Allocation of Taxing Rights in the Digitalized Economy: Assessment of Potential Policy Solutions and Recommendation for a Simplified Residual Profit Split Method

Abstract

In 2019, the OECD released a public consultation document and its work program that address the tax challenges raised by the digitalization of the economy. These documents essentially discuss proposals that either address the allocation of taxing rights (Pillar I) or unresolved Base Erosion of Profit Shifting issues (Pillar II). Regarding Pillar I, three solutions were proposed: user participation, significant economic presence, as well as the marketing intangibles approach. The purpose of this contribution is to assess the Pillar I proposals considering their policy rationale and the broadly agreed tax policy principles by tax administrations. In light of the assessment, the author takes the view that the marketing intangible proposal, which seems to apply to consumer (or user) facing businesses, could be the most appropriate solution to address the issue of the allocation of taxing rights. However, that proposal incites several issues concerning its profit allocation mechanism. Thus, in order to achieve tax certainty, the contribution offers a potential solution for implementing the consumer (or user) facing proposal, that is, to resort to a simplified residual profit split method that is based on operating profit margins of a MNE Group . The article provides a high-level overview of the design of the mechanism and briefly addresses issues related to scope and nexus as well as rules that deal with elimination of double taxation.