CHAPTER 1 - INTRODUCTION TO PILLAR ONE
The Report on the Pillar One Blueprint ("the Blueprint") regarding tax challenges arising from digitalisation was approved by the member jurisdictions of the OECD/G20 Inclusive Framework on BEPS on 12 October 2020. It reflects extensive technical work that has been done to define a sustainable taxation framework to reflect the increasingly digitalised economy. However, no agreement has been reached by the members at this point, and further significant work will be required to gain any consensus on many of the fundamental potential principles covered.
A public consultation was also announced based upon the Blueprint which will conclude on 14 December 2020. The stated aim is to then to bring the process of addressing issues and coming to a successful conclusion by mid-2021. This includes resolving technical issues, developing model draft legislation, guidelines, international rules and processes as necessary. Many would see this is an incredibly tight timeline given the complexities and issues still to be addressed. However, there is significant pressure to come to conclusions, as demonstrated by the European Commission's recent comments that the EU bloc will go it alone if the mid-2021 date is not met.
In summary, Pillar One seeks to expand the taxing rights of market/user jurisdictions where there is an "active and sustained participation of a business in the economy of that jurisdiction through activities in, or remotely directed at, that jurisdiction". It also seeks to improve tax certainty through dispute prevention and resolution measures. The three basic elements of Pillar One are a new taxing right for market/user jurisdictions based upon a share of a businesses' residual profits ("Amount A"), a fixed return for certain distribution and marketing activities physically in a market/user jurisdiction ("Amount B"), and dispute prevention and resolution processes to improve tax certainty.
Some of the particular issues that will need to be focused on at a political and technical level before Pillar One can be finalised and implemented include:
- what businesses should be in scope - the Blueprint proposes that certain automated digital services and consumer-facing businesses would be potentially impacted,
- what size thresholds should businesses meet before they are impacted,
- should Pillar One apply on a mandatory basis based upon activities tests, or should it be elective,
- what portion of residual profit should be allocated to market/user jurisdictions as Amount A, and based upon what measures should it be calculated,
- how to deal with businesses that have segments some of which are targeted by the new taxing rights, but other segments that are not,
- how to eliminate double taxation in a multi-lateral setting,
- how to take into account and simply deal with taxation of businesses that also have a physical or legal presence in market/user jurisdictions under Amount B,
- how to achieve tax certainty over acceptance of Amount A in a simple and coordinated way,
- how to implement the Pillar One solution, for example potentially through a multilateral convention process that would supersede all bilateral treaties on the points covered in the convention.
This client alert summarises how the Pillar One Blueprint currently proposes to deal with these issues, and highlights what still needs to be concluded.
CHAPTER 2 - SCOPE
The scope for the application of the Amount A tax base contemplates MNEs that perform in-scope activities as defined in the Blueprint, combined with a double revenue threshold that takes into account consolidated group revenues and the MNE’s revenue earned outside its domestic market. The exact amounts of these thresholds will be further defined based on the outcomes of the economic impact assessment conducted by the OECD, having regard to aspects such as compliance burden and expected fiscal consequences in terms of the available reallocation of taxation rights for market jurisdictions.
The definition of the in-scope activities includes the following two broad categories:
- Automated Digital Services (“ADS”) – Broadly defined as services made available to users (whether institutional or private individuals) through digital means (i.e., over the Internet or an electronic network), which access is obtained in an automated fashion (i.e., requiring minimal human involvement) by virtue of equipment and systems in place for this purpose. The definition of ADS combines also a positive list, and a negative list, in the sense that an activity on the positive list is an ADS business, while an activity on the negative list is not an ADS business.
- Consumer Facing Businesses (“CFB”) – This category includes traditional (i.e., non-digital) businesses that have embraced digitalisation, allowing them to participate in an active and sustained manner in the economic life of an external market through the use of consumer-facing intangibles, without necessarily investing in local infrastructure and operations. Companies included in this category comprise businesses that generate revenue from the sale of goods and services of a type commonly sold to consumers (i.e., sold for personal consumption and not for commercial or professional purposes), including those selling indirectly through intermediaries and by way of franchising and licensing.
While this chapter revolves mainly around the definition of qualifying activities for purposes of the application of Amount A, the Blueprint states that the scope of its guidance remains one of the key pending political issues to be resolved, and as such, governments and private institutions might still expect revisions to the scope envisaged in the Blueprint.
Scope: Automated Digital Services "ADS"
The overall definition of ADS is comprised of a positive list of nine qualifying ADS activities; a negative list of five non-ADS activities; and a general definition. It is recognized however that an ADS business may be comprised of multiple ADS qualifying activities – some of which are directly revenue-generating and others which are not.
The positive list of ADS activities includes the following:
- Online advertising services – Consisting of the placement of advertisements on a digital interface, typically offered by operators of social media platforms, online search engines, online intermediation platforms and digital content providers. Other automated systems and processes for the purchase and sale of advertising inventory are also included.
- Sale or other alienation of user data – Covers the monetisation of user data generated on a digital interface (such as a user’s habits, spending, location, hobbies, personal interests, etc.), irrespective of the source of the data (collected as raw data by the MNE itself or it may be acquired from another business).
- Online search engines – Comprises the monetization of a digital interface made available to search the Internet for webpages or information hosted on digital interfaces. Internal website search functions that are not monetised or, where the search results are limited to data hosted on that same digital interface are excluded from the scope.
- Social media platforms - Digital interfaces that facilitate the interaction between users such as social and professional networking websites, micro-blogging platforms, video or image sharing platforms, online dating websites, platforms dedicated to sharing user reviews, as well as online call and messaging platforms.
- Online intermediation platforms – Monetization of digital platforms made available to enable users to offer goods or services to other users. This category excludes the online sale of goods and services which form part of the platform’s own inventory (which may however be captured under CFB), unless the business is shielded from the ordinary commercial risks associated with the provision of the underlying product (such as where the business only takes flash title and is insulated from inventory risk, is fully indemnified against product liability risk and credit risk).
- Digital content services – Automated provision of digital content such as music, books, videos, texts, games, applications, computer programmes, software, online newspapers, online libraries and online databases, whether for access one time, for a limited period or in perpetuity. Two exemptions are distinguished:
The content is acquired as a tangible product (e.g. offline items such as music, films, books or computer games or software purchased on a physical medium). Although these activities are not considered as an ADS, they could be included as a CFB.
Highly customised software that has been designed for a particular businesses’ needs would not be included as ADS, even if the final product is made available online; however, the degree of customisation and the level of human involvement should be the primary factors to characterise the provision of software as ADS or otherwise.
- Online gaming – Multiplayer gaming platforms, irrespective of whether the access to the game is by way of fee or available for free, including the provision of in-game purchases. This category would not generally include single-player games or the purchase of a game sold on tangible media (which would be however in the scope of CFB).
- Standardised online teaching services – The provision of online education programmes which does not require the live presence of an instructor or significant customisation on behalf of an instructor to a particular user or limited group of users.
- Cloud computing services - The provision of network access to on-demand standardised (not customized to the need of a particular client) information technology (IT) resources, provided with a minimal degree of human involvement.
The list of non-ADS activities (negative list) includes:
- Customised professional services – Customised professional services, whether provided individually or as a firm; regardless of the means the service is delivered (i.e., digital format deliverable shared by e-mail).
- Customised online teaching services – Live or recorded teaching services delivered online, where the teacher customises the service (such as by providing individualised, non-automated feedback and support) to the needs of the student or limited group.
- Online sale of goods and services other than ADS – This means the sale of a good or service completed through a digital interface where the digital interface is operated by the provider of the good or service. This category would apply to sellers that use a digital platform to sell their own non-digital goods and services to customers.
- Revenue from the sale of a physical good irrespective of network connectivity (“Internet of Things”) – Sale of physical goods that may be connected to the Internet, or bundled with an online service are not considered ADS. The online service per se, might however be considered an ADS.
- Services providing access to the Internet or another electronic network – This category covers the provision of access (i.e. connection, subscription, installation) to the Internet or an electronic network.
It is acknowledged that some MNEs may be engaged in activities that incorporate ADS and non-ADS elements that might be highly integrated and thus be considered to be a single service. In those cases, the characterization of the activities would consider if a substantive part of the overall service is on either the positive or negative list. Further guidance will be developed to determine the appropriate materiality threshold in these situations.
Scope: Consumer Facing Businesses "CFB"
The definition of a customer-facing business is broad in scope and includes businesses that supply (directly or indirectly through a broker, agent, intermediary, or representative) goods or services of a type commonly sold to consumers. Products “of a type commonly sold to consumers” are those that:
- are designed primarily for sale to consumers;
- are made available in ways capable of being for personal consumption; and
- are developed by the MNE to be regularly, repeatedly, or ordinarily supplied to consumers, such as by engaging in consumer market research, marketing and promoting it to consumers, using consumer / user data, or providing consumer feedback or support services.
