Submission (To OECD Task Force on the Digital Economy) Concerning Tax Challenges of Digitalization

Abstract

Profit shifting has been on steroids. Despite this, at the initiation of the BEPS project in 2013, a decision was made to limit the project’s scope by accepting the separate entity concept and the arm’s length principle. It is now time to think more broadly. Considering this, in this submission I suggest four concrete approaches to dealing with BEPS behavior within the context of the digital economy. Certain of these approaches are new and presumably have not been previously considered by the Task Force. The first three may be initiated immediately. The fourth is a long-term approach. These four approaches are: • Identification of PEs in BEPS Structures and Applying Taxation to Them—Many BEPS structures involve the recording of profits in a principal company where the management and conduct of the business takes place in the MNEs home country or a third country. Such cases will involve undeclared PEs that would be appropriately taxable in the countries where the business is managed and actually conducted. I suggest in this submission various steps that would lead to taxation of such BEPS structures. This in turn would lead to the unwinding of some existing structures and discouraging new structures. (Note that this is a focus on the country where the principal company’s business is run and is not a focus on the BEPS project’s expansion of Article 5, which expands the PE definition for countries from which a non-resident is earning revenue.) • Expanded Use of the Profit Split Method and Development of Concrete Allocation Keys and Weightings—Broader use of the profits split method along with the creation of concrete allocation keys and weightings for common business models would ease compliance for taxpayers and significantly facilitate reviews by tax authorities. It would also greatly increase certainty for both taxpayers and tax authorities alike. • Abandonment of Territorial Tax Systems in Favor of Something Better—Territorial tax systems have significantly contributed to the BEPS contagion by strongly motivating MNEs to shift profits out of home countries, source/host countries, and the countries into which they sell products or provide services. Transfer pricing and CFC rules have been insufficient to protect home country tax bases. A typical goal of MNEs is to be taxable nowhere. The Task Force on the Digital Economy could recommend that the relatively few countries that are home countries to MNEs should abandon their territorial systems and adopt residency-based full-inclusion systems. Under full-inclusion systems, the home countries of MNEs would tax currently at home country tax rates the worldwide income of their MNEs irrespective of which group member recorded the income. This is a very practical approach that could be instituted in the short term since its adoption only requires participation by the relatively few countries that are home countries to MNEs. In addition, there is no need for uniformity with each country being able to define its own tax base, tax rates, sourcing rules, etc. This full-inclusion approach stands on its own as an approach that would provide an environment with much less motivation for BEPS behavior. If the longer term formulary apportionment dialogue recommended below is successful, this full-inclusion approach could be an effective interim approach. • Formulary Apportionment—Initiation of a dialogue amongst all nations with a long-term goal of developing agreement for the implementation of a formulary apportionment taxation system.