Pillar One: reallocation of taxing rights

The Organisation for Economic Cooperation and Development (OECD) proposes a two-pillar approach to address the tax challenges of the digitalisation of the economy. Pillar One focuses on the allocation of taxing rights and seeks to undertake a review of the profit allocation and nexus rules. The proposed reallocation of taxing rights would strengthen the taxing rights of market countries and weaken the tax position of the resident states.

In October 2019, the OECD Secretariat presented the "Unified Approach" for the reallocation of taxing rights for corporate profits. The proposal is built on the commonalities of the previous proposals and aims to make reaching a consensus by the end of 2020 more realistic.

The "Unified Approach" focuses on large and consumer-facing companies and proposes a new nexus to ensure taxation of corporate profits in the market country when a physical presence is not maintained but a certain sales threshold is exceeded. The OECD approach seeks to increase legal certainty for taxpayers and tax administrations through a three-part mechanism.

The first stage, "Amount A", represents the central response to the challenges of digitalisation and proposes to allocate additional taxation rights to source and market states. To this end, corporate profits are to be allocated on a formulaic basis if the sales of the multinational enterprise exceed group- and country-specific sales thresholds. As the new nexus understands sales as an indicator of significant economic activity in the market state, it would be irrelevant for tax purposes whether a company maintains a physical presence in the market state.

The second stage, "Amount B", is intended to provide the source states, i.e. those states in which a physical presence in the sense of a permanent establishment or a subsidiary is operated, with a fixed remuneration for so-called basic activities. The main focus in this context rests on marketing and sales activities.

If branches in the source state perform functions and bear risks beyond the basic activities, the third stage ("Amount C") enables source states to claim additional taxing rights. In this context, the “Unified Approach” aims to provide legally binding and effective dispute prevention and resolution mechanisms.

BDI assessment of the reallocation of taxing rights

The proposed "Unified Approach" is very complex and lacks clarity due to numerous outstanding technical details. A final assessment is therefore not yet possible.

If a revision of the allocation of taxing rights is politically desired, a global consensus is required. The reform needs to ensure that the complexity of the new measures does not lead to double taxation. Therefore, binding dispute prevention and dispute resolution should form an integral part of any consensus.

It is important that the participating countries apply a uniform interpretation of the new measures. Therefore, any reform should be based on internationally established principles of taxation like nexus, permanent establishment and the taxation of net income. Fundamental principles such as the arm’s length principle (ALP) should not generally be replaced and the deviations from the ALP need to be strictly limited and should constitute an exception.

In this context, it is important to ensure continuity. The international taxation system should keep pace with changing business models. The application of formulaic elements and monetary thresholds does not achieve the necessary flexibility.

To implement a possible compromise, the countries involved should be obliged to agree on a multilateral agreement in order to limit the administrative burden and legal uncertainty. The multilateral agreement should consider a centralised administration procedure to ensure uniform implementation and minimise compliance costs. In this procedure, the tax authorities of the country in which the parent company of the group is headquartered should manage the tax collection and allocation to the market and source countries.