Once a good or service meets the test of being of a type commonly sold to consumers, all sales of goods or services of that type of product will be entirely within scope. This remains true, even if the product is sold (licensed or franchised) to a business customer. This means that an MNE is in scope based on the nature of the product or service and this is not altered by the role of a third party in the distribution channel.
As such, an MNE would be regarded as being a CFB if the MNE is the owner of the consumer product or service, and holder of the rights to the connected intangible property. In this context, other third party MNEs, such as manufacturers, wholesalers, and distributors, which have no relationship with the customer – whether contractual or otherwise – are not in scope.
Based on the definition above, the following activities would be regarded as CFB:
Under the general notion that all pharmaceuticals are ultimately consumed / used by individual consumers, all drugs used by patients / consumers would be in scope irrespective of whether they are prescribed and individually acquired by the consumer or are acquired in the course of seeking broader medical treatment.
However, the Blueprint discusses that in some circumstances, prescription drugs could be excluded from the scope on the basis that, as compared with OTC drugs, they have specific features that do not fit as easily into the notion of a CFB. In particular:
They are prescribed by physicians or other medical professionals and delivered as part of the service of health care;
The choice to consume a prescription drug is made by a physician, who may prescribe a different drug from the one known to the patient;
Advertising prescription drugs to consumers is not permitted in most jurisdictions; and
The patient normally pays only a small proportion of the cost of the drug, with governments or insurance companies paying the rest.
These factors could suggest that the consumer relationship between the MNE producing the prescription drug and the consumer is more indirect than for other CFB, and as such, prescription drugs could be treated as out-of-scope.
Franchising and Licensing
As mentioned earlier, the proposed scope of Amount A would extend not only to businesses that sell goods and services directly to consumers, but also to those that sell consumer products indirectly through third-party resellers or intermediaries. In this respect, facing the consumer is broader than strictly contracting with the consumer, and as such, goods and services can be in scope irrespective of the particular distribution channel or selling agent.
For this reason, franchise models and licensing arrangements in respect of consumer goods and services are included within the scope to the extent that the rights forming the franchise or licensing arrangement are connected to an underlying product or service of a type commonly sold to consumers as per the definition of CFB above.
Dual use finished goods / services
Dual use finished goods / services refers to products that can be sold to both consumers and businesses. For example, passenger cars, personal computers and some medical products (such as blood pressure monitors) fall in this category. In these cases, where the good is of a type commonly sold to consumers, the full amount of sales of this type of product / service would be in scope, irrespective of whether a given purchaser is a business or an individual.
Dual use intermediate products and components
The Blueprint notes that businesses selling intermediate products and components that are incorporated into a finished product sold to consumers would generally be out-of-scope. However, intermediate products / components with dual use (i.e., of a type that is also designed for use by consumers) would be in scope. Possible examples include a car tyre, some replacement parts, batteries for consumer products, and some types of medical products such as bandages. However, they would be included in the scope only to the extent the sales are ultimately made to consumers.
Moreover, the Blueprint sets out some types of activities that are proposed to be specifically excluded from Amount A.
The term “natural resources” encompasses non-renewable extractives (such as petroleum and minerals), renewables (such as agricultural, fishery and forestry products) and renewable energy products and similar energy products (such as biofuels, biogas, green hydrogen).
Extractive industries and other producers and sellers of raw materials and commodities, including commodity traders, will not be within the CFB definition, even if those materials and commodities are incorporated further down the supply chain into consumer products. Generally, this remains true for consumer products that are generic, undifferentiated and sold on the basis of their inherent characteristics.
However, some products that incorporate natural resources, such as jewellery and chocolates, could still fall within the general definition of CFB.
Financial services (FS)
FS business comprises banking, insurance and asset management services. With regard to CFB, very significant parts of FS business are not consumer-facing. However, there are also significant parts of the FS business that involve CFB. Nonetheless, the regulations governing FS in the different sectors generally require that appropriately capitalised entities are maintained in each market jurisdiction to carry on business in the market concerned.
Due to this factor, the profits from CFB activities that arise in a particular market jurisdiction will generally be taxed in that jurisdiction with the result that there is no further need for any Amount A re-allocation. For this reason, FS business are generally considered to be outside of the scope of Amount A.
Infrastructure and general construction business
General construction can be broken down into commercial and residential. Commercial real estate includes the provision of office buildings, hotels, factories and warehouses. These are developed and sold or leased for use by other businesses. Neither infrastructure construction nor general commercial construction is within the scope of ADS or CFB based on first principles.
On the other hand, residential real estate refers to the construction of buildings for the customer’s personal use, such as an apartment or house. Applying the general definition of CFB, MNEs that sell residential real estate would be in scope, given that the nature of the product is of a type commonly sold to consumer. However, this outcome does not align with the policy rationale for Amount A in the sense that for residential real estate, the first element – the consumer relationship – is not one of remote engagement, and that a company selling or leasing its interest in residential real estate will require a substantial physical presence in a market to earn its revenue.
For those reasons the construction, sale or letting of residential dwellings by businesses that have engaged in the development and construction of the residential real estate is proposed to be excluded from the scope of Amount A.
However, it should be noted that the definition of residential dwelling means that the offering of temporary accommodation, such as hotels, remain in scope of Amount A.
International air and shipping businesses
The general view of the Inclusive Framework is that it would be “inappropriate to include airline and shipping businesses in the scope of the new taxing right”. This is sustained on the fact that there is a longstanding international consensus that the profits of enterprises operating ships or aircraft in international traffic should be taxable only in the jurisdiction in which the enterprise has its residence.
This special treatment, which is applied regardless of whether such an enterprise carries on business through foreign permanent establishments, is reflected in Article 8 of both the OECD and United Nations (UN) Model Tax Conventions and in the vast majority of the 3,500+ bilateral tax treaties currently in force. In that sense, it is considered that profits that fall within Article 8 of the OECD Model Tax Convention would therefore be excluded from the scope of Amount A.
Scope: Threshold Tests
The Blueprint defines two thresholds which would need to be met in order for the activities of the multinational group to be considered in scope. These thresholds serve the purpose of creating a balance between the additional compliance costs required to implement Amount A in practice and potential benefits arising from reallocation of profits under Amount A. The first test is a global revenue test, which would exclude multinational enterprises which have consolidated gross revenues below a certain amount. As a starting point, the threshold currently applied for CbCR, EUR 750 million, could be used. It is acknowledged that applying any lower global revenue threshold would increase compliance and administrative costs, while not leading to any substantial additional allocation of residual profits to market jurisdictions.
The second threshold aims to exclude multinational enterprises which generate only a small portion of their revenues from foreign market jurisdictions. It is proposed that this test be applied based on an absolute number rather than relative to the size of the domestic business of the multinational enterprise. If they would not meet the de minimis foreign in-scope revenue threshold, they would not be included within the scope.
CHAPTER 3 - NEXUS RULES
Nexus rules: Overview
While the scope tests in Chapter 2 seek to identify MNEs that are able to participate in an active and sustained manner in the economic life of market jurisdictions, the nexus rules set forth in Chapter 3 determine the entitlement of a market jurisdiction to an allocation of Amount A.
Nexus rules are based on a series of indicators of significant and sustained engagement of an MNE in a specific jurisdiction. Such indicators may differ depending on whether the MNE is an ADS or a CFB. In particular, although for ADS the Blueprint suggest only market revenue as a nexus test, for CFB further factors ("plus factors") might be relevant. The tests might also be lowered for developing economies.
It is apparent from the Blueprint that significant additional work is required, on several constituents of the nexus rules.
For ADS, market revenue higher than a certain threshold is sufficient to establish nexus between the MNE and the jurisdiction in question, thereby creating an entitlement for said jurisdiction to a portion of Amount A. A temporal requirement (for instance in the form of a duration test) might be developed, so as to avoid covering one-off transactions which would not be representative of a sustained engagement with a market.
