OECD’s Unified Approach Proposal for Taxation in the Digital Economy

[Dibya Prakash Behera is a 5th Year BA. LLB (Corporate Law Hons.) student at National University of Study and Research in Law, Ranchi]

The Organisation for Economic Co-operation (“OECD”) on 9 October 2019 released its Secretariat Proposal for a “Unified Approach” under Pillar One (“Proposal”) for public consultation. The Proposal, inter alia, introduces the concept of a nexus largely based on sales and not physical presence. It also lays down detailed guidelines for reallocating profits of multinational corporations which involve a highly digitized business model. It is intended to cover primarily the consumer facing businesses, the scope of which is yet to be decided. The Proposal is of crucial significance as it paves the way for a more inclusive tax policy suited to developing countries.


Pertinently, the Proposal sources its origin to the mandate by G20 Finance Ministers in March 2017, which led the Inclusive Framework working through its Task Force on the digital economy to deliver an interim report in March, 2018. The Inclusive Framework adopted a Programme of Work to develop a consensus solution to the tax challenges encountered in the digital economy. It was in January 2019 that the Inclusive Framework issued a Policy Note grouping the proposals under consideration into two pillars. The Programme of Work, inter alia, raised a concern that unless there is an agreement on the outline of the architecture of a unified approach by January 2020, it might become impossible to deliver a sustainable and relevant international tax framework. Considering the high stakes involved in the process of taxing players in the digital economy, the secretariat had to undertake the current Proposal. The current Proposal under Pillar One embraces within itself the concepts of “user participation”, “marketing intangibles” and “significant economic presence”. The need to arrive at a consensus position was also felt much more than before with the countries unilaterally starting to tax digital companies regardless of physical presence.

Unified Approach: Major Takeaways

Scope: The Proposal is intended to focus primarily on the consumer facing businesses. In other words, the focus is to tap on the contemporary world’s digitalized and globalized economy. It is an imperative fact that digitalization has ensured that the entities earning revenue need not have a physical presence in the nation. For instance, EBay, headquartered in the United States earns some of its revenue from its operations in India which largely comprise selling and buying on its online portal. In such a scenario, although it earns its income from its Indian operations, it might not be possible for India to impose a tax liability on the company for it has no physical presence in India. This is exactly the reason why a consensus for taxation in digital economy has become the need of the hour. The consumer -facing business approach is specifically based on the notions that entities can create a meaningful value without a traditional physical presence in the market. Although the approach might be applicable for any business, it becomes more relevant for the digital-centric businesses which intend to interact remotely with users and indulge themselves in collection and exploitation of data, working through an online platform.

New Nexus Rule: The most notable feature of the Proposal is the introduction of a new nexus, which is largely dependent on sales, and does away with the obsolete physical presence rule. It is no doubt that the digitalization of the economy has paved paths for companies to increasingly carry out business with customers in a particular jurisdiction without having a physical presence in it. The highly digitalized businesses like e-commerce, social media networking, internet sites and the like have made it all the more possible to evade taxation in lieu of not having a permanent establishment in the source nation. The tech giants such as Amazon, Google and Apple have faced tax assessment, being compelled to shell out a large sum of money to the Luxembourg, France and European Union respectively. The Proposal notes that the allocation of taxing rights can no longer be exclusively circumscribed by reference to physical presence. Considering the proposals made to the OECD to address highly digitalized businesses, it has proposed the idea of granting new taxing rights to the countries where the user base of such entities are located. The business shall have a sustained and significant involvement in the economy of market jurisdiction, through consumer interaction and engagement. The relevance of having a physical presence now matters little for the market jurisdictions. The Proposal proposes the revenue threshold to be a determinative factor of a sustained and significant involvement. The determination of the revenue limits are meant to be deliberated and discussed upon in the future consultations.

