Transfer Pricing Times: OECD on Tax Challenges of Digitalization of the Economy

In this edition: The OECD unveiled the latest proposals to address the tax challenges of the digitalization of the economy; the IRS updated its tax statistics database with Statistic of Income data for tax year 2016; Duff & Phelps spoke at the 2019 TP Minds Americas Conference; the Spanish tax authorities announced the Tax Control Plan for FY2019; Political developments in Spain postpone the implementation of the Digital Services Tax; German tax authorities to impose withholding tax on online advertising; and the Indonesian tax authority issued Regulation No. PER-02/PJ/2019 concerning procedures for the Submission, Receipt and Processing of Tax Returns.

 

OECD Airs Measures to Address the Tax Challenges of the Digitalization of the Economy 

The OECD has unveiled the latest proposals towards achieving consensus on the development of a long-term solution for the tax challenges raised by the digitalization of the economy, which potentially have far-reaching ramifications for transfer pricing and the continued application of the arm’s length principle. On January 29, 2019, the OECD released a policy note, in the name of the OECD/G20 Inclusive Framework on Base Erosion and Profit Shifting (BEPS), that identified two central “pillars” for further discussion.

The first pillar will consider how market territories can take a portion of the profits of multinational groups operating digital business models, to which they feel entitled but are currently denied through the absence of a taxable presence under existing transfer pricing principles. It proposes addressing this through an examination of the rules concerning “nexus” and profit allocation.

The second pillar seeks to render transfer pricing planning less attractive, if not irrelevant, through German and French sponsored proposals for the effective imposition of a minimum global tax rate for multinational groups.

The Inclusive Framework has followed up this policy note with a public consultation document, released on February 13, 2019, which provides more detail on the two pillars.

The first pillar will consider three proposals for revising the nexus and profit allocation rules: through the concept of “user contribution” already advanced by the UK government, a U.S. suggestion concerning recognition of marketing intangibles in a market territory, and a more recently submitted proposal from India concerning significant economic presence.

While the UK proposal is limited to digitalized business models, the U.S. proposal has the potential for a far wider impact across the whole economy. Both proposals would see a significant move away from the arm’s length principle in the attribution of profits to the market territory deemed to be contributing value in the form of user contribution or local marketing intangibles, introducing a form of global formulary apportionment, described as “a new type of residual profit split method”, requiring a move away from traditional transactional analysis.

The OECD has historically rejected formulary apportionment as an alternative to the arm’s length principle for several reasons, including the difficulty of finding international consensus on the formulae to be used and on the composition of the group in question. The challenge remains how the OECD will address the considerable risk of double taxation arising from such a formulaic approach.

The second pillar, described as the “Global anti-base erosion proposal”, draws on aspects of the U.S. GILTI regime and proposes two inter-related rules that would serve to ensure that all internationally operating businesses pay a minimum level of tax. Again, the scope of this proposal is not limited to highly digitalized business models. The proposed rules comprise an income inclusion rule that would tax the income of a foreign branch or a controlled entity if that income were subject to a low effective tax rate in the jurisdiction of establishment or residence and a tax on base eroding payments that would deny a deduction or treaty relief for certain payments unless that payment was subject to an effective tax rate at or above a minimum rate.

Invitation for comments on the proposals are to be submitted by March 6, 2019, in advance of a public consultation, which will be held on March 13-14, 2019 in Paris as part of the meeting of the Task Force on the Digital Economy. A team from Duff & Phelps is preparing comments for submission.

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IRS Publishes Aggregate Country-by-Country Report Statistics 

The IRS updated its tax statistics database with Statistic of Income (“SOI”) data for tax year 2016 taken from Form 8975 – Country-by-Country Report and Form 8975 Schedule A – Tax Jurisdiction and Constituent Entity Information. The available data is organized in two main categories: (1) Tax Jurisdiction Information and (2) Constituent Entities.

The Tax Jurisdiction Information presents data on the number of filers, revenues, profit, income taxes, earnings, number of employees and tangible assets. This data is further classified by major geographic region; selected tax jurisdiction; negative, zero, or positive profit before income tax; major industry group; and the effective tax rate of multinational enterprise sub-groups. The Constituent Entities section presents data on the number of constituent entities classified by major geographic region, selected tax jurisdiction, and main business activities. The IRS Country-by-Country Report data is available for download as Microsoft Excel® files at this link.

