The road to addressing the tax challenges of the digitalized economy was paved in October when most of the Organization of Economic Cooperation and Development (OECD) subscribed to a key political commitment in the Inclu-sive Framework on Base Erosion and Profit Shifting (Inclusive Framework). In their statement, members agreed to support potentially fundamental changes to the international corporate tax architecture. The two-pillar solution, which was first introduced in 2019, aims to mitigate or address the excessive corporate tax avoidance practices of various multinational enterprises (MNEs), particularly those generating revenue from the digital economy. The OECD estimates that these practices cost anywhere from $100 billion to $240 billion annually, or roughly 4-10% of global corporate income tax revenue.
With fine-tuning, the provisions of the two-pillar solution have become clearer, and the implementation plan is now more concrete compared to how they stood after initial discussions in 2017. The residual profit to be reallo-cated to market jurisdictions under Pillar One is now firmed up to 25% of the profit before tax. MNEs with a global turnover of €20 billion and profitability of above 10% will be covered under Pillar One. Twenty five-percent of the re-sidual profit of a covered MNE will be apportioned to market jurisdictions where the MNE derives at least €1 million in revenue. Countries with gross domestic product of less than €40 billion can qualify as a market jurisdiction if a covered MNE earns at least €250,000 in that country. Seven years after the effectivity of the multilateral agreement that will be used to implement this solution, the global revenue threshold may be reduced from €20 billion to €10 billion upon review.
Moreover, the members of the Inclusive Framework also solidified the solutions under Pillar Two. They have agreed to enact a jurisdictional-level minimum tax system with a minimum effective tax rate (ETR) of 15%. One of the two features of this pillar is the interlocking domestic rules consisting of an Income Inclusion Rule (IIR) and an Undertaxed Payment Rule (UTPR). IIR imposes a top-up tax on a parent entity for its affiliates’ low-taxed income. It will be considered low-taxed if it has not been subject to the minimum ETR of 15% on a country-by-country basis. Meanwhile, UTPR will apply where the IIR failed to capture top-up tax, and the low-taxed income was not subject to the minimum ETR. This rule will disallow deductions or provide adjustments to ensure that the low-taxed income will be subject to the minimum ETR. These interlocking rules will apply to MNEs with €750 million of revenue based on their country-by-country reports.
Once the Framework is implemented by 2023, except for UTPR which will become effective in 2024, the OECD estimates that more than $125 billion of profit would be reallocated to market jurisdictions annually under Pillar One, while Pillar Two will produce incremental annual global tax revenue of around $150 billion.
The Inclusive Framework member countries agreed to remove all existing Digital Services Taxes and those similar measures from Oct. 8, 2021 until Dec. 31, 2023, or upon the effectivity of a multilateral convention they intend to sign to implement this prohibition.
One of the studies conducted relative to this two-pillar solution calculated that 50% of the MNEs in the scope of Pillar One are located in the US, 22% are headquartered in other G7 countries, and about 8% have their head of-fices in China. Another study revealed that Pillar One would likely affect less than 100 corporate groups globally. In this regard, the Philippine government may have considered that it will not be able to fully optimize this two-pillar solution in generating taxes since only few MNEs will be covered by Pillar One and it can only exercise the features of Pillar Two on the MNEs headquartered in the country. Thus currently, it has not signed up to this global solution.
We have seen the Bureau of Internal Revenue (BIR) ramping up its preparations to tax digital transactions. It has also tapped the help of its Russian and South Korean counterparts in looking for the right way to get its tax share of online transactions. Since we are not yet an Inclusive Framework member, there is no prohibition against drafting digital service tax to date. A pending bill, passed by the House of Representatives in September, aims to impose a 12% value-added tax (VAT) on digital services like online advertisements, subscription services, and other services delivered through the internet. It would also require foreign digital service providers to collect and remit VAT to the BIR on all transactions going through their platforms.
The bill intends to level the playing field that local bricks-and-mortar establishments find themselves in against the foreign e-commerce giants that are not subject to local taxes under the current rules. However, the bill is still at an early stage. It will need to go through the legislative process before it takes effect. And since next year is an election year, the turnover of legislators may delay the passage of the bill. If it is not passed during the current Con-gress, it must be refiled under the new Congress.
On the positive side, our tax authorities have been carefully studying these developments in taxing the digital economy for some time. On the one hand, passing a unilateral digital service tax, which some view as inefficient, may lead to disputes with other countries over double taxation, as well as trade retaliation — although it arguably assures the government of tax collections from online transactions. On the other hand, subscribing to the two-pillar approach harmonizes our process with that of the rest of the world. Thus, the government should weigh the tax collections from the unilateral digital service taxation vis-a-vis the tax certainty and administrative effectiveness of the global solution. Meanwhile, MNEs should consider these developments in weighing their options and keep track of the work needed for its fruition.
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.
MAC KERWIN VISDA is a manager at the Tax Services Department of Isla Lipana & Co., the Philippine member firm of the PwC network. +63 (2) 8845-2728 mac.kerwin.visda@pwc.com
