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Taxing the Digital Economy - The ABCs of the Secretariat Proposal for a “Unified Approach under Pillar One”

  • United Kingdom
  • USA
  • Tax planning and consultancy


On 9 October 2019, the Organisation for Economic Co-Operation and Development (OECD) published its latest public consultation paper in relation to its proposals to address the challenges of taxing the digital economy, entitled “Secretariat Proposal for a “Unified Approach” under Pillar One” (the “Consultation”). This Consultation puts forth a suggested approach to addressing Pillar One of its previous proposals that focuses on issues of taxable nexus and profit allocation, which would apply to “large consumer-facing businesses,” not just businesses with highly digital models.

The approach proposed in the Consultation does not come as a surprise, but it is clear that there is still a lot of work for the OECD to do. The proposals represent a further step on from the proposals published earlier this year, but are still quite broad in nature with a lot of detail yet to be resolved. In this detail, it seems likely that the real differences and fault lines could arise between the 129 members of the OECD/G20 Inclusive Framework on Base Erosion and Profit Shifting (BEPS) .

Background to Proposals

These proposals trace their origin to the BEPS Action Plan, the 2015 BEPS Action 1 Report and the March 2018 “Tax Challenges Arising from Digitalisation – Interim Report,”, which identified the challenges of taxing the digital economy as one of the main focus areas of BEPS.

Further to a Policy Note (see our article on this) issued in January earlier this year, the proposals to address these challenges were divided into two pillars: Pillar One, which focuses on the allocation of taxing rights between jurisdictions and seeks to review the profit allocation and nexus rules in the context of the digital economy; and Pillar Two, which contains further proposals (such as a minimum tax proposal) to tackle the BEPS risks in relation to the digital economy. This Policy Note was followed by a public consultation on this broad approach in February 2019 and a Programme of Work issued in May 2019 aimed at developing these proposals and agreeing on a consensus solution by the end of 2020.

The Consultation puts forward more specific proposals for a “Unified Approach” for Pillar One.

The Unified Approach


A key choice for the Pillar One proposals was the scope of application, with previous options giving a choice between a narrow group of very highly digitalised businesses focusing on user participation or a much wider group of businesses that operate digitally.

The Unified Approach proposes applying the Pillar One rules to “large consumer-facing businesses” - businesses that generate revenue from supplying consumer products or providing digital services that have a consumer-facing element. For these purposes, consumers are to include users.

The Consultation states that this definition needs to be considered closely, but expects that sectors such as extractive industries and commodities would be carved out. It is also suggested that financial services could be carved out. It is also recognised that circumstances such as supplies through intermediaries, franchise arrangements and the supply of component products need to be considered in further detail.


One of the issues in relation to taxing digitalised businesses sought to be addressed by this proposal is that non-resident businesses that do not have a physical presence in a state are not subject to tax on business profits in that jurisdiction (unless they act through a dependent agent). This can mean that a business is not subject to tax in a jurisdiction, even though it may derive significant revenue from a jurisdiction.

The new nexus rule proposed by the Consultation seeks to address this issue by creating a taxing right in all cases where a business “has a sustained and significant involvement in the economy of a market jurisdiction, such as through consumer interaction and engagement, irrespective of its physical presence in that jurisdiction,”.

The OECD proposes that the “simplest” way that such a rule could be operated would be by defining a revenue threshold in the market, which, if satisfied, would indicate that there is sustained and significant involvement in the relevant jurisdiction. To address particular issues with online advertising revenues, this threshold is to take account of revenue raised through online advertising services directed at non-paying users in locations that are different from those in which the relevant revenues are booked. This rule would also apply to businesses that sell in a given jurisdiction through a distributor, whether a related or non-related local entity. It is suggested that this amount could be adapted to the size of the market, and this is one of the points to be determined by the Consultation.

It is interesting to note that this rule will not replace the permanent establishment rule but will operate on top of that rule. If implemented, therefore, businesses would have to consider both sets of rules.

Profit Allocation

The nexus test above or existing permanent establishment rules determine if a country has the right to tax. It is then necessary to determine how much profit can be taxed in a jurisdiction.

In the context of the digitalised economy, the difficulty with applying traditional arm’s length mechanisms is that there are situations where the taxpayer will not perform any functions, will have no assets and will not assume any risks in the market jurisdiction. This makes it impossible to apply traditional mechanisms, even where a taxable nexus has been created. In other circumstances where there is already taxable presence under current tax rules, it is perceived that in some cases, these do not allocate sufficient profit to market jurisdictions.

