A new global tax regime

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(First of two parts)

Rapidly shaping up at the global tax arena is a new tax regime that challenges the very core of generally accepted international tax rules and principles. Agreed to by 136 member countries of the Organization of Economic Co-operation and Development (OECD) on Oct. 8 is a historic tax pact in what could be the most drastic global tax reform of the century.

At the center of this two-phased reform (Pillar 1 and 2) is fairness in the sharing of revenues between and among countries owing to the rapidly increasing digitalization of the world’s economy where territorial borders, physical presence in brick-and-mortar businesses, on which the current global tax rules are based, are becoming inapplicable. This is Pillar 1 of the Blueprint.

Pillar 2 of the Blueprint, on the other hand, works for the eradication of tax havens and the so called “race to the bottom” practice of tax cuts/lowered tax rates and offering attractive incentives in attracting businesses and investments, resulting in revenue imbalances and significant losses to governments. To accomplish this, a 15% global minimum corporate tax (effective tax rate) has been agreed to.

This article focuses on Pillar 1. The next article (part 2) will focus on Pillar 2.

Under Pillar 1, a new concept called “market jurisdictions” are given taxing rights over revenues of companies despite absence of physical presence in their jurisdictions. Market jurisdictions refer to the locations/countries where goods and services are consumed. This is prevalent in digital companies which could earn income without having to set foot in those countries. Netflix, for example, has subscribers worldwide, earns revenue therefrom without having to pay tax in those countries (under current tax rules) absence physical presence. Under Pillar 1, Netflix can now be made to pay a tax in these market jurisdictions.

Apart from digital companies, Pillar 1 would also potentially apply to “consumer facing” businesses. Consumer facing businesses are those that generate revenue from the sale of goods and services typically sold to consumers. One example is Amazon. The scope of “consumer facing” businesses will be further defined.

Not all businesses will be covered by Pillar 1. As intended, Pillar 1 shall cover only large and profitable businesses with revenues of Euro 20 billion (P1.2 trillion, more or less) and a profit margin of 10% or more. Those falling into this category shall be required to reallocate 25% of their revenue above 10% (profit before tax) to the market jurisdictions with at least Euro 1 million (P60 Million, more or less) generated in that country. Applying it here, digital companies earning P60 million from Philippine customers may be made to pay income tax even without a physical presence in the country.

In terms of implementation, Pillar 1 shall first be applied, then Pillar 2, which means that companies would need to pay the taxes due to the location where they generate revenue and if the taxes paid is below the agreed minimum corporate tax of 15%, these companies would be required to “top up” the taxes to the host jurisdiction to meet the global minimum level agreed upon. In our earlier example, Netflix would be required to pay tax in every jurisdiction it earns revenue despite the absence of a physical presence, and if the taxes paid, computed on a per country basis, does not meet the 15% minimum corporate tax, it shall be required to pay additional tax in those jurisdictions where tax payments do not meet the minimum level.

The OECD has set a deadline of Dec. 14, 2021 for comments on the proposals with the hope of reaching an agreement on the final parameters by mid-2022 and implementation in 2023. At this point in time, the proposals remain subject to change.

Analyzing the proposed design parameters of the new global tax regime, there are a number of implications which we should watch out for. As they say, the devil is in the details.

Many of the issues surrounding the two Pillars are not yet set out. Certainly, there will be significant implementation burden and changes on both businesses and governments. Revenue authorities would need to have financial information, on a worldwide scale, of the income and operations of these multinational enterprises to be able to calculate what is theirs. Similarly, companies will have to keep up with humungous requirements for data reporting, tracking, system change, and compliance, among others.

Those in the host developing countries, like ours, may only have access to information about a multinational’s local data and may not be able to reasonably ascertain its share in the whole pie. For Pillar 1, our revenue authorities would need to know the global financial data of the multinationals to be able to ascertain and claim a portion of the residual profits for their country. This would need not only compliance reporting by businesses, but more so, a tighter, more transparent, honest-to-goodness government-to-government coordination and sharing of information.

Many implementation questions are still left hanging. How are jurisdictional effective tax rates going to be determined considering the variations in the tax systems of countries? How would the tax base be calculated? How will companies pay taxes to a specific jurisdiction when it has no relevant tax identification number in that location? Will the companies be taxed on a presumptive income or estimated basis? Will gross taxation be allowed as a substitute? How will collection be enforced? These are some of the questions that are yet to be addressed.

These new concepts are complex, especially in their application. Hopefully, the OECD and the Inclusive Framework will release common rules and guidelines, standardized model or templates for tax treaty agreements and even domestic legislation to lessen complexity and promote uniformity.

Locally, there may be a need to change domestic rules, laws, and regulations to align with these drastic changes in tax rules and principles under this global reform. Internationally, there may be a need to produce a new tax treaty model or renegotiate treaty agreements to effect and carry-out these changes.

Global taxation on the digital economy is inevitable. Businesses and governments should begin considering the impact of these global tax changes on their revenues and operations and prepare for adoption. There remain areas that require further guidance to provide certainty to businesses.

(To be continued.)

This article reflects the personal opinion of the author and does not reflect the official stand of the Management Association of the Philippines or MAP.

Benedicta “Dick” Du-Baladad is chair of the MAP Tax Committee, and founding partner and CEO of Du-Baladad and Associates (BDB Law).