For CFB, market revenue higher than a certain threshold (potentially different from the market threshold for ADS), possibly supplemented by one (or more) "plus factor(s)" are necessary to establish nexus between the MNE and the jurisdiction in question, thereby creating an entitlement for the jurisdiction in question to a portion of Amount A. A number of "plus factors" are presented in the Pillar 1 Blueprint and are still being discussed by members of the Inclusive Framework. A number of alternative "plus factors" are being considered, sustained presence of CFB's personnel in a market jurisdiction, or a test of advertising and promotion expenditures by jurisdiction - both of which have at least some support within the Inclusive Framework. It appears though that a "physical presence" test (i.e., whether an MNE has a subsidiary or a PE in a certain jurisdiction) likely will prevail in the discussion among the Inclusive Framework members, as the key plus factor that will be considered for CFB MNEs. In this regard, the Blueprint notes that the PE definition varies across tax treaties and domestic legislations, and the use of either a definition sourced from tax treaties or a definition sourced from domestic legislation is thought to potentially lead to issues of fairness and potential distortions. As such, the preferred approach seems to be the development of a PE definition specific for the purpose of Amount A.
For both ADS and CFB, lower nexus standards might be established for smaller, developing economies with a GDP below a certain level.
All-in-all, it appears that substantial further work still needs to be done by the OECD to achieve consensus among Inclusive Framework members, on several nexus-related matters. For one, the magnitude of market revenue thresholds still needs to be determined. Secondly, a common view still needs to be developed on whether said market revenue thresholds should be different for ADS vs. CFB, and on whether they should vary by jurisdiction (e.g., linked to the jurisdictions' GDP, for instance). Should the Inclusive Framework conclude that "plus factors" are indeed needed for CFB to have nexus, the nature of the plus factor(s) remains uncertain. Although a "physical presence" in the form of a subsidiary/PE appears to be the simplest way to establish nexus, important definitional issues still remain. In particular, the OECD may have to develop a "PE definition" specific for the purpose of establishing a new nexus for Amount A, which would not replace the PE definition in existing tax treaties or domestic legislation.
CHAPTER 4 - REVENUE SOURCING RULES
Revenue Sourcing Rules: Overview
Following the nexus rules, the revenue sourcing rules are aimed to determine the revenue that should be treated as derived from a particular market or jurisdiction. They reflect particularities of ADS and CFB. A sourcing principle is identified for each type of in-scope revenue, accompanied by a list of the acceptable indicators an MNE would use to apply the principle and locate the jurisdiction of source. The rules are presented in a hierarchical order.
The hierarchal, but flexible approach, is aimed to ensure that MNEs are able to apply the best revenue sourcing rules for their business model, but at the same time comply with the proposed framework with relatively low compliance costs. This approach is aimed to acknowledge different ways of collecting information by the MNEs but still provides a reasonable level of transparency for the tax authorities. This notion is emphasized throughout the chapter by underlining the need for keeping appropriate exhaustive documentation.
Revenue Sourcing Rules: Automated Digital Services ("ADS")
The rules of recognition are arranged in a certain hierarchy. The principle is that in the first instance an MNE should rely on factors independent of the user's subjective input, such as geolocation and IP address and, only if these are not available, should it proceed with indicators based on user's manual input to the system. The proposed hierarchy puts emphasis on objectivity of these criteria but also remains flexible in terms of compliance in case certain information were not available.
The hierarchal rule is introduced as initially obtaining the objective geolocation or IP address data of users. However, this might often prove difficult, especially in countries where use of VPN is more common than in the others which effectively hides a user's geolocation - mostly for privacy reasons. As this will cause difficulties in locating users, a hierarchy of sourcing rules is introduced, which also allows the basing of recognition on certain more manual inputs. The problem that may arise is whether the MNEs will have the means to identify which part of their userbase use a VPN service and how to potentially adjust for this.
The manually inputted data, such as user profile information and billing address are in theory more straightforward to collate. The chapter allows MNEs to create user profiles for the purpose of organising and understanding the user data. There's always risk that some information, including billing and home address might be different to actual residency of the user. If an MNE has a base for concluding that, it may resort to other forms of indicating the revenue source.
The chapter also sets out a non-exhaustive indicative list of revenues that ADS would typically earn. The main relevant indicators per type of revenue along with their detailed descriptions are listed below in the order of their appearance in the chapter.
Revenue from online advertising services
Revenue from online advertising usually comes from fees paid by advertisers. In order to ensure credible revenue source, MNE will need to monitor the extent to which the advertisement has been shown to users as it's the most efficient way to measure its impact.
The ADS business of Online Advertising Services generates revenue including Revenue from Online Advertising services. The chapter provides distinction between (a) online advertising services based on the real-time location of the viewer and (b) other.
The prevailing sourcing rule for the above would be based on the real-time location of the viewer of the advertisement determined by the geolocation of the device, jurisdiction of the IP address or, if the above are not available, other information. However, the sourcing rule for the latter is the jurisdiction of the ordinary residence of the viewer which could be indicated by examining their profile information, i.e. geolocation data or IP address, billing address, mobile country code or information inputted by the viewer into the system. So in the case of the revenue arising from other sources than advertisement, one could also be looking at what was manually input by the viewer into the system. The preference for the method should also be connected to what system the MNE uses for targeting its users in terms of advertising. It is advised that the MNE should apply the sourcing rule that reflects the type of information that is most important for the type of advertising in question.
Revenue from the sale or other alienation of user data
Many MNEs can be in the business of acquiring and monetising users data. It is commonly used in the advertising business. The data value is derived from the information that is contained with the dataset in question. If the dataset is more leaning towards user's personal profile, the right sourcing rule might be to link it to the residence location. However, if the real-time location is the key data point that is of interest of the advertisers, geolocation might be a more appropriate measure.
In terms of sale of the user data, the sourcing rule would be the jurisdiction of the real-time location of the user that is subject of the data being transmitted, as it was collected. The indicators are the jurisdiction of the geolocation, the IP address or other available information. Similarly as in case of revenue from advertising, revenue from alienation of user data other than based on real-time location can be indicated based on information input by the user manually.
Revenue from online search engines and social media platforms
Online search engines are free of charge, but the advertising space used on them can be monetised. For this type of revenue, the sourcing revenue for online advertising applies. Similarly to the previous categories, the jurisdiction of the ordinary residence of the seller based on user profile information, geolocation, IP address or other manually input information available such as billing address or mobile country code.
Intermediation of tangible and intangible goods and services
The sourcing rule for the purchaser and the seller of tangible goods and services is based on jurisdiction of the location of the purchaser at the time of purchase. The main difference is that in terms of intangible goods, the revenue recognition indicator is based on the factors mentioned in the previous paragraphs such as geolocation, IP address etc., whereas in terms of tangible goods the main indicator are still more "traditional" factors such as physical delivery and billing address of the purchaser and seller.
For the revenue derived from commissions or fees, the sourcing rule is a 50:50 split. It reflects the notion that both the purchaser and the seller contribute to the revenue generation and the jurisdictions where both access the platform should be rewarded accordingly.
Revenue from digital content services
Access to digital content means being able to access online films, music, and software through streaming and downloading. The revenue is generated by charging a service fee as well as selling the gathered information to advertisers.
The sourcing rule for the digital content is the ordinary residence of the purchaser based on geolocation or IP address. If these are not available, similarly to above, a billing address or mobile number becomes an indication. Similar rules apply to online teaching and gaming services as well as cloud computing services.
Revenue Sourcing Rules: Consumer-Facing Businesses ("CFB")
CFB have a more traditional business model, so revenue sourcing rules and the corresponding indicators are more straightforward and easier to observe, compared to ADS. The main relevant indicators per type of revenue along with their detailed descriptions are listed below in the order of their appearance in the chapter.
Revenue from consumer-facing goods sold directly to customers
In general, for goods sold directly to customers by a CFB the main revenue sourcing rule is the place of final delivery to the customer.
The revenue sourcing indicators are the location of the storefront (when the MNE sells through its own retail store) or the customer's shipping address (when the MNE sells through an online shop and thus has the product delivered directly to the customer). Given the direct relationship of the seller with the customer, the sourcing indicator can be identified with relative ease and no hierarchy of indicators is needed.
Revenue from consumer-facing goods sold through independent distributor
In case an MNE sells and delivers tangible goods through an unrelated intermediary (e.g., an independent distributor), the sourcing rule is the place of final delivery of the good to the consumer.
There is a hierarchy of revenue sourcing indicators, which looks first at the information reported by the independent distributor. Such information might be made available to the MNE directly - should that not be the case, the MNE is expected to seek a change in the contractual relationship with the distributor, to have the latter report the information (in aggregate and having due regard to privacy concerns) to the MNE.
Only in case the MNE can demonstrate that it has taken reasonable steps to change the contract to obtain the information directly from the independent distributor, but has been unsuccessful in doing so, would the MNE be able to use information that is already available, such as market research for the purpose of management reporting.
Revenue from consumer-facing services
The relevant sourcing rule for consumer-facing services is the place of enjoyment or use of the service. For example, in the case of tourism, the revenue sourcing rule would identify the location being visited as the place where the new taxing right would arise.
