The OECD and Digital Services Taxes
The digital economy has grown two and a half times faster than the global GDP over the last 15 years, fundamentally changing how businesses operate in foreign markets. International tax codes haven’t kept pace with its rapid expansion until recently.
Many multinational corporations don’t have a physical presence in countries where they conduct business. Consequently, some companies have avoided paying taxes using base erosion and profit sharing (BEPS) strategies, which exploit gaps and mismatches in tax rules among different countries. BEPS corporate tax planning strategies are harmful for countries, especially developing countries, that rely on corporate income tax.
The Organisation for Economic Co-Operation and Development (OECD) has been working with governments, policymakers, and citizens around the globe to standardize international taxation via the OECD/G20 Inclusive Framework on Base Erosion and Profit Shifting (OECD Inclusive Framework).
OECD and taxation of the digital economy
The OECD/G20 Inclusive Framework seeks to address tax challenges that have arisen from the digitalization of the economy through its two-pillar solution.
Pillar One nexus rules
Pillar One establishes new nexus and profit allocation rules for large multinational enterprises (MNE) that meet certain revenue and profitability thresholds. The pillar broadens the ability of countries to tax commercial activities occurring within their borders regardless of a company’s physical presence or market jurisdiction. Pillar One also aims to improve tax certainty through effective dispute prevention and resolution mechanisms.
These new Pillar One nexus rules establish fixed returns for baseline marketing and distribution activities within a market jurisdiction. For an MNE to be subject to tax in a market jurisdiction, it must have a nexus within that jurisdiction. The OECD rejects any type of qualitative approach and instead establishes nexus based on a fixed market revenue threshold of €1 million in revenue within a market jurisdiction. For smaller jurisdictions with a GDP less than €40 billion, the nexus is €250,000.
Under the Draft Model Rules there is a 12-month nexus revenue threshold period, which can be adjusted proportionally for any period that is shorter or longer than 12 months.
Pillar Two global minimum corporate tax
Pillar Two establishes two mechanisms to ensure that large multinational companies pay a 15% minimum tax regardless of where they’re headquartered or the jurisdictions in which they operate.
Subject to Tax Rule
The Subject to Tax Rule (STTR) applies when an intragroup payment is subject to a nominal tax rate in a payee jurisdiction that is below the minimum rate.
Global Anti-Base Erosion (GloBE) Rules
The Global Anti-Base Erosion (GloBE) Rules apply a global minimum tax on certain MNEs that are subject to tax on their profits below a 15% minimum effective tax rate (ETR). MNEs will calculate their additional “top-up tax” liability using a specified formula to first determine their ETR and then the top-up tax:
- Identify MNE groups and constituent entities within scope
- Calculate GloBE income
- Calculate covered taxes
- Calculate the ETR and top-up tax
- Allocate the top-up tax
The OECD has been working to implement these changes since 2013 but has had difficulties. Not all member jurisdictions have agreed to the two-pillar solution yet, which has pushed its implementation date from 2023 to 2024. So far, 140 OECD members have joined the framework.
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Digital services taxes around the world
While the OECD has been working to reach a global consensus on its inclusive framework, many nations have implemented unilateral measures to protect their tax base and tax income derived from certain digital activities carried out within their jurisdiction. One such measure is digital services taxes (DSTs).
What are digital services taxes?
Directed toward large U.S. multinational companies, DSTs are a tax on gross revenue derived from a variety of digital services. They are a mix of gross receipts taxes and transaction taxes that apply to receipts from the sale of advertising space, provision of digital intermediary services such as the operation of online marketplaces, and the sale of data collected from users.
How do digital services taxes work?
Countries levy DSTs differently. Austria, for example, applies a DST only to digital advertising, whereas Poland assesses a DST only on streaming services. Multinational companies can face double taxation if one government imposes DSTs on a company’s revenue and then another government imposes DSTs on the same revenue.
Pillar One implementation and digital services taxes
The implementation of Pillar One in 2024 will require that countries remove DSTs and similar relevant measures imposed on all companies. The OECD also issued a statement that no new DSTs or similar measures are to be imposed through the end of 2024, or the entry into force of the Multilateral Convention (MLC).
Under the Unilateral Measures Compromise – which is an agreement among the U.S., UK, Spain, Austria, France, and Italy – member countries can keep their existing DSTs in place until the implementation of Pillar One of the OECD Inclusive Framework. However, corporations that are subject to DSTs may receive a tax credit against future tax liabilities.
In return, the U.S. agreed to terminate proposed punitive trade actions under Section 301 of Trade Act of 1974 and to refrain from imposing further trade actions against these countries.
That said, DSTs and other similar measures for other countries may exist outside of this compromise. Companies should continue to track progress on this topic as the framework continues to unfold.
Are digital services taxes a value-added tax?
Digitalization of the world economy creates indirect tax challenges, and some countries have expanded the value-added tax (VAT) to digital sales. But DSTs are distinct from income taxes and online sales taxes, and they are not a VAT.
The OECD has delivered guidance on how to collect VAT on cross-border sales, beginning with the International VAT Guidelines, released in 2015 and updated in 2017. These guidelines set nonbinding international standards for the treatment of international trade in services and intangibles. Their aim is to simplify the administration of the VAT regime, increase tax certainty for compliant businesses, and reduce double taxation and opportunities for VAT fraud.
The OECD recommends that foreign business-to-consumer (B2C) service providers register and account for VAT in the jurisdiction where the customer is located, generally via a simplified registration process.
Stay on top of international digital services taxes with Bloomberg Tax Research
In an interconnected, global economy, you can’t be caught facing an unexpected tax burden from your current or potential digital operations. Bloomberg Tax is leading the way in providing up-to-the-minute information on potential tax changes in the digital services sphere, including OECD Pillars One and Two. Download our Roadmap to Digital Services Taxes and Other Unilateral Measures for guidance on international tax planning strategies for U.S. corporations in areas such as digital advertising services, the sale of user data, and the online sale of goods and services.
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