Unilateral Taxation of the Digital Economy: The fight is not over yet - it's only beginning.

• Author: Osborn, Jason

Notwithstanding the recent efforts of the G20/OECD Inclusive Framework on BEPS (hereafter the IF) to develop a uniform, multilateral, and consensus-based solution for taxing the digital economy, legislatures and tax administrations around the world continue to propose and enact a host of largely uncoordinated digital services taxes (DSTs) and other unilateral digital tax measures. This article examines the current status of the IF s efforts to thwart unilateral measures through a consensus-based solution, some of the proposed unilateral measures, the problems inherent in these measures, and what multinational enterprises (MNEs) can do now to prepare for the possibility of unilateral measures.

The Current Status

On January 31, 2020, the Organisation for Economic Co-operation and Development (OECD) published a statement (the IF statement) announcing that the IF, which currently includes 137 member countries, endorsed the "Pillar One" approach to taxing the digital economy and approved an architecture for finalizing the Pillar One principles by the end of 2020. (1) While much work remains, the IF's endorsement of high-level Pillar One principles was a significant accomplishment, considering that this approach promises the most extensive changes to the international tax system in a century. (2)

The IF statement also sets forth an ambitious revised work plan for delivering a detailed consensus-based solution to Pillar One by the end of 2020. As identified in the IF statement, additional work remains in eleven key areas, some of which are fundamental to the operation of Pillar One. (3) This work includes evaluating the feasibility and impact of the United States' proposal to make Pillar One a "safe harbor" that MNEs could elect to apply rather than a mandatory feature of the international tax system.

In terms of timeframe, the IF statement sets the objectives for the IF to approve "the key policy features of a consensus-based solution to the Pillar One issues" by July 2020 and to deliver a final report on Pillar One that sets out the "technical details of the consensus-based solution" by the end of 2020. (4) On a parallel track, the OECD continues to work on an economic analysis and impact assessment of Pillar One, the results of which will inevitably be a key factor determining whether the IF can meet its year-end objective of a consensus-based solution. (5) After the publication of the final report, implementation by domestic legislation and a new multilateral instrument (MLI) would follow in 2021 and beyond.

Risk of Unilateral Taxation Remains Real

As discussed below, unilateral measures are already in force or soon will be in a number of countries. Notwithstanding the impressive progress that the IF has made toward a consensus-based solution, the risk of further unilateral digital tax measures remains very real. To start, there is an obvious risk that the IF will not result in a consensus-based solution by the end of 2020, which could open the floodgates to unilateral measures. While the IF's recent agreement on the "architecture" of Pillar One demonstrates the IF's ability to reach a high level of consensus quickly, reaching agreement on specific policy features and technical details of a consensus-based solution is a much taller order, given the diverse and sometimes diverging interests of the IF's 137 members. Among possible hurdles, a failure by IF members to address the United States' proposal to make Pillar One a "safe harbor," or various countries' sovereignty-related concerns related to arbitration-like binding dispute resolution, present considerable challenges to consensus.

Reaching consensus will depend largely on whether the taxes collected through Pillars One and Two will match taxes collected through DSTs and other unilateral measures. A country can be expected to give up a DST only if it can collect a similar amount of tax through measures enacted through Pillars One and Two. Accordingly, the OECD's ongoing work on the economic analysis of Pillars One and Two is critical.

On February 13,2020, the OECD presented a preliminary high-level assessment of the economic impact of Pillars One and Two. That report estimated that annual corporate tax receipts would increase by roughly four percent or $100 billion based on certain broad assumptions and estimates. Notably, less than twenty-five percent of expected revenue was estimated to come from Pillar One. This may not be enough to persuade countries to forgo unilateral measures. (6)

Further, even if a consensus-based solution is reached, there is a risk that not all countries will withdraw their unilateral measures as currently contemplated, or that the consensus-based solution could be interpreted in ways that allow for supplemental unilateral measures. In this regard, the IF's statement indicates that "it is expected that any consensus based agreement must include a commitment by [the IF] members ... to withdraw relevant unilateral actions and not adopt such unilateral actions in the future." (7) Although this is certainly a step in the right direction, the modifier "relevant" could open the door to an argument that a particular unilateral tax is not a relevant unilateral action that must be withdrawn.

In addition, if the IF were to adopt (or permit member jurisdictions to adopt) the U.S. "safe harbor" proposal as part of its consensus-based solution, then countries could presumably apply unilateral measures to those MNEs that do not elect into the Pillar One safe harbor. While MNEs not electing into Pillar One would effectively be choosing to subject themselves to unilateral measures, the availability of this option could nevertheless defeat the Pillar One objective of ensuring the withdrawal of unilateral measures.

Finally, even if the IF agrees to a consensus-based solution, it may not be enacted soon enough through domestic legislation or a multilateral instrument in enough jurisdictions to be effective. In such a case, unilateral measures can be expected to make a comeback.

Overview of Specific Unilateral Measures

EU PROPOSALS

On March 21, 2018, the European Commission of the European Union (EU) presented two proposals for council directives introducing special tax regimes for digital companies. One proposal, which is intended as a long-term solution, would expand the permanent establishment (PE) concept to include "significant digital presence." This expanded PE definition would allow a source state to tax nonresident companies with substantial business activity in the state, even absent a physical presence or an agent.

Specifically, a company would have a "significant digital presence" if:

* it had annual revenues in an EU country in excess of 7 million [euro]; or

* more than 100,000 users in an EU country accessed the company's digital services in a year; or

* it concluded more than 3,000 business contracts for digital services in a year.

The other proposal, the...