The indicator for the place where the service is enjoyed or used is the address where the service is performed. In case of the service being rendered online, the revenue sourcing rule is the ordinary residence of the consumer. The indicators are the same as for digital content services.
Revenue from franchising and licensing
The supply of products/services further to a franchising/licensing arrangement will typically take place where the customers of the licensee / franchisee are located, which may be separate from where the licensor / franchisor is located. The licence / franchise payments will be made to the licensor / franchisor and represents a return from the market jurisdiction.
The relevant sourcing rule for a franchising business related to goods is similar to the ordinary sourcing rule for consumer facing goods, which is the place of delivery of the good. The relevant sourcing rule for: (i) a franchising business related to services, or (ii) an intellectual property licensing arrangement is similar to the ordinary sourcing rule of consumer-facing services, which is the place of performance of the service.
There is a hierarchy of revenue sourcing indicators, which looks first at the information reported by the franchisee / licensee. Such information might be made available to the MNE directly - should that not be the case, the MNE is expected to seek a change in the contractual relationship with the franchisee/licensee, to have the latter report the information (in aggregate and having due regard to privacy concerns) to the MNE.
Only in case the MNE can demonstrate that it has taken reasonable steps to change the contract to obtain the information directly from the franchisee/licensee but has been unsuccessful in doing so, would the MNE be able to use information that is already available, such as information collected for internal management reporting, market research, or quality control purposes. This information could also include information on the location where the franchisee / licensee is performing its operations, under the franchising / licensing agreement.
Revenue Sourcing Rules: Documentation
MNEs should document the processes described above, as well as the outcomes thereof. In particular, the following documentation should be retained:
- The functioning of its internal control framework related to revenue sourcing;
- Aggregate and periodic information on results of applying the indicators, for each type of revenue and in each jurisdiction;
- The specific indicator used for a given category of revenue; and
- The circumstances when an indicator lower in the hierarchy was used, including why the indicator higher in the hierarchy was not available (and the steps taken to obtain it) or not reliable (and the information available to confirm the presence of a more reliable indicator).
The MNE need not keep a record of all individual user’s geolocation information, IP addresses, and other information, provided that they have a robust internal control framework on which the tax authorities can rely. As such, MNE should document these internal controls, as well as keep a record of underlying indicators. The system should be able to extract the aggregate information about a location - at a jurisdictional level – included in the several sources of information.
The MNE is not obliged to keep the underlying data stored. It should however keep the extracted reports in its administration for the period consistent with the requirements of domestic law of the respective jurisdictions. It must be available to the tax administrations upon request. There must be a sufficient sample of the underlying data available to tax administrations in order to be able to justify that the internal control framework is operating in a robust manner.
Revenue Sourcing Rules: Next Steps
The guidance illustrated above will be further refined, along the following lines:
- the proposed order of the indicators within each hierarchy will be further reviewed, including whether more specific indicators are required for specific businesses. In particular, specific open issues include sourcing the commission / fees from online intermediation platforms in respect of tangible services and the revenue sourcing rules for cloud computing;
- providing further guidance on the extent of the steps that should be expected of an MNE to amend the contract with an intermediary (e.g., independent distributor) to obtain information on the final destination of goods, and whether such steps would create excessive undue burdens or any commercial competitive issues for either the MNE whose goods are being sold or the intermediary;
- providing further objective guidance on when an MNE can consider an indicator to be "unreliable" (e.g., use of VPNs, situations in which a delivery address should be regarded as "unreliable") and if/when safe harbours may be used;
- providing further guidance on the documentation requirements of internal control frameworks, whilst paying due attention to ensure privacy of users. In addition, consideration will be given to the action that a tax administration should take in the event of an MNE lacking the requisite internal control framework and documentation;
- further refinements which will become necessary as the work on in-scope activity progresses.
CHAPTER 5 - TAX BASE DETERMINATIONS
Tax Base Determinations: Overview
The Amount A tax base is determined on the basis of the group's, not separate entity, profits. The report explains that it will be necessary to start with a group's consolidated financial accounts. This approach raises three categories of issues for computing the Amount A tax base:
- The need to define a standardised measure of profit as a basis for Amount A. The report recognises that this includes deciding the extent to which adjustments are required to address divergences in existing accounting standards.
- The need to address the rationale for, and technical feasibility of, computing Amount A using segmented accounts, on either a business line or geographical basis.
- The design of loss carry-forward rules is required to ensure that losses are taken into account in the computation of Amount A.
A key objective of the Blueprint rules and guidance is to minimise, where possible, the additional compliance costs for taxpayers and administrative burdens for tax authorities. Despite this, it is clear from the report that this aim is to be weighed against the underlying policy objectives behind Pillar One. Moreover, agreement has yet to be reached on a number of critical design points.
Tax Base Determinations: Further Detail
As noted at the outset, whilst there appears to be considerable common ground on many aspects of the three key building blocks identified by the report (being PBT based on consolidated accounts, segmentation and losses), it is evident that there are a number of important and unresolved policy decisions throughout. A number of these open items have been included as questions in the public consultation document issued by the OECD.
Tax Base Determinations: PBT based on Consolidated Accounts
The Amount A tax base will be quantified using an adjusted PBT measure derived from the consolidated IFRS (or similar) financial accounts of in-scope MNE groups. Other GAAP will be allowed, provided that it does not result in material distortions in the calculation of Amount A. The report notes that, based on some initial research, GAAP viewed as eligible already covers roughly 90% of MNE groups with consolidated revenues above EUR 750 million and profitability above 10% for 2016.
Consistent with Pillar Two, no adjustments for variances between different GAAP were considered necessary at this stage. The report recognises that this would entail significant additional complexity, but notes that on-going monitoring for discrepancies that produce materially inconsistent outcomes will be necessary.
Some book-to-tax adjustments will apply to determine the PBT, which should broadly align the tax base for Amount A with the corporation income tax base.
These adjustments will provide for the exclusion of:
- income tax expenses;
- dividend income;
- gains or losses in connection with shares; and
- expenses not deductible for corporate income tax purposes for public policy reasons.
These adjustments are largely consistent with the approach under Pillar Two.
Tax Base Determinations: Segmentation Framework
Segmentation is a key area where the need for accuracy and a level playing field between taxpayers is to be balanced against the additional compliance burdens for taxpayers and tax administrations.
For some groups it may be necessary to compute the Amount A tax base on a segmented basis, although the report acknowledges that this will create compliance costs for taxpayers and burdens for tax authorities. The segmentation framework for Amount A aims to balance additional accuracy with the complexity and costs of segmentation.
While taxpayers could break down revenue between ADS, CFB and out-of-scope, it may not be possible for them to compute the net profits attributable to these activities. As Pillar One uses net basis taxation, it is necessary to only reallocate profits attributable to in-scope activities. The report acknowledges that the simplest method to achieve this is to use the consolidated profit margin as a proxy for the in-scope profit margin and apply it to in-scope revenues. From this proxy, Amount A would be calculated and allocated among market jurisdictions using the allocation formula. The segmentation framework adopts this calculation ("group basis") as the default rule, while providing that in some circumstances the Amount A tax base will be computed on a segmented basis.
The segmentation framework will be based on the following three-step process:
- MNEs in scope of Amount A would break down their revenue between ADS, CFB and out-of-scope activities.
- To limit the number of MNEs required to segment their Amount A tax base, MNEs with global revenue less than an as yet undefined amount would benefit from a "segmentation exemption", which would require them to compute the Amount A tax base on a group basis. The report notes that, alternatively, this exemption could be designed as a safe harbour (which, the report notes, for example, would be to the benefit of a taxpayer that operates a high profit margin out-of-scope business alongside a low profit margin in-scope business).
- MNEs not eligible for the exemption (or that do not elect for the safe harbour, if designed as such), would then test whether they are required to segment their Amount A tax base and on what basis using three sub-steps:
- MNEs will apply the as yet undefined "segmentation hallmarks" to determine whether they are required to segment their tax base. If they are not required to segment, they will compute their Amount A tax base on a group basis.
- For MNEs that do display these segmentation hallmarks, the disclosed segments in the MNE group financial statements will be tested to ascertain whether they meet the agreed hallmarks. If so, Amount A tax base will be computed on the basis of these segments. There will be an exemption for groups whose disclosed segments have similar profit margins to compute the Amount A tax base on a group basis.
- MNEs that are not eligible to use their disclosed segments will be required to compute the Amount A tax base on the basis of alternative segments. The report states that this is expected to be relevant for only a small number of MNEs.
