The Unified approach proposes a three-tier mechanism for allocating profits to the market jurisdictions.
By Ravi Mahajan
The ongoing OECD project to overhaul the global tax laws (popularly referred to as OECD’s BEPS 2.0 project) witnessed an important development earlier this month when the OECD Secretariat released a public consultation document proposing a ‘Unified approach’ to achieve the stated objectives. While there are three different proposals being discussed and debated by the OECD BEPS Inclusive Framework (BEPS IF), the Unified approach incorporates elements from all three proposals and is intended to facilitate further negotiations among the 120+ member countries, with the aim of achieving a political agreement by the first half of 2020.
The key aim of the proposal is to allocate more taxing rights to market/consumer jurisdictions in a way that goes beyond the existing profit/tax allocation rules, which are based on physical presence and arm’s-length principles (ALP). While countries such as the US, given their high consumption of traditional economy goods and services, have been strongly advocating that the new rules should apply to all businesses (including traditional businesses) and not be limited only to the new age businesses/business models, the Unified approach proposed intends to cover only highly digitalised business models as well as non-digitalised businesses that are consumer-facing.
The Unified approach proposes a three-tier mechanism for allocating profits to the market jurisdictions. The first step is to determine the ‘deemed’ non-routine profits of the multinational using a formulaic or fractional apportionment and allocating a portion of such non-routine profits to all market jurisdictions using suitable allocation keys (referred to as ‘Amount A’ in the proposal). The next step is to attribute a fixed remuneration for the baseline marketing or distribution functions that are performed by the multinational in the market jurisdiction (referred to as ‘Amount B’) and the last step is to attribute additional profits if such functions performed in the market jurisdiction exceed the baseline activity compensated under Amount B (Amount C). Under this approach, while Amount A captures the new taxing right for the market/user jurisdiction and triggers even if the multinational does not have physical presence in that jurisdiction, Amount B and Amount C are merely a modified operation of existing ALP.
While the G-20 has welcomed these efforts, it would be interesting to see how the fine print evolves. India’s oft-repeated position has been that the new rules should be unambiguous, enabling seamless implementation, thereby providing tax certainty. In this context, the likelihood of India advocating for adoption of a straight-jacket formula, in line with the draft profit attribution rules released by India in April 2019, cannot be ruled out.
Another interesting aspect to look out for would be the fate of the ‘equalisation levy’ that was introduced by some countries, including India, as an interim measure to make digital companies pay taxes in market jurisdictions, once these new rules are formalised. While the levy is not creditable against taxes payable by multinationals in home jurisdictions and hence adds to their overall costs, it may still find preference amongst multinationals given the ease and simplicity of undertaking compliances and potentially less litigation.
Net-importing countries like India, with their high consumer base, are likely to benefit from the new proposed rules. Nevertheless, it would be important to check the impact on Indian headquartered multinationals and unicorns. Potential tax revenues foregone in this space would be an important aspect to be considered by Indian policymakers.
It is important that the new rules are forward looking, fair and relatively simple to implement. Also, as has been acknowledged by the OECD that while the Unified approach has been released for public comments, further work is required on several fronts including quantification of the profits, elimination of double taxation, and other related implementation and administrative issues.
The writer is Tax Partner, EY India. Views are personal.
(With contribution from Saitej R Kuchimanchi, senior tax professional,EY)