OECD BEPS Project and the Digital Economy

The Base Erosion and Profit Shifting (BEPS) project is an international initiative led by the Organisation for Economic Co-operation and Development (OECD) to address tax avoidance by multinational corporations.

BEPS refers to the strategies used by multinational corporations to reduce their tax liabilities by shifting profits to low-tax jurisdictions and eroding the tax base of countries where they generate their income.

The OECD's BEPS project aims to combat tax avoidance by multinational corporations through various measures like addressing hybrid mismatch arrangements, preventing treaty abuse, and introducing substance-based regulations.

The BEPS project has introduced various measures aimed at addressing the specific challenges posed by the digital economy, such as the allocation of profits from digital businesses and the taxation of cross-border digital transactions.

The BEPS project is ongoing, and the OECD continues to monitor and adapt its recommendations based on the evolving landscape of international taxation and the impact of digitalization on business models.

The BEPS project has been adopted by over 130 countries, including the United States.

The OECD has produced various reports and guidelines on BEPS, providing guidance to countries on implementing the BEPS recommendations.

The BEPS project has led to changes in international tax laws, including new regulations and guidance on transfer pricing, treaty abuse, and the taxation of cross-border transactions.

A set of guidelines focused on the taxation of businesses utilizing digital platforms for selling or distributing products/services.

The Forum on Tax Administration's report specifically aimed to guide the development of standardized reporting by platforms like Uber and Airbnb.

The OECD's model rules for reporting by platform operators, aiming to facilitate taxation of gig economy businesses.

A way to separate business activities to determine how to tax them, particularly in multinational companies.

This refers to the part of a company's profits that's left after covering basic operating costs.

A method commonly used in international taxation involving dividing the profit of a company by specific factors to determine how much tax should be paid in each jurisdiction.

A system that aims to align profits with the creation of value, particularly in multinational corporations operating in multiple jurisdictions.

Classifying a gig worker as an employee despite their independent contractor label in their contractual agreements.

The portion of residual profit attributed to market jurisdiction factors, such as marketing, sales, and distribution. It's the profit directly generated within a particular market.

The portion of residual profit attributed to standardized returns, representing the average profit earned by similar companies in similar markets. It's calculated based on industry averages.

The portion of residual profit attributed to non-market jurisdiction factors, such as central management, R&D, and production. These factors are not directly linked to a specific market.

The principle that the three amounts (A, B, and C) representing different sources of residual profit should ideally not overlap, minimizing double taxation and ensuring a fair allocation of tax burden.

The factors that contribute to a company's profits but are not directly related to a specific market, such as central management, research and development, and production.

A threshold of revenue or activity that a company must reach within a specific market jurisdiction to be subject to taxation in that jurisdiction.

A company's engagement with a specific market jurisdiction that is significant and sustained over time, possibly leading to tax liability in that jurisdiction even if the revenue threshold isn't met.

The potential for overlap between Amount A (market jurisdiction profit) and Amount C (non-market jurisdiction profit) when a company has significant local marketing intangibles, which could lead to double taxation.

The proposed system aims to expand taxing rights for market countries specifically targeting businesses that directly engage with consumers and those that provide automated digital services.

Businesses that fall outside the scope of the system include extractive industries, financial services, and transportation sectors like airlines and shipping.

The system primarily considers businesses that provide services directly to consumers and offer automated digital services, but the specific criteria for these categories are still being finalized.

The inclusive framework provides non-exhaustive examples of business lines that could be classified as consumer-facing, including search engines, social media platforms, online marketplaces, and streaming services.

The inclusive framework also provides non-exhaustive examples of business lines that could be classified as automated digital services, including online advertising services, cloud computing services, and online gaming.

The proposed system aims to determine whether a business has a 'nexus' or significant connection with a market jurisdiction, which could trigger taxation. This is based on revenue generated in that market, as well as the nature of the company's engagement in that market.

The level of engagement required to establish nexus is not defined. This includes whether a limited physical presence or targeted advertising is enough to show significant and sustained engagement.

The inclusive framework needs to define source rules for allocating revenue to specific markets in order to determine nexus and apply taxes. These rules are important to ensure consistency and fairness.

A letter written in December 2019 by the US Treasury Secretary, Steven Mnuchin, to the OECD Secretary-General outlining the US position on BEPS 2.0. The letter expresses concerns about the potential proliferation of unilateral digital service taxes (DSTs) and the departure from traditional arm's-length transfer pricing principles in the proposed Pillar 1 solution.

A set of proposals by the OECD to address the tax challenges arising from the digitalization of the economy. It aims to update international tax rules and ensure that multinational enterprises (MNEs) pay their fair share of taxes in countries where they generate profits.

Taxes specifically targeting the revenues of large digital companies, such as those operating in the online advertising, social media, and e-commerce sectors. They are typically levied based on the digital service revenue generated within the taxing jurisdiction, regardless of the company's physical presence.

A framework developed by the OECD to address the tax challenges arising from the digitalization of the economy. It proposes to reallocate taxing rights for some MNEs and introduces new rules on profit allocation among countries. It consists of two pillars.

The first pillar of the Inclusive Framework proposes reallocating some of the taxing rights for large multinational enterprises (MNEs) to the markets where they generate revenue, regardless of their physical presence. This aims to address the issue of profit shifting and ensure that MNEs contribute to the tax base in countries where they have significant market share.

The second pillar of the Inclusive Framework proposes introducing a global minimum corporate tax rate for multinational enterprises (MNEs). This aims to prevent MNEs from shifting profits to low-tax jurisdictions and to create a level playing field for businesses operating in different countries.

The traditional approach in international taxation, where profits are allocated based on the physical presence and the location of tangible assets of a company. Profits are taxed according to the 'arm's-length' principle which means that transactions are taxed as if they were between unrelated parties.

The idea that MNEs should be taxed where they generate value, regardless of their physical presence, or where they have traditionally been considered to have taxable nexus (physical presence).

The 50-50 sourcing split, a rule applied to determine where income is earned, states that if a product is produced in one country and sold in another, income is split equally between both countries. This rule used to apply universally, including situations involving the US. However, changes have been made to this rule for US companies selling products outside the US.

The US 50-50 sourcing split is a rule that applies to income earned from foreign producers selling products in the US. This rule is separate from the 'amount A' split used for residual profits, emphasizing that different rules are applied to different types of profits.

The 50-50 sourcing split is still applied to foreign producers selling products in the US, even after changes to the rule for US companies. The sourcing split matters because it determines how much tax is owed to the US based on income connected to the country.

The application of the 50-50 sourcing split is based on the idea that routine business activities are standard and easy to price, while non-routine activities (like marketing, credit decisions, and local intangibles) are more complex and require a different approach. This helps keep things simple and predictable for routine activities.

Non-routine activities, like local marketing or credit decisions, go beyond the baseline. These activities require a more complex method to price them, known as 'amount C', which uses traditional arm's-length transfer pricing. This allows for dispute resolution mechanisms if needed.

The 50-50 sourcing split is designed to ensure that profits are taxed fairly between countries, while also simplifying the pricing process for common business activities. It aims to find a balance between accuracy and efficiency, even if it's not always perfect.

Although the 50-50 split might not capture all the complexities of international transactions, it offers a balance between accuracy and simplicity. It allows businesses to easily calculate their taxes for routine activities while addressing more complex cases with separate methods.

The 50-50 sourcing split is meant to simplify the process of determining where income is earned, especially for common business activities, like selling a product produced in one country and bought in another. The goal is to make the process easier and more predictable, but it does not apply to all situations.