Tax Base Determinations: Loss Carry Forward Rules
Loss-carry forward rules will apply through an earn-out, so that losses generated over a given tax period under Amount A, unlike profits, will not be allocated to market jurisdictions. Instead, they will be pooled in a single account for the relevant segment and carried forward to subsequent years, with the result that no profit under Amount A would arise for that segment (and be reallocated to markets) until historical losses reported in that account have been fully absorbed. This regime will be separate to any existing domestic loss carry-forward rules, and will include specific rules to deal with business reorganisations and anti-avoidance situations.
Some specific design aspects of the loss-carry forward rules will need to be refined. Two critical open issues identified by the report include:
- including a transitional regime for losses incurred prior to the introduction of Amount A (i.e. pre-regime losses); and
- whether the Amount A regime should apply exclusively to economic losses or also take into account situations where the profit of a group/segment is below the relevant profitability threshold (i.e. profit shortfalls).
The report notes both sides of the argument on these important unresolved policy choices, suggesting that reaching an agreement may not be straightforward. Both of these open issues are likely to be of increased importance for those MNE groups whose businesses have been adversely impacted by the ongoing disruption caused by COVID-19.
CHAPTER 6 - PROFIT ALLOCATION
Profit Allocation: Overview
Chapter 6 of the Pillar One Blueprint details the approach to be applied to determine the applicable portion of so-called residual profits to be allocated to the eligible market jurisdictions, referred to as Amount A. Amount A will be determined based on a three step formula which diverges from the determination of the allocation of profits within a multinational enterprise group under the arm's length principle.
It has been recognized that the interaction between Amount A and the current profits which are taxed in the local jurisdiction, could lead to double counting or double taxation. A marketing and distribution profits safe harbour has been proposed as a potential solution to the double counting issue which may arise. The said safe harbour rule would work as a "cap" and would be calculated as (a) allocable Amount A as computed by the formula plus (b) the fixed return for the routine marketing and distribution activities.
A number of important practical and technical topics have been identified where further work will be required. These include: interaction with existing taxing rights, defining the fixed return for routine marketing and distribution activities, carving out relevant profits covered by the safe harbour, designing a mechanism for transfer pricing adjustments, dealing with double counting issues and assessing the treatment of withholding taxes.
The ultimate success of Pillar One in respect to Amount A will largely rest on the ability of the Inclusive Framework countries to reach consensus on a standardized and easy to administer approach to both define and implement the Amount A formula, one which will provide tax certainty, which will not place unnecessary burdens on taxpayers, while limiting the amount of additional cases of double counting or double taxation.
Profit Allocation: Three Step Approach
Chapter 6 of the Pillar One Blueprint report details the approach to be applied to determine the applicable portion of so-called residual profits to be allocated to the eligible market jurisdictions, referred to as Amount A. 
Amount A will be determined based on a formula which diverges from the determination of the allocation of profits within a multinational enterprise group under the arm's length principle. Under the new Pillar One guidance, Amount A would be determined based on a three step approach.
Step 1 would define a profitability threshold above which the actual profits of the multinational enterprise would be considered to represent so-called residual profits. In this way, it is the intent to limit or mitigate the interaction between Amount A and the conventional application of the arm's length principle under the current transfer pricing rules. A pre-defined ratio of profit before tax over revenues would be used as a threshold measure.
Step 2 would define a percentage of the "residual profit" as the allocable tax base which is subject to reallocation to the market jurisdictions. This ensures that other value drivers such as trade intangibles, capital or risk are carved out from the scope of Amount A profits. It is proposed to apply a pre-defined fixed percentage to calculate this allocable tax base.
As a final step, the allocable tax base would be allocated to the eligible market jurisdictions, taking into account scope, nexus and revenue sourcing.
Two potential approaches have been considered to determine the quantum of Amount A to be allocated. The first approach would be based on an absolute profit amount, while the alternative approach would be based on a profit margin. In principle, both approaches should be applied in the same way, following the aforementioned three step approach, and would be expected to lead to the same overall result. The choice of the most appropriate approach will need to be further analyzed based on the practical considerations and potential implications, such as foreign exchange variations.
Profit Allocation: The Formula to Determine Amount A
The profitability threshold to be established in Step 1, would serve as a proxy to determine the residual profits a multinational group realizes from its participation in the economy of the local market jurisdiction. While variable profit thresholds could be considered, a fixed profit threshold has been put forward in order to eliminate complexity. The threshold should not alter the allocation of profits under the current transfer pricing rules. Based on an initial estimate by the OECD, the number of companies that would be covered, assuming a EUR 750 revenue threshold, would be in the range of 150 to 990, depending on the profitability threshold percentage applied, ranging from 8% to 25%.
In its initial impact assessment, the OECD presents scenarios of 10%, 20% and 30% of the residual profits being subject to the reallocation percentage under Step 2. Under the assumption that a 10% fixed profitability threshold is used in Step 1 and a 20% reallocation is used in Step 2, the OECD estimates a total of USD 98 billion of global residual profits being reallocated to market jurisdictions, relying on 2016 data.
The application of the allocation key will need to consider the appropriate definition of revenues, e.g., whether the current approach of relying on accounting treatments as included in the financial statements, is appropriate for purposes of determining Amount A. The application of Step 3 will also be impacted by the choice of approach, either a profit based or a profit margin based one.
Profit Allocation: Potential Differentiation Mechanisms
The work undertaken has also considered whether the formula for Amount A should be implemented in a consistent way, or whether potential differentiation mechanisms should be introduced. Two broad categories have been analyzed to assess whether the quantify of profit should be increased. The first deals with the potential differentiation arising from the level of digitalization amongst the in-scope activities. The second addresses the divergence which may exist in the actual profit levels amongst the eligible market jurisdictions.
Amongst the discussions by the Inclusive Framework members, three distinct viewpoints have emerged relating to the potential differentiation arising from the level of digitalization. One group of members has argued that there should not be any differentiation when determining Amount A. A second group has advocated for a differentiation through adjustments in Amount A, either through a lower profitability threshold (Step 1) or a higher reallocation percentage (Step 2). A third point of view is that the Amount A should be differentiated through a profit escalator, based upon the argument that higher overall returns are in-part due to higher contributions from the markets.
Incorporating jurisdictional or regional differentiation has been considered as a second potential category. However, a number of potential technical issues arise which could make it difficult to appropriately and accurately capture the amount of profits to be attributed to the more profitable markets. Furthermore, a "domestic business exemption" which would carve out profits which are derived by the multinational enterprise exclusively or predominantly from a single jurisdiction, is amongst the options being considered. It is however acknowledged that in practice it may be difficult to identify domestic-only businesses and also to accurately determine the corresponding profits, taking into account any centralized costs to be allocated, of such a business.
Profit Allocation: The Issue of Double Counting
It has been recognized that the interaction between Amount A and the current profits which are taxed in the local jurisdiction, could lead to double counting or double taxation of the same profits. Chapter 7 addresses the mechanisms to eliminate any such double taxation which may arise. In the case that a local market entity is already entitled to residual profits, such as may be the case with full-fledged distributors, this entity may itself be treated as a "paying entity" for Amount A purposes, and so would bear a part of the overall Amount A tax liability, under the so-called "netting-off" effect.
A profits safe harbour mechanism specifically for marketing and distribution activities has also been proposed as a potential solution to the profit double counting issue which may arise in relation to such activities. The said safe harbour rule would work as a "cap" and the safe harbour would be calculated as (a) allocable Amount A as computed by the formula, plus (b) the fixed return for the routine marketing and distribution activities. Three scenarios could emerge. First, if the existing marketing and distribution profit is less than the prescribed fixed margin, the safe harbour would not apply and full Amount A profit could be allocated. Second, if the existing marketing and distribution profit is higher than the fixed margin but lower than the safe harbour, the Amount A to be allocated would be reduced by the difference between the fixed return and the existing profit. Lastly, if the existing return is higher than the safe harbour return, no Amount A would be allocated to the local jurisdiction. Such safe harbour return could be determined by region or industry, while there are arguments that in certain industries (e.g., pharmaceuticals) a higher safe harbour return could also be applied.
Profit Allocation: Next Steps
A number of important topics have been identified where further work will be required. These include: interaction with existing taxing rights, defining the fixed return for routine marketing and distribution activities, carving out relevant profits covered by the safe harbour, designing a mechanism for transfer pricing adjustments, dealing with double counting issues and assessing the treatment of withholding taxes.