Therefore, these new rules adopt a hybrid approach by introducing new rules to deal with situations that would not be appropriately covered by the existing arm’s length principle while still retaining the arm’s length principle for situations where it would function appropriately. To achieve this, the Consultation proposes a three tier mechanism for determining the amount to be taxed in a market jurisdiction:

Amount A

• This amount will be calculated by determining the “deemed residual profit” of a multinational enterprise (“MNE”) group and allocating a portion of that profit to relevant market jurisdictions.

• It is proposed that the deemed residual profit is calculated using features of both the residual profit split method and the fractional apportionment method. Essentially, it would use agreed on thresholds based on profitability to exclude remuneration of routine activities, and formulas to calculate and allocate profit.

• Particular issues to consider further are noted as:

o calculation of group profit based on business or regional lines to reflect differences;

o the basis of the group profits to be allocated;

o applicable percentage to allocate profit; and

o avoiding double taxation.

Amount B

• This amount applies where there is already a taxable presence in a jurisdiction under existing rules.

• The amount relates to routine distribution and marketing activities in market jurisdictions, and the Consultation’s proposal is to establish a fixed return for such activities.

• The intention behind this proposal is to simplify the transfer pricing rules in this area and thereby reduce a significant source of current international tax disputes.

• Particular issues to consider further are noted as:

o the need for a clear definition of the activities that qualify for the fixed return; and

o determination of the quantum of the fixed return.

Amount C

• This amount is proposed in recognition that in some market jurisdictions the distribution and marketing activities might be more significant than assumed for the purpose of calculating the fixed return for Amount B, or that the MNE group performs other business activities in the jurisdiction unrelated to marketing and distribution.

• The Consultation proposes that there should be legally binding and effective dispute prevention and resolution mechanisms that give market jurisdictions mechanisms to address this issue.

• Amount C would be any amount of additional profit (above Amount B) agreed through these mechanisms to be attributable to distribution and marketing activities in the relevant jurisdiction.

• Particular issues to consider further are noted as:

o ensuring that the profit under Amount A is not duplicated in the market jurisdiction; and

o interplay with the existing prevention and resolution mechanisms such as APAs, ICAP, and MAP arbitration.

A key issue in relation to all of the above is how potential double taxation is addressed, both between the three different tiers but also in relation to existing profit allocation rules.

The Consultation also raises a variety of other issues and design points that still need to be addressed without putting forward substantive proposals, such as how losses are addressed, collection mechanism such as withholding taxes and the need to ensure simultaneous implementation of these changes by all jurisdictions.


These proposals come against the backdrop of unilateral measures being imposed by individual jurisdictions. Therefore, the need to reach a feasible and efficient solution which that draws consensus is pressing. Since these proposals are subject to public consultation, it is probably premature to determine whether these proposals will be fit for purpose. However, some observations can be made.

• Despite being described as a Unified Approach, it is expected that jurisdictions are still likely to have conflicting positions on the detail of these proposals. Everything depends on where the thresholds and percentages are set, and it is possible that these new rules could lead to only a relatively minor reallocation of taxing rights. For many market countries, this likely would not be acceptable. An indication of the divergence in views can be gleaned from the different rates/rules applied in jurisdictions in relation to the unilateral digital tax measures that have been introduced. Further, the tax competition between states in the US, which adopted/have adopted formulary apportionment, is also an indication of potential problems with this proposal in operation.

• Because the proposals would apply to consumer-facing businesses, and not just businesses with highly digital models, the proposals have the potential to impact nearly all multinational businesses, except for specifically excluded businesses such as extractive industries and commodities and potentially financial services. The participation of a broader range of companies in the discussion may further complicate the ability to achieve consensus.

• As noted above, the Unified approach and the permanent establishment rules will operate in conjunction with each other. Unless there is clear guidance, this may require taxpayers to rely more on dispute resolution mechanisms to prevent double taxation.

• The profit allocation rules could create significant complications in relation to calculating the deemed residual profits. Moreover, while there is some merit in having an assumed baseline activity, as anticipated by the OECD, this is likely to result in complications and disagreements between jurisdictions that assert that further activities were undertaken in those jurisdictions. There is the potential for an increase in disputes.

• The Consultation seeks comments on the use of unilateral/multilateral APAs, ICAP and mandatory binding MAP arbitration as possible dispute resolution mechanisms. Each of these methods have historically/conceptually been subject to various issues and, more importantly, are not swift dispute resolution methods. Given that Amount C anticipates disputes, lengthy procedures (on what will predictably be contentious procedures) may not be welcome.

Submission for comments on the public consultation closes at noon (Paris time) on 12 November 2019. The public consultation meeting will be held on 21 and 22 November 2019 in Paris.

If you would like to discuss the potential impact of these proposals or how you might convey the particular implications of these proposals for your business through the public consultation procedure, please contact: