Cross-border tax rules face a shake-up
The international tax world is facing another major shake-up once the new rules on the taxing rights of income generated from cross-border activities are finalised.
The final report from the Organisation for Economic Co-operation and Development (OECD) on the tax challenges facing countries in an increasingly digitised world is expected in 2020.
The new rules will look at ways to allocate taxing rights to countries where multinational companies do not have a physical tax presence, but their goods and services are consumed in that country.
At the recent SA Institute of Tax Professionals (SAIT) transfer pricing summit in Cape Town, it transpired that these rules will not be limited to the digital economy, but that the OECD intends to apply this to all cross-border activities.
The OECD issued a new public consultation document last week as a follow-up to its previous report, called “Programme of work to develop a consensus solution to the tax challenges arising from the digitalisation of the economy”.
The reports highlight the need for new rules given that a growing number of jurisdictions are not content with the taxation outcomes produced by the international tax system based on the base erosion profit-shifting action plans (BEPS action plans).
One of the main points of dissatisfaction relates to how the existing profit allocation and nexus rules (connection between a state and a business that must collect or pay the tax) take into account the increasing ability of businesses to be active in the economy of a country without an associated or meaningful physical presence.
In about 2013, the OECD embarked on an ambitious programme to change the rules to stem the erosion of especially developing countries’ tax bases, mainly through transfer pricing.
It published the BEPS action plans in 2015. Many revenue authorities are still grappling with implementing some of the OECD’s 15 BEPS action plans. In 2016, the OECD established the inclusive framework to involve developing countries.
Johannesburg-based independent tax and transfer pricing consultant Okkie Kellerman raised concerns about the mechanics in the proposed new rules.
He says Pillar 1 proposes to allocate a portion of the residual tax of a multinational company by way of a formula, using the group’s global profit, to the market countries in which the group operates. This formula-based allocation will be over and above the routine profit earned under the arm’s-length principle.
“I do not think it is necessary to explain what chaos that is going to cause,” he said.
What it boils down to is that companies in large economies, such as the US and Europe, will be forced to allocate some of their residual profits to developing countries where they have a significant economic presence.
Nishana Gosai, group tax executive at Adcorp, says there is a lot of excitement among developing countries about the new proposals.
“That is only because no-one has done the analysis from an audit perspective.”
She says the proposals under Pillar 1 are based on looking at all profits at a global group level with a split between routine and non-routine profits.
“With the devil being in the detail, it would be interesting to understand how routine and non-routine profits at a group level would be determined.”
Kellerman explains that the current rules in terms of profit allocation are based on the arm’s-length principle — the price companies in a group can charge one another for services and goods offered in cross-border transactions.
This is to ensure that companies in market countries receive a routine return commensurate with the level of functions it performs and the risks assumed.
However, says Kellerman, the new thinking is that the arm’s-length profit that can be taxed in the country where the manufacturer has a market is not enough.
The OECD’s latest document expresses concern about the use of the arm’s-length principle, saying it is becoming an “increasing source of complexity”. It wants an “administrable” solution, especially for emerging and developing countries.
In the latest documents, the OECD suggests a “unified approach” that retains the current rules based on the arm’s-length principle in cases where they are widely regarded as working as intended, but would introduce formula-based solutions in situations where tensions have increased — notably because of the digitalisation of the economy.
The African Tax Administration Forum (Ataf) welcomed these proposals for a unified approach. “Ataf is determined to ensure that the changes made to the global tax rules as the outcome of the work of the inclusive framework address the needs of African countries and are fit for purpose in Africa.”
Gosai says while the reasoning behind the proposals is the pursuit of unification and simplicity, it is equally underpinned by “pure and simple politics”.
“As yet there is no articulation of the actual nuts and bolts of how the new rules will be implemented.”
She further questions whether developing countries fully comprehend the impact of where this will get them, taking into account their current domestic revenue collection capacity and capabilities.
“The promise of more is enticing, but not if more is unimplementable at grassroots audit levels,” says Gosai.