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The growth in the number of digital companies dedicated to the sale of goods and/or services and the evolution of the business models of existing companies that tend to reduce face-to-face activities and fixed places of business are some of the main challenges faced by tax authorities globally. For this reason, we are facing a questioning of international taxation models and discussions for the development of new forms of taxation adapted to new business models.

During the second half of 2018, member countries of the inclusive framework of the OECD-G20 BEPS Project presented their proposals in response to these issues. These proposals are summarised in two "pillars".

- Pillar One focuses on an attribution of taxing rights between jurisdictions that is consistent with profit sharing and the concept of nexus, unifying the main proposals received which are based on user participation, marketing intangibles and significant economic presence.

- Pillar Two addresses the strengthening of additional measures to combat base erosion and profit shifting.

Through public consultations, both pillars have been subject to comments from any interested party and it is expected that a consensus solution on the proposals will be reached by the end of 2020.

The "Pillar One" or Unified Approach

The unified approach aims to compile the three relevant factor proposals into a single model for attributing taxing rights and benefits across jurisdictions. In unifying these proposals, the OECD has drawn on the commonalities between the proposals, including:

- Reallocation of taxation rights in favour of the user jurisdiction.

- Distancing from the Arm's Length Principle and the Separate-Entity Approach.

- New nexus rule that does not depend on physical presence in the user's jurisdiction.

- Simplification and Legal Certainty.

The scope of the unified "Pillar One" approach not only includes fully digital business models, but is intended to cover any business model oriented towards the end consumer, taking into account that the way of doing business will tend towards digitisation regardless of the goods or services traded. For the time being, only the extractive industries have been explicitly excluded from the scope.

The new nexus of the Unified Approach raises the possibility of taxation without the condition of physical presence, based on sales as a connecting factor. A threshold defined on the basis of turnover for a particular market could be the test for significant presence in that market or jurisdiction.

The proposal also envisages, for in-scope groups, a new profit attribution criterion which departs from the arm's length principle and which is independent of the way in which sales are made to the final consumer (physical marketing/distribution presence or unrelated distributors). In summary, the unified approach introduces a three-tiered profit attribution mechanism, referred to as the A, B and C Amounts.

Amount A would constitute the "new tax right" resulting from the proposal. Once the "routine" profit is allocated to the parties (Amount B), Amount A would be calculated as a proportion of the residual profit using a formula-based approach, irrespective of location or place of residence, provided that the new sales-based nexus rule is complied with.

Amount B attributes remuneration for certain "routine" distribution and marketing activities that take place in the market jurisdiction. These activities will, for the time being, remain subject to transfer pricing rules based on the arm's length principle and the attribution of profits to permanent establishments under Article 7 of the OECD Model Tax Convention. It is possible that fixed remuneration may eventually be established for such "routine" activities in order to increase certainty for taxpayers and tax administrations and to reduce the number of disputes on the subject.

In addition, it is proposed to impose additional profits, called Amount C, which could be attributed to a given market jurisdiction when the activities carried out in the territory of the jurisdiction go beyond the remuneration allocated as "Amount B" and therefore justify a higher profit. Amount C" would be allocated with the adoption of effective dispute avoidance and resolution mechanisms on a binding basis through the application of the Arm's Length Principle.

"Pillar Two" or Global Proposal against Base Erosion (GloBE)

Pillar Two addresses the issue of base erosion mainly by introducing an overall minimum tax rate, which is expected to reduce the incentive for profit shifting between jurisdictions. In case of non-compliance with the overall minimum, the tax administration of the group's parent jurisdiction could tax the results of its subsidiaries or branches.

The "GloBE" proposal has four components:

1. Income inclusion rule that would tax income of foreign branches or subsidiaries if that income was subject to an effective rate below the global minimum rate.

2. Deduction or source taxation (including withholding) disallowance rule for payments to related parties if they were subject to an effective rate below the global minimum rate.

3. Switch-over rule in tax treaties that would allow the jurisdiction of residence to change from an exemption method to a tax credit method when the profits of a permanent establishment were subject to an effective rate below the global minimum.

4. Source taxation rule and adjustment of applicability of treaty benefits on certain types of income where payments are not subject to a minimum rate.

The rules described above would be implemented through changes to each jurisdiction's domestic regulations and tax treaties, taking into consideration that additional measures will also need to be implemented to avoid double taxation that may arise from disputes over the application of the new rules.



Galindez, Medrano & Asociados have participated in the public consultations and discussions regarding issues in the digital economy and we would like to share some general comments below.

While it is clear that both the Unified Approach and the GloBE Proposal have evolved from views on what would be appropriate solutions to current problems, they should be broad and clear enough to provide solutions for all parties involved (tax administrations and taxpayers) and should be applicable to all markets (developed and developing countries).

We believe that the initial idea of Action 1 of the BEPS project, which seeks to accommodate the digitisation of all types of business models and sectors, should be pursued and therefore should not be limited in scope to specific sectors and sizes, which in the end only benefit a few countries and do not balance the global tax situation.

Given our experience with transfer pricing developments in developing countries, these proposals present a high degree of complexity, transparency and cooperation that would require broad political support and investment and therefore should be beneficial for all parties.


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