CHAPTER 7 - ELIMINATION OF DOUBLE TAXATION
Elimination of Double Taxation: Overview
Amount A will apply as an overlay to existing profit allocation rules. Consequently, a mechanism to reconcile the new taxing right with those existing rules is necessary to prevent double taxation. The report describes such a mechanism, which is based on two components:
Component 1. Deals with identification of those entities that should bear the Amount A tax liability within an MNE group. The approach described consists of four sequential steps: (1) an Activities test based on the functions performed, assets utilized, and risks assumed by the entities; (2) a Profitability test based on financial accounts, to identify those entities earning the residual profits for the purpose of Amount A; (3) a Market connection priority test to allocate the Amount A tax liability in order of priority among those entities that have a connection with the markets where Amount A is due; and, (4) Pro-rata allocation of remaining Amount A among paying entities.
Component 2. Deals with the methods to eliminate double taxation. The report contemplates that tax on Amount A may be relieved by paying entities via either the credit method, where the resident jurisdiction retains secondary taxation rights, or the exemption method, where they do not, to remedy the fact of double taxation.
Elimination of Double Taxation: Elimination of Double Counting
The mechanism described by the report to prevent double taxation arising from overlaying Amount A to the existing profit allocation rules, is based on two components.
Elimination of Double Taxation: Component One
Once the Amount A is calculated, it is necessary to identify those entities that should bear the Amount A tax liability, and determine how that liability must be broken down among them. The Component 1 outlines this process, which takes the form of four sequential steps. Steps 1 and 2 would lead to identification of the Paying entities. Steps 3 and 4 will then determine how the Amount A reallocation burden is allocated among them.
Step 1. Conduct an Activities test to identify the entities within an MNE group that make material contributions to the residual profits, as these entities would be entitled to, and should be earning that residual profit corresponding to Amount A, in line with the recommendations set forth by the OECD Transfer Pricing Guidelines. The Activities test would describe the activities performed by the entity and focus on (i) its functions developed, assets utilized, and risks assumed, (ii) an entity’s characterization, and (iii) the transfer pricing methods to determine its arm’s length remuneration. This should be based on the documentation already required to prepare for compliance purposes to limit the compliance and administrative burden, such as Master File, relevant Local Files and CbCR. These existing documents along with any additional relevant ones would constitute the single standardized documentation package for the Amount A tax certainty process.
Step 2. Perform a Profitability test on those to ensure they have the capacity to bear Amount A tax liability. The Profitability test, like the Amount A formula, will be applied to financial accounts (as opposed to tax accounts) following IFRS or comparable accounting standards, and has the objective of ensuring that entities making routine, low profits or losses are not identified as paying entities. The Inclusive Framework is considering a profitability test aligned with the substance carve-out that is being developed under Pillar Two, which is based on expenditures for payroll and tangible assets. Thus the test would identify entities earning income in excess of such fixed return for payroll and tangible assets. Where a potential paying entity derives profit from more than one segment, it will be necessary to segment the entity-level accounts and conduct separate profitability tests on them.
Step 3. Conduct a Market connection priority test to allocate the Amount A tax liability in order of priority among those entities that have a connection with the markets where Amount A is due. The Market connection priority test would be introduced to require that, in the first instance, the Amount A tax liability for a market jurisdiction is allocated to a Paying entity that is connected to that market jurisdiction through the performance of activities identified under the Activities test. The activities performed by an entity may be related to its engagement in a market jurisdiction, even where there is no direct transactional connection between such entity and market jurisdiction. In most cases, the legal entity structure and legal agreements will provide a sufficient basis for this test. For instance, this is likely to be the case in respect of structures with centralized ownership of intangibles. How to allocate Amount A among those paying entities with a connection to the market jurisdiction is still undefined, and may follow either a more hierarchical approach taking into account the “strength” of the connection, or a more formulaic one.
Step 4. Pro-rata allocation of the remaining Amount A, where insufficient connection exists among those able to bear the liability. Where the entity (or entities) identified under the market connection priority test do not have the sufficient profits to bear the full Amount A tax liability for a given market jurisdiction, a formulaic pro-rata allocation of the remaining portion of the Amount A tax liability among other paying entities would ensue. However, a paying entity will be deemed to have no profits to bear a further Amount A tax liability once the taxing rights of the residence jurisdiction have been reduced to a routine return, as defined under the profitability test.
The report also mentions the issues presented by the application of transfer pricing adjustments and existence of entity-level carry forward losses. On the former, it is stated that retrospective changes on the application of Amount A pursuant to transfer pricing adjustments would be challenging, but instead prospective adjustments may be adopted to compensate. On the latter, the report suggests the modification of steps 3 and 4, to deem an entity to have insufficient profits to bear an Amount A tax liability when it has domestic carried-forward losses, so as to avoid the risk that an entity bears such liability when it does not pay tax in the jurisdiction where it is resident. However, it is also highlighted the fact that such a measure would potentially give rise to opportunities to exploit differences across jurisdictions of loss carry-forward rules.
Elimination of Double Taxation: Component Two
Having identified the paying entities, it is then necessary to ensure that they are not taxed twice on the profits reflected in Amount A, first under the existing rules in their jurisdiction of residence and then again in the market jurisdiction under Amount A. The OECD proposes allowing each jurisdiction to choose between employing the credit method or the exemption method for preventing double taxation.
Credit method. Here the residence jurisdiction, also referred to as the relieving jurisdiction, retains secondary taxing rights over a paying entity's profits, as long as they have been taxed at a lower rate in the market jurisdiction. The tax already paid in respect of Amount A in the market jurisdiction remains available to the paying entity as a tax credit in the relieving jurisdiction. This will be capped at either the amount of tax actually applied in respect of Amount A in the market jurisdiction, or the tax that would have been paid on Amount A in the relieving jurisdiction; whichever is lower.
The credit limit can be determined on a jurisdiction by jurisdiction basis, which compares the tax that would have been paid in the relieving jurisdiction to the tax paid in each market jurisdiction separately; or by using the blended approach, which compares the tax that would have been paid in the relieving jurisdiction to the tax applied to the total Amount A liability allocated to each paying entity. The blended method generally provides a higher level of relief, and where the tax that would have been paid in the relieving jurisdiction is lower than the weighted average tax rate that it is compared against, the net effect is likely to be similar to that of the exemption method.
Exemption method. With this method, the paying entity's residence jurisdiction has no secondary taxing rights. Rather the paying entity is exempt from paying tax on the profits already allocated to the market jurisdiction under Amount A.
Some key considerations for relieving jurisdictions deciding between the two methods are set out below:
- Secondary taxing rights. The OECD predicts that the value of this will be limited except in residence jurisdictions with relatively high tax rates, as the average rate applied to Amount A is expected to be relatively high in itself.
- Taxpayer benefits. The OECD has considered whether using the exemption method could benefit taxpayers where profits allocated to market jurisdictions are taxed at a lower rate than in their country of residence. However, initial global economic analysis apparently shows that there is a low risk of this situation occurring.
The main issues to address in allowing jurisdictions of residence to choose between methods are as follows:
- Different methods applied to different paying entities identified in one MNE group. There may be complexities associated with different resident jurisdictions applying different methods to entities within the same group. However, the OECD has acknowledged that MNE groups often already operate different credit and exemption methods in their tax returns, and no one paying entity will have to operate more than one method as resident jurisdictions will only be allowed to choose one.
- Danger of manipulation. MNE groups could potentially make decisions based on which entities reside in jurisdictions that have chosen what the group considers to be the most favourable method. The OECD has highlighted that the tax certainty process should go towards addressing this problem.
There are a number of important further technical issues in relation to these methods that also require work, including the interaction of these rules with Pillar 2 rules, existing domestic rules, the tax certainty process, and withholding taxes that already may be taxing part of residual profits.
Elimination of Double Taxation: Marketing and Distribution Profits Safe Harbour
There is some flexibility under the existing ALP profit allocation rules for MNE groups to adjust their transfer pricing systems to increase the profits allocated to a market jurisdiction, thereby reducing or even eliminating their Amount A tax liability. In this way, there would be no danger of double taxation arising. However, the profits could not be increased beyond the relevant arm's length amount and there will be some market jurisdictions where the safe harbour return is not met, in which case the group will have to rely on the above methods for those paying entities.
CHAPTER 8 - AMOUNT B
Amount B: Overview
Amount B is a "fixed return" for "baseline marketing and distribution activities", performed by distribution entities or permanent establishments, part of an MNE group (hereafter: "the distribution entity"). Amount B is intended to simplify the administration of transfer pricing rules and to increase tax certainty and reduce tax controversy for taxpayers and tax administrations.
