1. Optionality: The Original Sin
The Final Report on Action 1 was the greatest failure of the BEPS Plan; it did not conclusively respond to the direct taxation issues posed by the digital economy and, instead, it suggested various options but recommended none, so that the issues remained open and countries became free to proceed unilaterally, which they did widely.
The optionality (come and take as you like) approach postulated by the Final Report to Action 1 opened the door to diverging unilateral responses in the subsequent years, including: (i) The UK-type DPT; (ii) the Indian equalization tax; (iii) the DST utilized all over Europe; (iv) the significant economic presence test used in a variety of jurisdictions, including, among others, Malaysia, Israel, the Slovak republic, and India; and (v) income withholding taxes (WHT) in conjunction with innovative source rules as adopted in Latin America.
2. Subsequent Developments: OECD 2.0 Project. Support from G-20 and the Inclusive Framework
OECD efforts to arrive at a uniform solution for the taxation of the digitalized economy was kept alive after 2015, and, indeed, the process was invigorated with a strong support from the G-20, and the pooling since 2016 of peripheral nations (approx. 140) in the process through the Inclusive Framework.
The creation of the Inclusive Framework allowed OECD to bring into the Project and aligned with the global objectives pursued by the leading nations, a meaningful group of peripheral economies (including the BRICS) gathered to that end, more or less unconditionally, and, at instances, even against their own particular interest. For instance, as a condition for the application of Pillar I on targeted MNEs, all previous unilateral experiments (DST, WHTs, and the like) are to be dismantled. Query whether WHTs are actually caught by the ban, though I definitively believe they should be: If Amount A were to be applied on top of existing WHTs without crediting them against the Amount A attributed to a given jurisdiction, the tax burden in market States would increase beyond what might have been expected by targeted MNEs, thus creating multiple layers of tax on the same item of income, and inter-nation inequities among market jurisdictions with or without existing digital service WHTs at the time of implementation of Pillar I.
3. The Unified Approach: Pillar I and II. Pros & Cons
The OECD Secretariat Proposal for a “Unified Approach” under Pillar I, released in November 2019, was aimed at reaching a viable solution that avoided complexities and increased certainty. To this end, a three-tier mechanism was developed, consisting of Amount A, Amount B as defined, as well as a binding dispute resolution mechanism.
After the final shaping of the Blueprints, later refined and agreed by G20 in October 2021, Amount A equals 25% of residual profits, defined as profits in excess of 10%; amount A is allocated to market jurisdictions in which targeted MNEs are deemed to meet a certain sales threshold, based on an allocation key and source rules. Targeted MNEs are groups with a global turnover of at least EUR 20 billion and a profit margin which exceeds10%.
Pillar I would entail the following advantage which benefits central and peripheral countries as well: It is a global unified response which materializes the pro-business objective of worldwide harmonization by preventing/minimizing the double or multiple taxation situation that otherwise would have arisen from the co-existence of diverging and conflicting unilateral systems of taxation.
Disadvantages for peripheral countries, instead, focus on (i) the excessive complexity for both taxpayers and tax administration, coming from formulary rules on the allocation of income to markets, which apply throughout the chain of entities belonging to targeted MNEs. This entirely new allocation system would co-exist with traditional TP rules, and might be far beyond the tax administrations’ current human and technical capacities in peripheral countries; (ii) revenue dissatisfaction: A wide perception among peripheral countries that, under Pillar I, OECD lacked the flexibility required to arrive at a satisfactory outcome that genuinely contemplates their interest. In other words, that compared with competing alternatives (e.g., WHTs, DST) Pillar I would not change much in terms of an actual, meaningful allocation of taxing powers and resulting revenue collection; and (iii) particularly in LATAM, the highly improbable acceptance of binding conflict resolution procedures, bearing in mind that no LATAM country adopted similar procedures (tax arbitration) under the MLI. As designed, these binding procedures would be pivotal for the resolution of expected allocation conflicts in connection with the application of Amount A.
Starting with the mandate of a global minimum tax rate equal to an effective 15% computed on a state-by-state basis, Pillar II, provides a disruptive, innovative income inclusion rule (IIR) which allows the jurisdiction of the ultimate parent to tax controlled entities down the chain, up to the minimum effective 15% rate. Targeted MNEs are those with turnover in excess of EUR 750 million. The implementation of Pillar II would require domestic statutory changes, and if a State does not implement it, it must at least allow other countries to apply the Globe Rules of which IIR is the core.
The predicated advantage of Pillar II centers on the elimination of harmful tax competition (race to the bottom), an objective mainly associated with common practices among industrialized countries. It is worth mentioning, however, that among peripheral countries, the granting of tax incentives is more a pivotal tool associated with macroeconomic and tax policy design geared towards attracting FDI.