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Duff & Phelps Experts Speak at TP Minds Americas 2019

Duff & Phelps was a Gold Partner at the TP Minds Americas 2019 Conference, held at The Biltmore Hotel in Coral Gables, Florida on February 26-27, 2019, which examined current issues in transfer pricing, tax and valuation. This year’s conference focused on ongoing shifts in transfer pricing guidance and administration following the OECD’s BEPS projects (and follow on work), tax reform in the U.S. and elsewhere, and various countries efforts to tackle taxation in the digital economy.

This year’s conference included two panels led by Duff & Phelps’ transfer pricing experts:

  1. Mark Bronson, Managing Director and office leader for the Boston transfer pricing practice, led a panel on hard-to-value intangibles (HTVI). This panel focused on explaining the potential use by tax authorities of ex post data to make adjustments to or recharacterize certain intangible transfers, and on the steps taxpayers might be taking to mitigate the risk of these sorts of adjustments. 
  2. Stefanie Perrella, Managing Director and office leader for the New York transfer pricing practice, led a panel on the OECD’s Discussion Draft on Financial Transactions. The panel focused on regulatory and administrative considerations governing a wide variety of intercompany financial transactions, including intercompany loans, performance and financial guarantees, and cash pooling arrangements. The panelists emphasized the importance of coordination between treasury and tax departments, challenging taxpayers to collectively and proactively tackle financial transactions.

Other panel topics ranged from practical considerations of value chain analyses to the intersection of transfer pricing and customs. Transfer pricing experts provided updates to regulatory changes and requirements in Latin America, with discussion on Brazil’s independent approach to transfer pricing, and Peru’s convergence towards the OECD Guidelines. Advanced Pricing Agreements (APAs) were a continuous topic of conversation during the conference, with discussion on when, where and how APAs may be beneficial to the taxpayer. Several sessions also touched on taxpayers’ approaches to U.S. Tax Reform and the associated impact on their tax obligations.

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Spanish Tax Authorities Announce the Tax Control Plan for FY2019

On January 11, 2019, the Spanish tax authorities announced the Tax Control Plan for FY2019, continuing its work in both tax fraud prevention and control. As in 2018, transfer pricing remains a key aspect of this Plan, with close scrutiny in five key areas:

  1. Documentation requirements;
  2. Related-party financial transactions;
  3. Risk analysis;
  4. Business restructurings; and 
  5. Activities carried out by entities covered by functional structures of low business risk and significant presence in the economy (e.g. those in manufacturing, distribution, intra-group services and transfer of intangibles).

Both the deductions of the tax base and lack of income declaration will trigger inspection activities, especially arising from services or transfer of intangibles not passed on. Inspection actions will focus on effective application of anti-avoidance measures, measures regarding permanent establishments, and existing tax-haven regulations. 

In 2019, the Tax Agency will continue to optimize its tools. The Country-by-Country Report (“CbCR”), will remain as a risk analysis tool to detect fiscal erosion practices. Also, in line with previous years, the intention is to continue with the policy of promoting Mutual Agreement Procedures (“MAPs”) and Advanced Price Agreements (“APAs”), but with special emphasis on those of bilateral or multilateral nature. The main inclusion to the Plan, is the DAC 6, derived from the transposition of the Directive 2011/16/EU that emanates to ensure disclosure of aggressive tax planning mechanisms and techniques aimed at concealing the ownership of income and assets. Any intermediary, consultant or adviser will be bound by it. 

In 2019, it is intended to continue along the same lines of research as in previous years, yet, incorporate four main new ones. These include: (1) an initial study of FINTECH technologies will be carried out; (2) new distribution models (e-commerce); (3) analysis and study of new means of payment; and (4) logistics activities linked to e-commerce.

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Political Developments in Spain Postpone the Digital Services Tax

On January 18, 2019, the Spanish Government made public the final draft bill of the Digital Services Tax (“DST”) that was slightly modified compared with the preliminary draft bill released in October 2018. The final draft was laid before the Spanish Congress for further approval.