The "baseline marketing and distribution activities" in scope of Amount B will be defined by a "positive list" and a "negative list", which still require further technical work by the members of Inclusive Framework. The applicable fixed fee remuneration for the "baseline marketing and distribution activities" for the distribution entity, together with a potentially differentiated fixed return to account for variations between geographic locations or industries, also still requires further analysis. It is, however, anticipated that Amount B will approximate results determined under the transactional net margin method, calculated on a net return of sales.
Under the narrow scope, Amount B will only apply to the intercompany transactions performed by a distribution entity as yet to be defined by a "positive list" and "negative list". Under the broad scope, entities and permanent establishments, part of an MNE group, that act as commissionaires or sales agents may also be in scope of Amount B.
It is proposed that Amount B will operate under a "rebuttal presumption." This entails that the distribution entity will need to apply Amount B, unless the taxpayer can provide sufficient evidence that another transfer pricing method is more appropriate.
It is important to note that it is not intended that Amount B will supersede any Advanced Pricing Agreement or any MAP settlement that has been agreed before the implementation of Amount B.
Amount B: Entities in Scope of Amount B
Entities in scope of Amount B include legal entities and permanent establishments with a foreign parent that perform "baseline marketing and distribution activities", under an already delineated transaction. A functional analysis of the intercompany transactions should be performed, in accordance with section D.1.2. of the 2017 OECD Transfer Pricing Guidelines, to determine whether the distribution entity qualifies as such. Pillar One will not supersede any functional analysis, but only intends to "define what controlled transactions and baseline marketing and distribution activities qualify" for Amount B remuneration.
Amount B: Controlled Transactions in Scope of Amount B Remuneration
It is proposed that the transactions which will be in scope of Amount B remuneration are activities related to:
- The acquisition of products from a foreign related party for resale to third parties and the associated 'defined baseline distribution activities' in the local market. It is important to note that the members of the Inclusive Framework propose that, in order for the transaction to qualify, the resale will be 'predominantly' (i.e. >50%) to customers resident in the same jurisdiction as the distribution entity; and
- The performance of the "defined baseline marketing and distribution activities" by the distribution entity, dealing with a foreign related party.
It is important to note that these are cumulative requirements. If the distribution entity acquires goods from a foreign related party for resale, but does not perform sufficient 'baseline marketing and distribution activities', the transaction will not be in scope for Amount B, but the existing arm's length principles should apply to the respective transaction.
Amount B: Proposed "Positive List"
As indicated, the "positive list" requires further technical work and no agreement has been reached yet. In order to avoid any disputes or uncertainty, the members of the Inclusive Framework have proposed a "positive list of activities" that could serve as indicators that a transaction performed is in scope of Amount B. This proposed list is currently exhaustive. The following activities, performed as an intercompany transaction, would serve as an indicator that the respective transaction is in scope of Amount B remuneration:
- The import of products for resale within the local market.
- The purchase of goods for resale within the local market.
- The provision of customer relationship management within the local market.
- The performance of price and contract terms negotiations, within the scope of the MNE pricing guidelines and policies.
- The provision of order management, customer contract management and inventory management services.
- The provision of logistics, warehousing and transportation services.
- The provision of general administration services, such as sales invoicing, AP/AR services and finance/tax reporting obligations.
- The provision of demand planning services, within the parameters set by the MNE group.
- The performance of local marketing activities, incl. providing pre- and after-sales services, within the parameters set by the MNE group.
Amount B: Proposed "Negative List"
As a counterpart to the "positive list", the "negative list" provides a list of activities that serve as indicators that the transaction performed is not in scope of Amount B. This list is also still under development and no agreement has been reached on it yet. The following activities, performed as an intercompany transaction, would serve as an indicator that the respective transaction is not in scope of Amount B remuneration:
- Activities relating to the development, enhancement, maintenance or protection of marketing intangibles (other than customer lists).
- The performance of strategic sales and marketing functions in the local market, outside the scope of the parameters set by the MNE group.
- The assumption of entrepreneurial risks and responsibilities in relation to the controlled transaction. The assumption of entrepreneurial risks and responsibilities outside the scope of the respective transaction is permissible.
- Activities relating to the resale of products to government entities or government contractors. Although there is currently no agreement amongst the members of the Inclusive Framework to include this fourth indicator, it is currently included in the Pillar One Blueprint.
Amount B: Assets and Risks
The assets which may be used by the distribution entity for its performance of the controlled transactions are leased or owned real estate to use as office and warehousing space or distribution center, limited ownership of inventory, customer lists, local registrations and licenses and rights to sell and use a product name or brand in the local market. The distribution entity, however, should not own valuable marketing intangibles (other than customer lists), as this would be an indicator that the distribution entity performs activities that are beyond the "baseline marketing and distribution activities."
Likewise, the risks borne by the distribution entity in relation to the controlled transaction should be limited and not economically significant for the MNE group as a whole.
Amount B: Multifunctional Entities
It is entirely possible for a distribution entity to also perform other functions or activities within the MNE group. A distribution entity may, for example, also perform R&D or manufacturing activities. It is important to note that Amount B may therefore also be applied in certain cases to distribution entities that are "multifunctional", through segmentation. Whether Amount B applies to "the baseline marketing and distribution activities" for such entities needs to be determined on a case-by-case basis, but is not ruled out.
Amount B: Implementation and Next Steps
In case the narrow scope of Amount B is implemented, Amount B needs to be effectuated in domestic law in all applicable jurisdictions. Any tax disputes arising in relation to Amount B between jurisdictions and taxpayers can be resolved through the current dispute resolutions provided for in the applicable tax treaty. However, a new treaty on dispute resolution may still be required to resolve tax disputes between jurisdictions that have no bilateral tax treaty in place. Further guidance to facilitate consistent implementation across the multiple jurisdictions will certainly be required.
In case the members of the Inclusive Framework opt to implement a broader scope for Amount B, all of the above would need to be implemented. It would also require an amendment to article 9 of the existing OECD Model Convention, and would thus also require amendments to existing bilateral tax treaties based on the OECD Model Convention. The implementation of the broader scope for Amount B is thus much more complicated.
Agreement still needs to be reached about issues such as the implementation of the exact scope of Amount B, the "positive list", the "negative list" and the appropriate fixed fee remuneration and differentiation for geographic and industry variations, and these topics still require further analysis before such agreement by the members of the Inclusive Framework.
CHAPTER 9 - TAX CERTAINTY
Tax Certainty: Overview
According to the members of the Inclusive Framework, securing tax certainty is an essential and important element of the Pillar One Blueprint. The members of the Inclusive Framework have tried to provide a blueprint for tax certainty in two different scenarios:
- Dispute prevention and resolution applicable to taxation of Amount A; and
- Dispute prevention and resolution for tax disputes beyond the application of Amount A rules.
The proposed framework should achieve tax certainty in a simple and coordinated way.
Tax Certainty: Dispute Prevention and Resolution for Amount A
Aim and scope of the dispute prevention and resolution for Amount A
The Blueprint proposes to introduce a binding dispute prevention process that should provide tax certainty at an early stage, in order to prevent disputes regarding all aspects of Amount A. The introduction of a representative panel and a determination panel (if necessary) should achieve this purpose. The scope of the tax certainty process covers potentially litigious topics, such as: (i) whether an MNE is within the scope of Amount A and (ii) the determination and allocation of Amount A, including the identification of "paying entities" and methods to relieve double taxation. The reason a new dispute resolution mechanism is introduced, is due to the fact that the members of the Inclusive Framework recognize that would be impractical and unlikely that all disputes concerning Amount A rules could be resolved by existing bilateral dispute resolution tools.
The procedure of the new framework of the tax certainty process
- Submission of a request to the lead tax administration: The proposed tax certainty process will be available to MNE Groups on an entirely voluntary basis. The first step in the process is the submission of a request by the MNE group's to its leading tax administration (i.e. the tax administration in the jurisdiction of the ultimate parent entity). The applicable deadline regarding the submission of the request is six months following the end of the applicable fiscal year. In order to proceed with the submission, the MNE group must submit an agreement, which has been signed by all entities undertaking applicable residual profit activities.
In this regard, it is envisaged to develop a self-assessment return and documentation package. This approach should have multiple benefits. Most importantly, the use of the self-assessment return and documentation package will reduce the administrative burden on MNEs and contribute to a consistent application of Amount A rules.
- Lead tax administration exchanges self-assessment return and documentation package: The lead tax administration will, subsequently, exchange the self-assessment return and documentation package with the affected tax administrations. The affected tax administrations are the tax administrations of the respective jurisdictions where the respective MNE maintain(ed) (i) an entity or (ii) a market that exceeds the applicable threshold amount. This exchange of information includes, generally, one of the following primary conclusions:
- The lead tax administration conducted a high-level initial review to filter low-risk MNE groups to examine whether the affected tax administrations are willing to provide early certainty without the review by panel, and recommend that review by the panel is not
- The lead tax administration conducted a high-level initial review and concluded that review by the panel is required; or
- The lead tax administration has not conducted an initial review and concluded that a review by panel is thus required.
