International: Pillar One - Draft model rules for Nexus and Revenue Sourcing published

OECD seeks comments on two building blocks of Amount A

In brief

On 4 February 2022, the OECD published the draft model rules for two of the building blocks of Amount A under Pillar One, namely Nexus and Revenue Sourcing. This is the first extensive publication on Pillar One since the political agreement on the Two-Pillar Solution in the form of the joint statement from the Inclusive Framework dated 8 October 2021. The draft model rules enable an MNE group in scope of Amount A (i.e., global turnover above EUR 20 billion (or local equivalent) and profitability above 10%, subject to some exceptions; hereafter referred to as a "Covered Group") to determine its so-called market jurisdictions to which part of the Covered Group's residual profits will be allocated. It should be noted that the draft model rules are still a work-in-progress and subject to changes. The OECD welcomes comments from the public until 18 February 2022.


Contents

Recommended actions and comments

  • Amount A is proposed to come into effect already in 2023 even though many details are still unknown. Being conscious of this ambitious timeline, companies in scope of Amount A are well-advised to start preparing and assessing the potential impact of Amount A by identifying their relevant market jurisdictions.  The draft model rules provide the basis for assigning the source of a Covered Group’s revenues to individual market jurisdictions, which is critical for determining both whether the Covered Group has enough nexus in a market jurisdiction for some Amount A to be allocated there and the proportionate share of Amount A liability to be allocated to each market jurisdiction where nexus exists.
  • According to the draft model rules, a Covered Group sources its revenues from a jurisdiction depending on its type of business, on a transaction-by-transaction basis (unless revenue cannot be sourced at a transaction level, in which case certain allocation keys may be used). In that regard a differentiation is made among the following revenue-generating business activities:
  1. sale of tangible finished goods;
  2. sale of digital goods;
  3. sale of components:
  4. provision of location-specific services;
  5. provision of advertising services;
  6. provision of online intermediation services;
  7. provision of transport services;
  8. provision of customer reward programs;
  9. provision of financing;
  10. provision of business to consumer services (if not otherwise specifically addressed);
  11. provision of business to business services (if not otherwise specifically addressed);
  12.  licensing, sale or other alienation of intangible property or user data; and
  13.  sale, lease or other alienation of real property.
  • Moreover, specific revenue sourcing rules are also provided for government grants, and non-customer revenues.
  • Considering this background, it is advisable to, as a first step, analyze the types of revenues a Covered Group generates through its transactions with customers (both B2C and B2B transactions). As a second step, the source of the revenues (i.e., the market jurisdictions) should be identified based on the indicators provided by the draft model rules (see "In depth" section below for details).
  • Of particular interest is the OECD's statement according to which the draft model rules are still to be complemented by detailed record-keeping requirements (including an internal control framework). Companies are expected to be in a position to demonstrate their conceptual approach to revenue sourcing, their way of obtaining relevant data and their internal controls to ensure the accuracy of the relevant data. Further developments in this regard should be closely monitored.
  • While the OECD has expressly aimed for a balance between the need for accuracy with respect to the source of revenues and the need for limited compliance costs, the preparation and implementation of the revenue sourcing rules will undoubtedly create significant challenges for in-scope companies in terms of time and resources. Based on the current draft and practical complexity associated with the implementation of these rules, companies may be led to adopt the  usage of allocation key methodologies to the extent allowed, more commonly than the OECD may envisage.

In depth

The Model Rules will serve as the basis for the substantive provisions that will be included in the Multilateral Convention, which is intended to implement Amount A, as well as provide a template that jurisdictions could use as the basis to give effect to the new taxing rights over Amount A in their domestic legislation.

The draft model rules subject to consultation cover two building blocks of Amount A, namely Nexus and Revenue Sourcing. While the model rules contain the text of the general articles and a schedule A for these building blocks, the current draft does not reflect the final views of the Inclusive Framework members at this stage. The draft is a working document released by the OECD Secretariat for the purpose of obtaining input from stakeholders.

The Nexus and Revenue Sourcing rules are required to determine the market jurisdiction to which residual profits may be allocated under Amount A. Whilst the Nexus rules are fairly brief, the provisions on Revenue Sourcing are lengthy and detailed. An explanatory commentary will also be released to further complement the model rules.

The Nexus rules can be summarized as follows:

  • For purposes of Amount A, a Covered Group has nexus in a jurisdiction in a given year if revenues arising in that jurisdiction amount to a minimum of EUR 1,000,000 (or local equivalent). The revenue threshold is lowered to EUR 250,000 (or local equivalent) if the respective jurisdiction has an annual GDP of less than EUR 40 billion; well over 100 jurisdictions worldwide fall into this category. These revenue thresholds were already specified in the Inclusive Framework's statement dated 8 October 2021.
  • Revenues are those reported in the consolidated financial statements of the Covered Group, after excluding revenues derived from Extractive and Regulated Financial Services.
  • The OECD acknowledges that indicating the revenue thresholds in only one currency (i.e., EUR) is not sufficient for global implementation of the rules. Further discussions are needed to address coordination issues with respect to currency fluctuations.