The draft bill “remained on draft” since it was part of the overall tax reforms conceptualized on the draft of the State Budget Bill for 2019, which was rejected by the Spanish Congress in mid-February. It is uncertain whether the draft will be approved by the new Congress, which will be elected in April 2019. However, the major political parties in Spain have previously demonstrated their disapproval for being the pioneers to implement the new tax, underlining the importance of a multilateral approach. These recent political developments may jeopardize the implementation of the DST.

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German Tax Authorities to Impose Withholding Tax on Online Advertising

Recently, there has been a controversial development in the tax audit practice in parts of Germany regarding the taxation of the digital economy. While the Federal Government appears to be skeptical of unilateral measures by countries in respect of Digital Services Tax ideas, some local tax authorities apparently have decided to take matters into their own hands. A few weeks ago, the head of the tax audit department of the Munich Tax Office, which is responsible for federal income and corporate taxes within the Munich area, has published a controversial article in an important tax journal in Germany. In that article, he argues that payments from German companies to “online advertising companies” (read: Google and Facebook) constitute “royalties” for German withholding tax (“WHT”) purposes. Consequently, he argues that companies making such payments are required to withhold 15.8% (or 18.8% if a grossed-up) of the payment and pay it to the Munich Tax Office.

The Munich Tax Office has started to issue notices to German resident companies who have paid for cross-border advertising services. The notices are requiring the companies to pay the WHT which they (according to the tax office) failed to withhold. This puts the affected companies in a difficult position, as they considered the advertisements they bought as a service rather than a royalty and thus were not expecting WHT on the transactions. Typically, advertising services agreements will have a WHT clause which requires the service recipient to gross-up the payment amount in case taxes are imposed, which means the German resident companies (rather than the targeted online advertising companies) will ultimately pay the additional tax. It is unclear whether double tax relief, which may be available in accordance with the applicable double tax treaty, can be sought in light of very strict German anti-treaty shopping rules.

It should be noted that these actions by certain tax offices in Germany are not officially sanctioned by the German Federal Ministry of Finance, which is currently investigating the issue and is expected to publish an official position later this year. Such official position would be binding for the German tax authorities once issued. It also remains to be seen what the German courts will make of this, but until the first judgements or an official position from the Ministry of Finance come out, companies that are being served a notice in this matter would do well to challenge them (i.e. file a formal objection) and then assess their options, which could involve litigation or trying to defer the matter until official guidance or court precedent becomes available.

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New Regulations Issued by Tax Authority in Indonesia

The Indonesian tax authority (“DGT”) issued DGT Regulation No. PER-02/PJ/2019 (“PER-02/2019”) concerning procedures for the Submission, Receipt and Processing of Tax Returns (“SPT”) which came into effect January 23, 2019. According to a later redistributed version of PER-02/2019, it was reiterated that only the following would be required for submission with the annual tax return:

  1. Summary (“Ikhtisar”) form confirming the content of the Master file and Local file as well as the date as at when these files are available; and
  2. Receipt of either the Country-by-Country (“CbC”) report notification and/or CbC report as well as the “working papers” submission in the DGT online system.

These updated requirements are in line with the existing transfer pricing regulations, namely the Ministry of Finance (“MOF”) Regulation No. 213/PMK.03/2016 (“PMK-213”) and DGT Regulation No.PER-29/PJ/2017 (“PER-29”). While the clarification addressed earlier inconsistency issues regarding documentation requirements, the issuance of PER-02/2019 indicates that the DGT will likely take a stricter approach to the timing of the preparation of transfer pricing documentation in future. 

Some leeway was afforded to taxpayers for documentation for the financial year 2016 (“FY16”) and FY17, but for FY18 and future years, the DGT is likely to request the submission of transfer pricing reports earlier. Requests for submission of transfer pricing reports usually only provide a 14-day deadline for compliance. The risk is that if the transfer pricing documentation cannot be provided to the DGT in that timeframe, and hence was not actually “available” within four months of the year-end as required, then the DGT can conclude that no such documentation exists and can proceed to make transfer pricing adjustments based on their own analyses.

Therefore, it is important for taxpayers to comply with the tight deadlines for preparation of their annual transfer pricing documentation in accordance with the Indonesian regulations. For more on this development, see a more detailed discussion here.

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Note:
Hruschka: Onlinewerbung im Fokus der Betriebsprüfung DStR 2019, 88 [in German].
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