- Review panel: The review panel will ideally consist of 6-7 representatives of relevant tax administrations which should accurately represent the geographical spread of the MNE group. The review panel will review the MNE group's self-assessment and may -if needed- also verify actual information or request additional information. It is expected that the duration of such a review will vary. However, the aim is that the majority of the tax certainty will be completed within a nine-month period.
- Determination panel: A distinction should be made between a review panel and a determination panel. In the cases where the review panel does not reach agreement, it is proposed that a determination panel is constituted. A determination panel is obliged to reach agreement. The review panel provides the determination panel with the specific questions and analysis and an overview of the contested items.
Different outcomes regarding the tax certainty process
- The MNE agrees with the panel: the outcome of the process is binding for the MNE and the jurisdictions of the affected tax administrations.
- The MNE does not accept the panel conclusion: the MNE can refer the matter to the applicable authority under the existing domestic dispute resolution mechanism within its respective jurisdiction(s).
- The MNE withdraws its request for the binding procedure: it is envisaged that the new approach should improve the existing dispute resolution framework. There are a number of consequences depending upon at what point an MNE withdraws, but generally it would be appropriate that neither tax administrations nor the MNE is bound by any conclusions, but those conclusions may set an expectation in the event of any later enquiries.
Tax Certainty: Dispute Prevention and Resolution Beyond Amount A
Aim and scope of the dispute prevention and resolution for Amount A
The members of the Inclusive Framework are not in agreement on the scope of dispute resolution in respect to dispute prevention and resolution beyond the application of Amount A rules. There are differences of opinion to what extent Pillar One should incorporate new dispute prevention and resolutions for tax disputes applicable beyond Amount A rules. Therefore, the Pillar One Blueprint proposes an approach divided into three phases.
Phase 1: Improve the existing dispute prevention framework
The members of the Inclusive Framework emphasize that preventing tax disputes from the beginning should be prioritized, by improving the currently existing dispute prevention mechanisms. Existing dispute prevention mechanisms which can be improved, are, for example, ICAP, joint audits, processes regarding bilateral as well as multilateral APAs and the use of standardised benchmark in common transfer pricing situations. Improving existing dispute prevention tools should be complementary to the newly proposed dispute resolution mechanism.
Phase 2: Improve the existing MAP framework
Besides the improvement of the existing dispute prevention framework, the effectiveness of the existing MAP should also be strengthened. According to the implementation of the Action 14 minimum standard, several elements are currently being explored in relation thereto. Such as, the introduction of the obligation to suspend tax collection if a MAP case is pending, or the obligation that all MAP agreements can be implemented notwithstanding the expiration of the domestic time limits of the relevant jurisdiction. The introduction of a mandatory and binding dispute resolution mechanism beyond Amount A rules would also contribute to a more effective MAP, as this could be an incentive for the competent authorities to achieve agreement.
Phase 3: Introduction of a binding dispute resolution mechanism
As indicated earlier, there are different views about whether Pillar One should introduce a new binding mechanism beyond Amount A, in addition to the improvements to the existing dispute resolution tools.
In this regard, the Blueprint proposes to develop a mechanism that is based on four different elements:
- In-scope taxpayers: If the MAP case remains unsolved, the Pillar One Blueprint proposes a new mandatory and binding resolution process for MNEs with a consolidated annual revenue above the Amount A threshold. This approach also includes out-of-scope activities to a limited extent. This new mechanism should become part of the existing MAP framework.
- Other taxpayers: In general, all other taxpayers would benefit from the improvements made in relation to the existing dispute resolution mechanisms, as proposed under Phase 1 & Phase 2. The next steps will be an exploration into additional benefits of a mandatory and binding dispute resolution and a mandatory non-binding dispute resolution process.
- Amount B: The Pillar One Blueprint emphasizes that, in order to give certainty on other aspects in addition to Amount B remuneration, issues such as whether Amount B should apply to given arrangements of an MNE should also be subject to a mandatory binding dispute resolution. Developing economies with no or low levels of MAP disputes: With respect to developing economies with small or non-existent MAP inventories and with regard to the limited capacity of their competent authorities, the Pillar One Blueprint proposes that such jurisdictions should commit to an elective binding dispute resolution mechanism.
CHAPTER 10 - IMPLEMENTATION & ADMINISTRATION
Implementation & Administration: Overview
Before Amount A can be effectively taxed in a respective jurisdiction, the jurisdiction would need to implement the rules ultimately agreed by the Inclusive Framework into its domestic law. The new taxing right would need to be adopted in domestic law, before the jurisdiction will have the authority to impose a tax on Amount A. The implementation and adoption of Amount A, thus, requires local implementation and adoption in each applicable jurisdiction.
Furthermore, the implementation and adoption of Amount A also requires extensive amendments to instruments of public international law. Domestic implementation is not sufficient, as existing bilateral tax treaties would generally prevent the imposition of a tax on Amount A. Many existing bilateral tax treaties bar a jurisdiction from taxing (a part of) the (overall) income of a non-resident taxpayer that has no permanent establishment in that particular jurisdiction. The existing tax treaties would thus have to be amended. It is needless to say that this is a great ask of the respective tax administrations globally.
The Inclusive Framework thus proposes to implement "a new multilateral convention", which would coexist with the existing tax treaty network, but would supersede the existing tax treaties on the points it covers. The adoption of such a "new multilateral convention" would avoid the need of amending existing tax treaties. The proposed tax on Amount A cannot be included in the existing MLI, as it is proposed that the new multilateral convention should also be applicable in situations where jurisdictions do not have a bilateral tax treaty in place. The proposed multilateral convention would thus exist within the existing tax treaty network, but an existing tax treaty would not be required for the multilateral convention to be applicable.
Implementation & Administration: Domestic Law Implementation
In general, the new taxing right will be imposed on "paying entities" that have sufficient nexus with the taxing jurisdiction and have in-scope revenue, and are part of an MNE group, whose annual global revenue exceeds the proposed income threshold. The identification of the "paying entities" should follow the rules as described in chapter 7 of the Pillar One Blueprint. Under these rules, it is not impossible to identify more than one "paying entity" in a single taxing jurisdiction. In the proposed simplified administration process, which is still under development, it would be possible for a single entity of an MNE group to compute and pay the Amount A tax liability on behalf of all paying entities of the MNE group, acting as an agent, to alleviate the administrative burden of both taxpayers and tax administrations. In order for this new taxing right to be effectuated, the taxing right would need to be implemented into domestic law. The members of the Inclusive Framework propose that the domestic legislation will, at its very least, do the following:
- Create domestic taxing rights consistent with the design and implementation of Amount A. The domestic legislation would need to include rules on the (i) identification of the taxpayer, (ii) the object of taxation, (iii) the tax base, (iv) the tax period, (v) the tax rates. While it is expected that the applicable (iv) tax period and (v) tax rates would follow already existing local tax legislation, new local legislation would most likely be required on the remaining rules before Amount A can be effectuated.
- Provide sufficient relief from double-taxation for the resident taxpayer.
- Incorporate procedures for the administration of the new taxing right and relief from double-taxation for the resident taxpayer.
- Provide an effective remedy against double-taxation, including dispute prevention and resolution mechanisms, even in the absence of tax treaties.
It is proposed that further guidance would need to be released to ensure a consistent and coherent implementation of the rules of Amount A in local legislation.
Implementation & Administration: A New Multilateral Convention
The new multilateral convention that is proposed would function within the existing tax treaty network and would be applicable to the taxation under Amount A rules. The new multilateral convention would not be applicable to cross-border transaction not in scope of Amount A rules, and existing dispute resolution rules would continue to apply to those transactions.
Like the MLI, the new multilateral convention would supersede existing tax treaties in case of conflict for the points covered in the agreement, so there would be no need to amend existing tax treaties. Unlike the MLI, however, the new multilateral convention would not seek to modify the wording of existing tax treaties, but would rather seek to complement it. It would also apply in cases where no tax treaty is applicable, as the multilateral convention will also apply when jurisdictions have not agreed a bilateral tax treaty.
More technical work needs to be performed by the members of the Inclusive Framework about the "architecture of the proposed multilateral convention" and its implementation before such a convention can be released.
 The report includes a placeholder for "EUR [X] billion".
 Annex A provides a detailed process map on the application of Amount A. Annex B presents an overview of the approaches for implementing the Amount A formula, while Amount C outlines a number of illustrative examples.