According to a recent report released by OECD/G20 Base Erosion and Profit Shifting Project, dubbed “A Progress Report on Amount A of Pillar One”; there is an ongoing development to update and fundamentally reform the international tax rules by 137 members of the OECD (Organization for Economic and Corporation Development) who joined the statement on a Two-Pillar Solution to Address the tax challenges arising from the digitalization of the economy. Theses efforts are geared towards resolving tax disputes and enabling Digital MNEs to maneuver with certainty.
Against that background, Amount A has been developed as part of the solution for addressing the tax challenges arising from the digitalization of the economy. It introduces a new taxing right over a portion of the profit of large and highly profitable enterprises for jurisdictions in which goods or services are supplied or consumers are located. In addition, the Task Force on Digital Economy (TFDE) has been tasked to develop and fine tune the Multilateral Convention (MLC) and Domestic Model Rules.
The MLC once finalized shall contain provisions requiring the jurisdictions that have already implemented the Digital Service Tax (DST) like Kenya in its Finance Act 2022/23 bill, to withdraw all existing digital service taxes and relevant similar measures with respect to all companies; as well as a commit not to enter into such measures in the future. The MLC shall enter into force only upon a critical mass of countries endorsing and adopting it.
On the other hand, the model rules shall provide a template that jurisdictions could use as the basis to give effect to the new taxing rights over Amount A in their legislations. As mentioned by BEPS 2.0 project, Jurisdictions will be free to adapt these Model Rules to reflect their own constitutional law, legal systems, and domestic considerations and practices for structure and wording of legislation as required; whilst ensuring implementation is consistent in substance with the agreed technical provisions governing the application of the new taxing rights.
The architecture of Amount A has been designed to:
- Apply to a portion of the residual profit of large and highly profitable enterprises for the benefit of jurisdictions in which goods or services are supplied or consumers are located.
- Operate as an overlay to the existing profit allocation rules, and therefore includes a mechanism to reconcile the respective different profit allocation systems and prevent double taxation; and
- Lastly, it includes improved tax certainty processes that bring increased certainty for enterprises on Amount A and matters related to Amount A.
The core elements of the rules that act as building blocks for Amount A, include the following:
- Nexus and revenue sourcing: A special purpose nexus rule identifies market jurisdictions that are eligible to receive Amount A. The nexus rule contains quantitative thresholds based on the amount of Revenues a Group generates in the market jurisdiction. A lower nexus threshold will apply for smaller market jurisdictions to ensure that these are able to benefit from Amount A as well. The nexus rule is supported by detailed revenue sourcing rules, which provide a methodology for determining where the Revenues of a Group are generated, based on reliable indicators or allocation keys.
- Tax base determination: The tax base rules provide the steps to calculate the profit (or loss) of a Group that will be used for Amount A calculation purposes. It is the measure of profit that forms the basis for the partial reallocation. The Consolidated Financial Statements of a Group, prepared under Acceptable Financial Accounting Standards, form the starting point for the tax base determination. The rules include a limited number of book-to-tax adjustments and a framework allowing Groups to carryforward losses.
- Scope: The scope rules contain thresholds that are designed to ensure that Amount A only applies to large and highly profitable Groups and, as far as possible, have been drafted to apply in a quantitative and objective manner, to be readily administrable and provide certainty as to whether a taxpayer is within scope.
- Exclusion of extractive industries and regulated financial services: Revenues and profits from Extractives Activities and Regulated Financial Services are excluded from the scope of Amount A
- The profit allocation rules are based on a formula which allocates 25% of a Group’s profit in excess of 10% of the Group’s Revenues to eligible market jurisdictions. These profits will be allocated to market jurisdictions in proportion to the amount of Revenues that the Group generates in that jurisdiction, and subject to any adjustment arising from the Marketing and Distribution Profits Safe Harbour (MDSH).
- The elimination of double taxation rules will apply to eliminate any double taxation that arises from applying Amount A as an overlay to the existing profit allocation system. The rules will apply on a quantitative and jurisdictional basis to identify Relieving Jurisdictions that will be responsible for the elimination of double taxation.
Implications
At the global level, once Amount A is finalized and implemented by MLC through a critical mass ratification and adoption by jurisdictions members; it shall create a stable framework for taxing international business income including but not limited to digital MNEs such as Facebook, Amazon, Netflix and Google. The in-scope MNEs shall benefit from dispute prevention and resolution mechanisms which will avoid double taxation for Amount A, including issues related to transfer pricing and business profits disputes as highlighted by OECD progress report.
As the OECD member jurisdictions join multilateral treaty for international tax co-operation and exchange of information through signing the multilateral Convention; developing countries like Kenya shall need to strike off their bilateral tax approach on Digital Service Tax. This therefore means that the local tax revenue derived from digital MNEs shall be certain hence curbing illicit financial flows out of the region.
Author: Eddie Opiyo