (and therefore smaller market), etc.

It is important that such rules be established on a principled basis and that businesses have certainty about whether they fall in or out of scope. Therefore, it would be imperative for these principles to be strong and it could be useful for such principles to be supplemented by an illustrative positive/negative list. There also is concern that if the rules are not clearly defined, there could be conflicting views in different countries on what falls in or out of scope and whether upfront certainty could be obtained (e.g. through a ruling). The OECD is also urged to take a practical view in delineating situations where an out-of-scope business may have related ancillary businesses and in developing de-minimis thresholds that are straightforward to apply.

In addition to revenue thresholds, the OECD is working to define indicators of significant and sustained engagement with a market jurisdiction (e.g., generation of in-scope revenue in a jurisdiction over a period of years). In the case of consumer-facing businesses, these 'plus factors' may need to be present in order to find nexus under the new standard. However, for ADS, it is expected that satisfaction of the revenue thresholds alone will be sufficient for finding the nexus.

How and whether these nexus tests will be aligned for the two categories of in-scope businesses, as well as how they will apply to businesses that fall into both categories, are questions still being considered. Other key issues to be addressed include how to look at groups with different or varying stages of digitalisation, whether this needs to be weighted and how small jurisdictions and markets are to be considered (e.g., are matrices to be set based on the gross domestic product (GDP) of countries?).

To determine the tax base for the purposes of Amount A, it is anticipated that the starting point will be profit before tax (PBT) figures based on consolidated financials using universal accounting standards (e.g., IFRS or US GAAP).

The next steps are expected to involve segmentation by business line or geography, including allocation of income and costs, in order to get to the PBT for each business segment. At present, it is expected that there will be no requirement to make adjustments to the financials in an effort to harmonise the different universal accounting standards. However, other issues still need to be further evaluated such as those related to accounting for losses (e.g. pre-BEPS 2.0 regime losses, earn-outs) and interactions with other base-eroding payments (e.g. deductions for certain interest payments).

The OECD also still needs to work through how to establish the allocation keys for the redistribution of taxing rights to market jurisdictions, as well as other issues such as preventing double-counting or overlap between Amounts A, B and C, ensuring the elimination of double tax, and whether there are ways to simplify the administration of Amount A.

It is expected that Amount B will be focused on low risk distributors (LRDs). Commentators have called for clear identification of what is considered to be 'baseline activities' (e.g. through positive and negative lists) and clear principles on what constitutes a covered LRD (e.g. whether owning intangibles would result in falling out of the LRD definition, whether it needs to only sell to third parties, etc.).

The OECD should work through implementation issues such as whether fixed points vs. a range of returns need to be defined and whether these need to be differentiated based on regions, industry and/or functional intensity. Other issues to be further developed surround treatment of multifunctional entities and how positions already agreed under advanced pricing agreements (APAs) or mutual agreement procedures (MAPs) are to be taken into account.

It is also important for the OECD to safeguard against Amount B being the 'ticket' for tax administrations to increase distribution returns in the market in violation of the arm's-length principle.

In relation to Amount C, dialogue is ongoing to develop mechanisms to provide certainty, as well as prevent and (if needed) counter double-counting and overlap among the different amounts, and to address concerns about double taxation expected to arise from pillar one.

In relation to the US proposal on the treatment of pillar one as a safe harbour, the OECD has indicated that it will consider an alternative approach to pillar one implementation (e.g. whether an electing multinational enterprise (MNE) group could agree, on a global basis, to be subject to pillar one or not). The OECD intends to work on identifying whether there may be appropriate ways to modify the scope in relation to Amount A, implementation guidance and mechanisms to avoid double taxation that would be workable in such an alternative approach.

The January 2020 statement included a brief progress report on the work on pillar two. The report indicated that work was advancing at a fast pace with good technical progress but that there was significant work still to be done. The report also noted that some countries favoured refocusing the design of pillar two on addressing BEPS issues and viewed any design that aimed at ensuring all international businesses pay a minimum level of tax as going beyond the policy objective of pillar two.

In the report, the OECD covers all of the components, with a particular emphasis on the income inclusion rule.

The OECD intends to use a mechanism like a controlled foreign company regime that would impose a top-up tax on income of a corporation that has not been subject to a minimum effective tax rate, with the tax imposed on the shareholder of the corporation by its taxing jurisdiction. The OECD is working on how to use financial accounts as the basis for the income determination, together with a mechanism for addressing temporary differences between tax and financial accounting.

