The Organization for Economic Cooperation and Development (OECD) has strived, in the last decade, to develop a two-pillar approach to address base erosion and profit shifting (BEPS) by multinational corporations.
The Pillar One initiative is focused on addressing issues related to the allocation of profits among countries and proposes changes to the international tax rules to ensure that profits are taxed where economic activities take place and where value is created.
To achieve this objective, Pillar One plans to introduce several measures, such as (i) the development of a new framework for determining where multinational corporations have significant economic activities, and therefore where their profits should be taxed. This framework is based on the concept of “significant economic presence”; (ii) the introduction of new rules for determining the tax residence of a multinational corporation, which will ensure that companies are taxed in the countries where they have significant economic activities, and (iii) the development of new transfer pricing rules that take into account the location of intangibles, risks, and capital in determining where profits should be taxed.
The implementation of Pillar One is ongoing, albeit facing some hurdles. On 11 July 2022, the OECD Secretariat issued a revised timetable for implementing the Pillar 1 provisions, which establishes the new target for Pillar 1 is for it to take effect in 2024.
Given that negotiations between countries on this issue have now stalled, the start date may get pushed even beyond 2024.[1]
So where do Digital Services Taxes come into play?
The Digital Services Tax (DST) is a tax that has been introduced or is being considered by many jurisdictions, as a way to ensure that multinational digital companies, such as those in the technology sector, pay their fair share of taxes. The DST aims to address the issue of these companies not paying enough taxes in the countries where they make significant profits, by imposing a tax on their revenues rather than their profits.
The DST is typically applied to revenues generated from the provision of digital services, such as online advertising, the sale of user data, and the sale of digital goods and services. The rate of the tax can vary depending on the country and can range from around 2-3%.
In the specific case of Portugal, on November 19, 2020, Law 74/2020 was published, transposing Directive (EU) 2018/1808 of November 14, amending local legislation on the provision of audio-visual media services, and introduced a tax through which audio-visual on-demand service operators (such as Netflix and HBO) are subject to an annual levy corresponding to 1% of their ‘relevant income’ in Portugal.
Furthermore, Austria, France, Hungary, Italy, Poland, Spain, Turkey, and the United Kingdom have implemented a digital services tax, and other jurisdictions have expressed their intention to follow along.
However, the OECD/G20 Inclusive Framework issued a statement, which includes the reference that no newly enacted DSTs or other relevant similar measures are to be imposed from October 8, 2021, until the earlier of December 31, 2023, or the coming into force of the multilateral convention to give effect to Pillar One. However, this statement did not address the treatment of existing DSTs.
Following this statement, some countries have reached an agreement with the US in respect to the existing DSTs, pending the implementation of Pillar One[2], under which countries can keep their existing DSTs in force, until the implementation of Pillar One. However, corporations that are subject to DSTs may receive a tax credit against future tax liabilities.
This said, the conflict between DST and Pillar One centres on the question of how best to tax the digital economy.
As already mentioned, Pillar One is focused on addressing issues related to the allocation of profits among countries and proposes changes to the international tax rules to ensure that profits are taxed where economic activities take place and where value is created. It aims to prevent multinational corporations from artificially shifting profits to low-tax jurisdictions and to ensure that they pay a minimum amount of tax in the countries where they do business.
On the other hand, DSTs are a type of consumption tax that target the revenue of digital companies such as Google, Facebook, and Amazon, which are often headquartered in countries with lower corporate tax rates. DSTs are intended to level the playing field for domestic companies and to ensure that digital companies pay their fair share of taxes in the countries where they do business.
The conflict arises because DSTs and Pillar One address the same problem of profit shifting by multinational corporations but from different angles. DSTs are intended to target specific companies and sectors of the economy, while Pillar One aims to address the issue through a more comprehensive, global approach.
The OECD has, for years, been working on a consensus-based solution on this matter, however, individual jurisdictions jumped the gun at trying to solve an issue with growing impact in the latter years.
Considering the pushback Pillar One has faced in very relevant jurisdictions in the digital services sector, which the US is a prime example, DSTs may be back in play, as the feasible short-term solution – albeit somewhat unfair with regards to double taxation issues.
Maria Lima Ferreira
January 2023
[1] In particular, the implementation of both Pillar 1 and Pillar 2 have faced pushback in the US. It is relevant to note that the ratification of a US international tax agreement requires (at least) two thirds of senators to cast a favourable vote. However, the US Republican Party, which was able to secure a small majority in the House of Representatives in the mid-term elections last November 2022, has expressed opposition to both Pillars of the global tax reform.
[2] The agreement, named Unilateral Measures Compromise – agreed upon by the U.S. and Austria, France, Italy, Spain, the United Kingdom, Turkey, and India – covers the period between January 2022 (April 2022 for India) and the date Pillar One formally takes effect or December 31, 2023 (March 2024 for India), whichever happens first.