Profit Allocation Rules: With the introduction of the new nexus, profit allocation rules under Article 7 and Article 9 might be a thing of the past. The concerns become all the more relevant when the extant rules are inapplicable to situations wherein no functions are performed, no assets are used, and no risks are assumed in the market jurisdictions. The Proposal seeks to strike a balance between the criticism of the arm’s length principle and the significance of the same by providing for a threshold in respect of business activities at market jurisdictions. It is intended to reconcile the existing rules with the new rules and provide for its effective application to both profits and losses. It proposes a three-tier system for profit allocation as follows:

1. Deemed residual profit: The Proposal seeks to confer a new taxing right to the market jurisdictions over a multinational enterprise’s deemed residual profits. It intends to define deemed residual profit as the profit that remains after allocating what would be regarded as a deemed routine profit on activities to the countries where the activities are performed. In other words, the Proposal intends to consider above normal profits for the purposes of taxation.

2. Fixed Returns: The Proposal provides for a method to contain the resentment against the transfer pricing rules. It intends to allocate profits on fixed returns basis, i.e., fixed remuneration would be explored, reflecting an assumed baseline activity. It is specifically focused on companies that use distributors in a local market.

3. Binding Dispute Resolution: The Proposal, inter alia, provides for a legally binding and effective dispute prevention and resolution mechanisms between the market jurisdiction and the taxpayer over its elements. This might go a long way in reducing conflicts and arriving at a consensus among all the nation. However, the Proposal maintains a stoic silence on the provision of binding arbitration for the disputing parties.


In a rather welcoming approach, the intention of the Proposal to provide for a new nexus will definitely increase revenue prospects of the large markets such as India and China. Pertinently, the business models of online aggregators such as Airbnb (headquartered in Ireland and operating through support service in the local market) helps it to avoid tax liability for lack of a permanent establishment (“PE”) in India. Nevertheless, the company generates a large share of revenue from its operations within India. Not surprisingly, Uber manages to escape the tax net by operating through a platform which is linked to an application that connects independent drivers with potential customers. Its local service providers only offer marketing and support services which don’t constitute PE in India. Due to their core dependence on digitalization, the business models of Netflix, Amazon, Facebook, and Google provide them with leverage to escape the constitution of any PE in India, thereby not being taxed for the revenue generated from within the territory of India. In such situations, India loses out on a major chunk of tax revenue. Although equalization levy and concept of significant economic presence in India has been introduced, the lack of clarity in the provisions has made it a cumbersome affair for the revenue department to tax digital companies.

The Proposal, inter alia, ponders upon the idea of excluding the financial services sector from its ambit. This might have serious implications and the revenues might take a hit, especially when it has been time and again observed that “fin-tech” has become the new buzzword after digitalization. Fintech is generally employed with a view to enhance interaction with customers and gain greater penetration into the market. The advent of cryptocurrency, usage of block chain and big data help the financial services sector to extend leverage over their peers. Retail banking is no longer solely branch-based, but can be conducted in many ways, including using mobile telephones. Digital payments system have become the norm lately. The OECD has also noted that data-driven markets can lead to a “winner takes all” situation”. The exclusion of financial services sector from the ambit of the Proposal might do more harm than good.

The Proposal has a major drawback in the form that it treats both losses and profits for purposes of taxation. The OECD, on this note, seems to forget that the highly digitized businesses, in a bid to gain massive consumer base, invest huge capital in their initial years and are only able to show profits after around six to seven years in their consolidated financial statements. Imperatively, Amazon took five years following its initial public offering (“IPO”) to generate quarterly profits. Interestingly, while unveiling its IPO, Uber warned the investors of its increasing operating expenses and negligible signs of showing profitability in the near future. Moreover, the situation becomes grim with the proposal focusing on the non-routine profits i.e. “above normal profits”, which seems to be a distant possibility considering the present business models of highly digitalized businesses focusing more on market penetration than being profitable. The OECD’s proposal on this point might defeat the whole purpose of digital taxation. It is a matter of time to consider if the final framework addresses such concerns, which is expected to be completed by the end of 2020.

Dibya Prakash Behera

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