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:

1. Identify MNE groups and constituent entities within scope
2. Calculate GloBE income
3. Calculate covered taxes
4. Calculate the ETR and top-up tax
5. 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.