While our physical movement has been limited by the pandemic, technology enables us to reach even the farthest corners of the digital world. Nearly a year under community quarantine, virtual meetings and gatherings have remained part of our everyday life. At the end of a workday, most people’s routines consist of turning to online video and audio streaming services, or clicking the add-to-cart button to shop online. Even though these online transactions were present before the pandemic, they have continued to flourish given our current circumstances. This has also heightened the intention of governments worldwide to throw the net of taxation to capture a fair share of the income earned by these online businesses.
Long before COVID-19, the Organisation for Economic Co-operation and Development (OECD) acknowledged the challenges brought about by digitalization. The OECD/Group of Twenty (G20) Inclusive Framework intends to address these challenges with consensus-based and long-term solutions. According to the OECD, without this kind of solution, the world can expect the passing of domestic and unilateral digital services taxes (DSTs). Consequently, it may produce damaging tax and trade disputes, which would undermine tax certainty and investment. And if left uncontrolled, these unilateral DSTs worldwide may start a global trade war. The OECD estimated that the failure to reach a consensus to handle the challenges brought about by digitalization could reduce global gross domestic product (GDP) by more than 1% annually. For instance, in response to France’s DST that it found to be discriminatory against US companies, the US announced that it would be levying import duties on products from France beginning January of this year. However, this duty imposition was deferred since France delayed its DST implementation. The US is currently reviewing if it can also apply the same import duties against nine other countries which have adopted or drafted DST legislation.
To work on this consensus-based solution, the G20 Finance Ministers and Leaders endorsed in June 2019 the Programme of Work that laid down a two-pillar approach in an attempt to solve this challenge. Pillar One aims to create a new nexus and profit allocation rules, while Pillar Two will provide the formation of a global base erosion mechanism. In October of the same year, the OECD Secretariat developed and published the “Unified Approach” under Pillar One.
Unhampered by the pandemic and even by their political differences, last year, the Inclusive Framework members released for public comment the Reports on the Blueprints of Pillar One and Pillar Two. These blueprints reflect their perspectives on various key policy features, principles, and parameters on both Pillars, and identify remaining political and technical issues where differences of views remain to be bridged, including the next steps to be taken to reach an agreement by mid-2021.
From only having a Unified Approach in 2019, which I considered a game-changer in the digital taxation landscape as mentioned in a 2019 article, Pillar One has now become clearer under this blueprint. In line with the Unified Approach, the Blueprint still classified Pillar One’s 11 key elements into three groups: (1) Amount A, which is the new taxing right for market jurisdictions over a share of residual profit calculated at a Multinational Enterprise (MNE) group (or segment) level; (2) Amount B, which is the fixed return for certain baseline marketing and distribution activities taking place physically in a market jurisdiction, in line with the arm’s length principle; and (3) the processes to improve tax certainty through effective dispute prevention and resolution mechanisms.
While the Blueprint for Pillar One still has some open issues on key features of the solution, like the scope of application, amount of profit to be allocated, and extent of tax certainty, it already provides for a process map to apply the various elements in possibly computing for Amount A. In determining whether an MNE will be covered by this Amount A, global revenue and foreign-source income in-scope revenue threshold shall be used. Afterward, the consolidated financial accounts of the MNE groups will be used to compute for the profit before tax where tax adjustments, segmentations, and carry-forward losses can be applied. Upon arriving at the proper tax base, a three-step formulaic calculation (i.e., profitability threshold, reallocation percentage, and allocation key) will be applied to determine the share of an eligible market jurisdiction.
In case the MNE has a taxable presence in a certain country, the MNE can eliminate duplicative allocation of residual profit from its share in Amount A. Lastly, MNE groups should identify the jurisdiction(s) where they are required to relieve double taxation and determine the entities that have to pay Amount A tax liability through a simplified administrative procedure.
On the other hand, Pillar Two Blueprint provides a solid basis for a systemic solution that is designed to unravel the remaining issues about base erosion and profit shifting. It also laid down the rules enabling countries to have the right to “tax back” transactions where other jurisdictions have not exercised their primary taxing rights or where these transactions were subjected only to low levels of effective taxation. Despite not reaching an agreement yet, this Blueprint is a giant leap for the future agreement that would ensure that all large internationally operating businesses pay at least a minimum level of tax.
Although the Philippines is not yet a member of this Inclusive Framework, our government may consider these as positive developments since our country can be considered a large market jurisdiction for these digital products. Though there is a pending bill in Congress that seeks to impose a value-added tax on digitally supplied services including those rendered by non-resident foreign corporations, it would be good if our legislators consider the above changes in the international tax architecture in balancing our fiscal needs with the additional administrative burden it may impose on MNEs. With this in mind, we can help prevent the danger of having a unilateral DST.
The views or opinions expressed in this article are solely those of the author and do not necessarily represent those of Isla Lipana & Co. The content is for general information purposes only, and should not be used as a substitute for specific advice.
Mac Kerwin P. Visda is a Manager at the Tax Services Department of Isla Lipana & Co., the Philippine member firm of the PwC network.