As multinational entities (MNEs) continue to expand their businesses internationally, Base Erosion and Profit Shifting (BEPS) persists as a major concern by taxing authorities. Given the differences in tax policy among countries, MNEs implement tax strategies that effectively lower their tax bases or shift profits to countries with more favorable tax policy.
To address this concern, the Organisation for Economic Co-operation and Development (OECD), together with the G20 countries, led the BEPS 1.0 initiatives and published a 15-point Action Plan. These BEPS Action Plans were initially published in July 2013 and final reports were published in October 2015. Throughout the years, over 135 jurisdictions have implemented the 15 Action Plans.
These Action Plans tackle tax avoidance and aim to improve the consistency of various international tax rules and promote a more transparent tax environment by providing guidance on transactions such as interest, hard-to-value intangibles, mandatory disclosures and country-by-country reporting, mutual agreement procedures, etc.
While there have been developments on the other Action Plans since their launch, in this article, I’d like to focus on Action Plan 1, which covers the challenges of the digital economy (more commonly known as BEPS 2.0), specifically Pillar 1, considering the recent updates on the House Bill (HB) concerning Digital Services Taxes (DST) and Amount B of Pillar 1.
BEPS 2.0On October 2021, the two-pillar solution of the OECD was agreed to by 137 countries and endorsed by the Finance Ministers and Leaders of the G20 countries. Since then, draft publications and public consultation documents have been made available as work progresses.
Pillar 1 focuses on the reallocation of residual profits of MNEs to the market jurisdictions where their customers are located, regardless of the presence of a permanent establishment of the MNE in such locations. It entails the determination of “Amount A” and “Amount B.”
Pillar 2 aims to implement a tax system wherein MNEs will be subject to a minimum effective tax rate of 15% on income generated in low tax jurisdictions. The scope of the Pillar 2 rules includes all multinational groups with global turnover above 750 million euros, except those which operate pension, investment funds, and international shipping services.
PILLAR 1: AMOUNT AGoing back to Pillar 1, the scope of Amount A includes MNEs with profitability above 10%, based on profit before tax with reference to financial accounting income, with adjustments (also referred to as residual profit), and global turnover above 20 billion euros. Generally excluded from the coverage of this rule are those which operate extractives and regulated financial services, provided that their non-extractives or non-regulated financial services income does not meet the revenue and profitability scope thresholds. On the other hand, for those covered by the rules of Amount A, 25% of the deemed residual profit will be allocated to market jurisdictions with sufficient nexus, using a revenue-based allocation key.
PILLAR 1: AMOUNT BOn the other hand, Amount B aims to simplify and streamline the application of the arm’s length principle to in-country baseline marketing and distribution activities, focusing on the needs of low-capacity countries. The qualifying transactions and scoping criteria of Amount B would apply to intra-group transactions where the tested party is a distributor under either buy-sell arrangements or sales agency and commissionaire arrangements, as determined primarily by the level and type of functions performed, assets owned, and risks assumed by the parties to the controlled transaction. The Inclusive Framework of the OECD is currently evaluating the set of scoping criteria for purposes of Amount B, but among the criteria are the documentation of the qualifying transactions in a written contract that would reflect the responsibilities, obligations and rights, and the assumption of risks of the distribution activities.
The recent public consultation document published by the OECD in December 2022 also provided that generally, the transactional net margin method (TNMM) shall be the pricing methodology for determining Amount B, except in cases where local market comparables are available, or if there is a most appropriate method than the TNMM. Work is still ongoing as regards the benchmarking criteria, net profit indicators, and comparability adjustments for purposes of determining Amount B. Nevertheless, the OECD acknowledges that it may be pragmatic to use local or homogenous market comparables if these provide a more reliable arm’s length price.
CHALLENGES FROM A PHILIPPINE PERSPECTIVECurrently, the groundwork and consultations on Pillar 2 are ahead of Pillar 1. Among the challenges in the implementation of Pillar 1 is the removal of DST with respect to all companies.
In the Philippines, the House of Representatives recently approved on third and final reading HB No. 4122, which imposes value-added tax (VAT) on digital transactions. The bill aims to clarify the imposition of VAT on digital advertising services (such as those on search engines and social media platforms), subscription-based services (including music and video streaming subscriptions), and services rendered using information communication technology (ICT)-enabled infrastructure, among others.
Moreover, from a Philippine perspective, there may be gaps that need to be addressed to apply the guidance on benchmarking search criteria, net profit indicators, among others, that will be used for purposes of determining Amount B. This is considering that the Philippine tax authorities under Revenue Audit Memorandum Order No. 1-2019 (otherwise known as Philippine TP Audit Guidelines) provided for certain rejection criteria for purposes of benchmarking and other guidance in conducting their TP audits.
While the implementation of these pillars will largely depend on the large MNEs, mostly from the G20 countries, Philippine affiliates who are part of these multinational groups need to disclose relevant information on their operations (including proper documentation of related party transactions) and profitability to aid in the adoption of the two-pillar approach. In the same vein, the cooperation of the Philippine tax authorities is essential for the success of the envisioned two-pillar solution.
The views or opinions expressed in this article are solely those of the author and do not necessarily represent those of Isla Lipana & Co. The content is for general information purposes only, and should not be used as a substitute for specific advice.
Maria Isabel Silpedes is an assistant manager at the Tax Services department of Isla Lipana & Co., the Philippine member firm of the PwC network.