The Revenue Sourcing rules can be summarized as follows:

  • For every transaction through which a Covered Group generates third-party revenues the Revenue Sourcing rules must be applied.
  • A transaction may be composed of several elements (e.g., sale of a finished good including after-sales service). If so, the element which gives the transaction its predominant character is decisive for determining the relevant Revenue Sourcing rule.
  • All revenues of a Covered Group must be consistently sourced based on a reliable indicator or, if permitted, an allocation key. An indicator is reliable if it results in outcomes that are consistent with the revenue sourcing rules and meets at least one of several reliability tests, e.g., if the Covered Group uses that indicator also for commercial purposes or to fulfil its legal or regulatory obligations. If the Covered Group has taken “reasonable steps” to try to apply a reliable indicator and demonstrates that none is available (e.g., due to lack of relevant information), specified allocation keys shall be used to source revenues as detailed in the draft model rules.
  • The draft model rules provide a Sourcing Rule for various types of revenue-generating business activities as well as revenues from government grants and non-customer revenues (see above). For each type of revenue, a general Sourcing Rule is given to determine the jurisdiction in which the revenue arises (e.g., location of the viewer of an ad for online advertising services). In addition, a detailed Schedule accompanying the Sourcing Rules provides for potentially reliable indicators or allocation keys to pinpoint the source jurisdiction (e.g., IP address of the viewer of the online ad).
  • Revenues derived from the sale of finished goods (either directly or through an independent distributor) are sourced from the jurisdiction where the place of delivery to the final customer is located. A reliable indicator for the place of delivery may be e.g., the customer's delivery address. The same applies to revenues derived from the sale of components. The draft model rules acknowledge the potential difficulty of obtaining reliable information about the place of delivery to the final customer in the case of sales of finished goods through independent distributors and sales of components, and they provide certain tailored deemed reliable indicators or fallback allocation keys for those cases.
  • Revenues derived from the sale of digital goods to an individual consumer are sourced from the jurisdiction where the consumer is located. The "location" of an individual consumer is defined in a general way in the draft model rules as the "place where an individual is habitually located"; this may be determined based on the tax residence but the draft rules indicate that additional guidance will be provided in this respect. Reliable indicators for the location of the consumer are provided, e.g., the billing address - how these indicators will interplay with the potential tax residence criterion will need to be closely followed. The same applies to revenues derived from business to consumer services (when not otherwise specifically addressed).
  • Revenues derived from the sale of digital goods to a business are sourced from the jurisdiction where the digital goods will be used, including when they are sold through a reseller. A reliable indicator for the place of use may be e.g., the place as specified in the contract or commercial documentation. The same applies to revenues derived from business to business services (when not otherwise specifically addressed).
  • Revenues derived from the provision of location-specific services (e.g., provision of utilities services to a fixed premises) are sourced from the jurisdiction where the services are performed. A reliable indicator for the place of performance may be e.g., the location of the tangible property which is the object of the services.
  • Revenues derived from the provision of advertising services are sourced from the jurisdiction where the viewer is located for online services and from the jurisdiction where the advertisement is displayed or received for other than online services. A reliable indicator for the location of the viewer may be e.g., the so-called user profile information which the Covered Group holds for commercial purposes and may include data on geolocation or IP address of the device used by the viewer.
  • Revenues derived from the provision of online intermediation services which facilitate e.g., the sale of a tangible good (excluding real property) are sourced by 50% from the jurisdiction where the purchaser is located and by 50% from the jurisdiction where the seller is located. A reliable indicator for the location of the purchaser as well as the seller may be e.g., the billing address.
  • With respect to revenues from the provision of transport services a differentiation is made between passenger transport services and cargo transport services and then a further differentiation whether the transport is by air or not. For these transport services the draft model rules provide that they are sourced from the jurisdiction where inter alia the place of landing or destination is. However, no reliable indicators are provided in this regard, while the rules directly refer to the usage of an allocation key. For example, for passenger air transport services revenues are deemed to arise in a jurisdiction in proportion to its percentage share of available passenger capacity determined by dividing the Covered Group’s passenger capacity arriving to places of landing in that jurisdiction by the Covered Group’s total available passenger capacity arriving to places of landing in any jurisdiction.
  • Revenues derived from the provision of customer reward programs are sourced from the jurisdiction where the program member's location is. A reliable indicator for the location of the member may be the member's user profile information.
  • Revenues derived from the provision of financing follow the same rules as business to consumer services or business to business services as described above. The OECD explicitly states that the work on the exclusion of regulated financial services for purposes of the scope of Amount A is still in progress and may require a revision of the Revenue Sourcing rules in that regard at a later stage.
  • Revenues derived from the licensing, sale or other alienation of intangible property that supports the provision of a service are sourced from the jurisdiction where the service supported by the intangible property is used. In all other cases, where e.g., the intangible property relates to a copyrighted work, the sourcing jurisdiction is the jurisdiction where the final customer uses the intangible property. In the latter case, the place of delivery of the copyrighted work to the final customer determines the source jurisdiction as reliably indicated by e.g., the final customer's user profile information. Revenues derived from the licensing, sale or other alienation of user data are sourced from the jurisdiction in which the user, whose data is being transferred, is located, which may be reliably indicated by e.g., the user profile information.
  • Revenues derived from the sale, lease or other alienation of real property are sourced from the jurisdiction where the real property is located. A reliable indicator for this location may be the address of the real property.
  • Revenues derived from government grants are sourced from the jurisdiction whose government provided or funded the grant.
  • Non-customer revenues refer to revenues that are not derived from customers and include, amongst other, foreign currency gains, releases of provisions, asset revaluations, changes in pension liabilities, returns from and gains on the disposition of assets. Any such non-customer revenues are basically proportionally allocated to all source jurisdictions that were identified in one of the other sourcing rules as described above.
  • As stated above, certain specific allocation keys are provided depending on the type of revenue which should be used if the application of a reliable indicator is not feasible. For example, for revenues generated through business to business services to a large business customer the Headcount Allocation Key should be applied. Based on the Headcount Allocation Key the customer jurisdiction's revenues are determined by the percentage share of employee headcount as reported in the customer's most recently filed Country-by-Country Report. The draft model rules say the Covered Group “must take reasonable steps to obtain the jurisdictional breakdown of headcount” of the large business customer.
  • In a number of cases the general default allocation key to be used where no other method is feasible is the so-called Global Allocation Key. According to this allocation key, the revenues sourced from a jurisdiction equal the jurisdiction's percentage share of final consumption expenditure as published by the United Nations Conference on Trade and Development. When applying an allocation key, Covered Groups may make use of the so-called Knock-out Rule and demonstrate that in certain jurisdictions no revenues arise (e.g., due to a trade embargo) or demonstrate actual knowledge of the good or service in the case at hand being ultimately consumed in a specific set of jurisdictions which would then automatically rule out any other jurisdictions as revenue source.