Work is also continuing on the question of blending income and taxes globally or within jurisdictions, with jurisdictional blending seeming to be the preferred approach. Another important aspect of the ongoing work relates to potential carve-outs. While the PoW indicated that substance-based carve-outs would undermine the policy of pillar two, the OECD acknowledges that some countries view substance-based carve-outs as necessary to ensure that pillar two is appropriately focused on remaining BEPS issues.

This mechanism is intended to facilitate the implementation of the income inclusion rule and ensure that pillar two applies equally to foreign branches and foreign corporations by enabling jurisdictions that apply the exemption method to foreign branches under their tax treaties to switch to a credit method where the income is subject to low tax.

This mechanism addresses low tax income by denying a deduction or otherwise adjusting intra-group payments. Particular issues being addressed include coordination of this mechanism with other rules, avoidance of double taxation or tax in excess of economic profits, and the potential use of carve-outs such as those being considered under the income inclusion rule.

This mechanism is intended to work by subjecting payments to withholding or other taxes at source and denying treaty benefits on income where the payment is not subject to tax at the minimum rate. Issues to be addressed include the payments to be covered and the design of the minimum tax test, as well as the potential application of this mechanism to unrelated party payments.

A key issue that needs to be addressed is the prioritisation for application of these four mechanisms. Another important question, in addition to the question of carve-outs, is the threshold for application of these rules. Most significantly, the central matter of the actual rate to be specified as the minimum rate must be resolved.

Considering the approaching October 2020 and end-of-2020 targets for agreement on a solution, it is clear that the OECD and the Inclusive Framework countries have their work cut out for them. The challenges in moving forward are both technical and political.

The aim and principles of pillar one clearly are a departure from the international tax framework of determining nexus and profit allocation under the arm's-length principle through an evaluation of where value is created and substantial activities are undertaken. This departure is a concern to many.

The arm's-length principle, while not an exact science, is based on sound economic principles that aim to allocate profits by assimilating pricing conditions in the free market. Without strong governing principles on how a formula-based approach could be applied consistently across the world, a departure from the long-standing global tax framework based on the arm's-length principle could give rise to significant tax uncertainty, increased tax disputes and widespread double taxation. However, an agreed formula-based approach with effective measures to ensure consistency would be preferable to a proliferation of unilateral tax measures.

Unlike pillar one, pillar two is not contingent on achieving full consensus within the Inclusive Framework on adoption and implementation identical rules. However, failure to fill in the technical details of a coordinated framework for global minimum tax rules that can be used by countries that choose to pursue a minimum tax would result in a pillar two agreement that also could lead to tax uncertainty, tax disputes and double taxation. This risk also is a concern to many. Here too, there is need to guard against a proliferation of unilateral measures.

The OECD has a long history of supporting global cooperation to facilitate international trade and investment. With the unprecedented economic crisis gripping the world, the need for global cooperation is greater than ever. As the work on the BEPS 2.0 project continues, the OECD should continue its long-standing focus on facilitating international trade and investment.

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Barbara Angus Principal T: +1 202 327 5824 barbara.angus@ey.com Barbara Angus is a principal and global tax policy leader based in Washington, DC. Her focus is on engaging with clients and governments on tax policy development and implementation across the globe. From 2016 through 2018, she served as Chief Tax Counsel for the Committee on Ways and Means of the United States House of Representatives, playing a key role in the development and enactment of the US tax reform. Her prior public-sector roles included being the international tax lead for the Office of Tax Policy, US Department of the Treasury, serving as the federal government's principal legal advisor on international tax policy, and representing the US in the OECD as a vice chair of the committee on fiscal affairs. She also has more than 20 years of private sector experience in international tax matters, including that of forming a consulting firm that developed legislative and regulatory solutions for multinational clients. Barbara holds a bachelor's degree from Dartmouth College, a JD from Harvard Law School and a MBA in finance and accounting from the University of Chicago Graduate School of Business.

Luis Coronado Partner T: +65 6309 8826 luis.coronado@sg.ey.com Luis Coronado is a partner and global tax controversy leader and Asia-Pacific transfer pricing leader based in Singapore. He has more than 25 years of advisory experience in international tax, transfer pricing, tax policy and controversy issues. Before relocating to Asia, he spent several years serving domestic and multinational companies in Latin America. He advises companies on the negotiation of bilateral advance pricing agreements and competent authority resolutions with a range of countries. In the past, he has advised the Inter-American Development Bank, the UN's Economic Commission for Latin America and the Caribbean, and the World Bank on tax policy issues especially on transfer pricing policy and legislation. Luis holds a bachelor's degree from the Universidad Iberoamericana and a MBA from the University of Southern California.