OECD and New Zealand focus on digital tax reform

The consultation (32 page / 564KB PDF) makes three proposals for revising profit allocation rules to reflect the digitalisation of the economy, which it now wants input on.

At the same time the New Zealand government has announced that it will consult on the design of changes to tax rules which currently allow multinational companies in the digital services field to do business in the country without paying income tax.

The government’s revenue estimate for a digital services tax was between NZ$30 million and NZ$80m (£16m-£42.5m). Revenue minister Stuart Nash said the New Zealand preference was to work within the OECD to find an internationally-agreed solution for including the digital economy within tax frameworks, but an interim measure could be required until the OECD finds agreement.

"New Zealand's stance is yet another example of a country looking to introduce unilateral measures whilst the OECD scrambles to get some form of consensus on this difficult issue," said tax expert Eloise Walker of Pinsent Masons, the law firm behind Out-Law.com.

"It is good to see the OECD making some progress, although their task has not been made easy given it is some countries' unilateral measures which are driving the options they have to explore," Walker said.

The OECD consultation proposals have previously been flagged in earlier work including an interim report on the issue of digitalisation published last year.

The 'user participation' proposal focuses on the value created by digital businesses through developing an engaged user base and encouraging them to create content and provide data. It would apply to businesses running social media platforms, search engines and online marketplaces.

The OECD is suggesting that tax rules change so that for these types of company, an amount of profit would be allocated to countries where the business's active users are based, irrespective of whether the company has a physical presence there.

The proposal acknowledges that there would be significant challenges in calculating the 'non-routine' profit of a company in order to work out how much of this would then be allocated to user activity.

"It is not surprising to see the OECD acknowledging this difficulty, given the very real issues the UK is encountering in trying to explain what the concept of user participation means and how exactly it should be defined," Walker said.

The UK recently proposed a digital services tax focused on revenue attributable to UK users, but is yet to finalise its plans.

The 'marketing intangibles' proposal would apply to a wider range of businesses and addresses a situation where a company can "reach" into a jurisdiction either remotely or with a limited local presence to develop a user or customer base. It relies on an "intrinsic fundamental link between marketing intangibles and the market jurisdiction".

The intangibles identified by the OECD include a favourable view by customers of a brand name, or data derived from the relationships a company builds with customers in a particular jurisdiction. The market jurisdiction would be able to tax some or all of non-routine income associated with these intangibles.

Other income would continue to be allocated based on existing profit allocation principles. The OECD is also exploring a proposal based on the concept of 'significant economic presence' motivated by a view that the digitalisation of the economy and other technological advances have enabled businesses to be heavily involved in the economic life of a jurisdiction without a significant physical presence.

Under the proposal, a taxable presence in a jurisdiction would arise when a non-resident company had a significant economic presence, established through factors such as revenue generation, the existence of a user base, the volume of digital content, billing in a local currency, the presence of support services, or sustained marketing activities.

The consultation document also sets out proposals to address the risk of profit-shifting to entities subject to no or low taxation through the development of an income inclusion rule and a tax on base eroding payments. While respecting each country's right to set its own tax rates, the OECD wants to reinforce the right for a jurisdiction to "tax back" profits if other countries have "not sufficiently exercised their primary taxing rights".

"It posits that global action is needed to stop a harmful race to the bottom, which otherwise risks shifting taxes to fund public goods onto less mobile bases including labour and consumption, effectively undermining the tax sovereignty of nations and their elected legislators," the OECD said.

A number of countries including the UK, France, Italy and Spain as well as the EU have all proposed or put in place a form of digital taxation as an interim measure until the OECD proposals are agreed.

If agreed, the new rules would be implemented through domestic law and double tax treaties and would include a coordination rule to avoid the risk of double taxation.

The OECD consultation is open until 1 March.