In light of the OECD Secretariat's stated goal to limit and simplify compliance burdens, we will monitor with great interest to what extent the additional (and potentially revised) guidance will address the current complexity resulting from the above source rules.

With special thanks to our contributors:


Copyright © 2022 Baker & McKenzie. All rights reserved. Ownership: This documentation and content (Content) is a proprietary resource owned exclusively by Baker McKenzie (meaning Baker & McKenzie International and its member firms). The Content is protected under international copyright conventions. Use of this Content does not of itself create a contractual relationship, nor any attorney/client relationship, between Baker McKenzie and any person. Non-reliance and exclusion: All Content is for informational purposes only and may not reflect the most current legal and regulatory developments. All summaries of the laws, regulations and practice are subject to change. The Content is not offered as legal or professional advice for any specific matter. It is not intended to be a substitute for reference to (and compliance with) the detailed provisions of applicable laws, rules, regulations or forms. Legal advice should always be sought before taking any action or refraining from taking any action based on any Content. Baker McKenzie and the editors and the contributing authors do not guarantee the accuracy of the Content and expressly disclaim any and all liability to any person in respect of the consequences of anything done or permitted to be done or omitted to be done wholly or partly in reliance upon the whole or any part of the Content. The Content may contain links to external websites and external websites may link to the Content. Baker McKenzie is not responsible for the content or operation of any such external sites and disclaims all liability, howsoever occurring, in respect of the content or operation of any such external websites. Attorney Advertising: This Content may qualify as “Attorney Advertising” requiring notice in some jurisdictions. To the extent that this Content may qualify as Attorney Advertising, PRIOR RESULTS DO NOT GUARANTEE A SIMILAR OUTCOME. Reproduction: Reproduction of reasonable portions of the Content is permitted provided that (i) such reproductions are made available free of charge and for non-commercial purposes, (ii) such reproductions are properly attributed to Baker McKenzie, (iii) the portion of the Content being reproduced is not altered or made available in a manner that modifies the Content or presents the Content being reproduced in a false light and (iv) notice is made to the disclaimers included on the Content. The permission to re-copy does not allow for incorporation of any substantial portion of the Content in any work or publication, whether in hard copy, electronic or any other form or for commercial purposes.