Meanwhile, Pillar II imposes a severe limitation on the market States’ jurisdictional power to tax or exempt; and a transfer of public revenues to foreign countries (MNEs’ home country) through the top up taxation (IIR), which do not appear to be entirely justified under current principles of international law.
Beyond the particular case of passive and other easily allocable income to foreign sources, under certain statutory conditions which are similar among countries, there is no opinion iuris in international tax law allowing one country to tax income that another country (not a tainted offshore jurisdiction) having a primary right to tax decides to exempt or otherwise privilege following its own criterion for tax policy design.
Besides, one may wonder whether this was the most adequate, proportional response to fight tax havens’ proliferation: I am persuaded that there might have been others, less detrimental to peripheral countries that are not tax havens. Unless substantive business carve outs are finally contemplated (far beyond that presently contemplated), Pillar II interference with the market/source countries’ right to design its tax policy on legitimate businesses operating within their borders is unguaranteed under international law and disproportionate with the objectives pursued.
4. On Winners and Losers: Particular Considerations Addressed to LATAM
Adhering to Pillar I would not be revenue neutral in LATAM. In the years following the 2015 Final Report on BEPS Action 1, WHTs on digital services spread over LATAM. Peru enhanced old rules on technical services to that effect, while Uruguay aimed at enhancing its jurisdictional reach on foreign digital services, adopted source rules which confer tax jurisdiction to the country where the customer or client is situated, regardless of the place where the digital service or goods supplier performs its activities. A similar rule for B2B services was proposed in Argentina in 2017, but eventually discarded. Although the Argentine income tax law has not been changed on point since 2017, the National Tax Directorate (the Argentine Competent Authority for treaty purposes) has issued a couple of opinions beyond the reach of the applicable statutory rules, which collide with the Argentine domestic and treaty rules (Uber and Facebook cases).
In Uber, based on an extravagant assimilation between the digital intermediation activity deployed by Uber from the Netherlands, and the underlying private transport business carried out locally by resident third parties which offer services through the digital platform, the National Tax Directorate found that Uber was engaged in transport business in Argentina; and, on that basis, built the argument that Uber had a Service PE in Argentina under the Argentina-Netherlands Treaty. In Facebook, reverting a binding opinion issued by the tax authorities less than 2 years before, The National Tax Directorate sustained that advertising services rendered from abroad should be characterized as telecommunication services covered by article 14 of the Income Tax Law, thus mixing up, mistakenly, the nature of the digital service provided by Facebook (advertising through a foreign digital platform without an actual transmission to Argentina) with the technological means through which the service is received by local users (the Internet), i.e., a different service usually provided by a third-party ISP to the end user.
Brazil traditionally applies WHTs on payment remittances for technical services rendered from abroad at a 15% rate (or 25% for black-listed jurisdictions), though specific treaties may contemplate lower rates, i.e.10%. Technical services is a concept which might be construed to embody digital services as well.
Most Brazilian treaties establish in their Protocol that technical services should be treated as royalties under article 12. Exceptions to this rule are the treaties with Austria, Finland, France, Japan and Sweden where technical services should be treated as business profits under article 7 as per the Brazilian Federal Revenue Interpretative Act 5/14. More recent treaties provide for technical services in dedicated treaty articles.
Chile, Colombia and Mexico have been, instead, more OECD-aligned concerning the direct taxation of digital services, though proposals have existed in Colombia and Mexico to proceed otherwise.
Pillar II may also be costly to LATAM because of the wide use of the tax systems as a tool to attract FDI, including but not limited to free-trade zones which are significant in Brazil (Manaus), Uruguay (Montevideo, Nueva Palmira), Costa Rica, Argentina (Tierra del Fuego), and sectoral incentives to targeted industries. Query also whether corporate territorial regimes in the region (such as those in Bolivia, Costa Rica, El Salvador, Guatemala, Nicaragua, Panama, Paraguay, Uruguay) might be impacted by the minimum taxation under Pillar II. There is no readily available data in LATAM on the effect of eliminating current tax incentives to avoid IIR under Pillar II.
5. Soak Up Taxes Ahead
One possible development one might envision within peripheral countries unless business carve out under Pillar II becomes meaningful, is the proliferation of soak-up taxes to neutralize top up taxation, either under the form of a minimal 15% taxation on targeted MNEs, or a provision similar to that existing under Argentine Income Tax law (section 28), pursuant to which tax benefits afforded should not be effective whenever they result in a transfer of revenues to foreign treasuries as would happen with IIR.