OECD Provides a Unified Approach Proposal for Profit Allocation

On October 9, 2019, the Secretariat of the OECD proposed a “Unified Approach” for allocating taxing rights that attempts to combine three alternatives previously grouped under Pillar One of an action plan focused on the tax challenges of digitalization. The Unified Approach proposes significant departures from the arm’s length principle and from traditional permanent establishment rules (which to date have largely emphasized physical presence in a jurisdiction). The implementation of any guidance that might come out that aligns with the Unified Approach would require significant changes to many countries’ tax law and tax treaties. The scope of the Unified Approach is broader than the original focus on the “digital economy,” and now could impact any “consumer-facing business”.  

Unless exempted by size thresholds or industry carve-outs (that have not yet been specified), consumer-facing businesses would become subject to income tax in any market where they have “sustained and significant involvement in the economy”, even if the group has no physical presence in that market, and performs no functions, assumes no risks and deploys no assets there. Residual profits would be calculated and allocated between countries based on a simplified formula, instead of applying the arm’s length principle.  


Early in 2019, the OECD published the “Programme of Work to Develop a Consensus Solution to the Tax Challenges Arising from the Digitalization of the Economy” (PoW), which called for two types of measures to prevent tax base erosion and profit shifting and to ensure that multinationals pay their fair share in taxes. Pillar One included three proposals concerned with providing additional taxing rights to market jurisdictions, while Pillar Two contained proposals intended to ensure that multinational groups pay at least a minimum level of tax. Pillar Two proposals included an income-inclusion rule and an anti-base-erosion rule. The PoW was endorsed by the G20 countries, with a stated commitment to reaching a consensus-based solution by the end of 2020.

The Unified Approach proposes a formulaic approach for Pillar One issues, essentially allocating a pre-determined portion of residual income, identified through a formulaic approach using pre-determined functional returns, to allocate a layer of a multinational’s income to local markets, independent of physical presence in those markets.

The Unified Approach

The Unified Approach is proposed to apply to all “consumer-facing businesses”, not just those with digital business models. Extractive industries and commodity businesses would be excluded, and the proposal suggests that additional sectors (such as financial services) may be carved out as well. Size thresholds, such as for global group revenues and local market revenues, are also expected to be considered.  

For companies within scope, local market taxing rights would be based on a new nexus rule that would not require the company to have a physical presence in the market in order to be subject to tax there. The new nexus rule would be based instead on local market sales, potentially with different sales thresholds by country.

The Unified Approach would calculate three types of profit subject to taxation in a given jurisdiction:

  • Amount A calculations would first deem an amount of “residual profit”, after assigning a pre-determined rate of “routine profit” to the activities of the group or business. This could be calculated at the overall group level, or separately by business line. This residual profit or loss would then be allocated among each market where the new nexus rule applies, based on sales by market.
  • Amount B would be intended to award baseline local marketing and distribution functions and would remain taxable under existing rules. It is worth noting, however, that the Unified Approach document contemplates exploration of the use of fixed returns for these baseline activities in order to reduce the number of tax disputes associated with profit allocations for these activities.
  • Amount C would apply in markets where the company has functions beyond the “baseline” marketing and distribution activities already rewarded under Amount B and would reward those functions based on the arm’s length principle.

One assumes that profits that remain after Amounts A, B, and C have been identified would be allocated among the parties in accordance with existing rules under the arm’s length principle. With respect to Amount A, it is worth noting that the identification of returns to the market would be determined by simplifying conventions (including pre-determined returns to routine functions, and pre-determined apportionment of identified residual profits to the market (as opposed to other sources of non-routine returns). These pre-determined percentages (for both routine functions and for the portion attributable to the market) remain to be determined and would be part of the consensus-based agreement among Inclusive Framework members.

Next Steps

The Unified Approach is a proposal from the OECD Secretariat, and does not reflect consensus views from the G20 or from the more than 130 countries that comprise the OECD/G20 “Inclusive Framework” on Base Erosion and Profit Shifting (BEPS). The Unified Approach proposal seeks public comments on several policy and technical issues associated with the Unified Approach by November 12, 2019, such as:

  • How to define which businesses are in scope, including size thresholds and industry carve-outs;
  • How nexus thresholds may vary by country;
  • How to calculate Amount A, and deal with different accounting standards and business lines; 
  • What activities would qualify for a fixed return, how to determine that return, and to what extent it should vary (by industry, region, etc.); and
  • How to prevent and resolve tax disputes and double taxation.

Public consultations on the Unified Approach are scheduled in Paris for November 21-22. Separately, further details on Pillar Two proposals are expected to be released in November, with a public consultation to follow in December 2019. The OECD is seeking consensus on the “outline of the architecture” for the Unified Approach by January 2020, with the goal of completing proposals for both Pillars by the end of 2020.

The OECD’s urgency on dealing with Pillar One and Pillar Two issues is partly driven by a desire to prevent market jurisdictions from taking unilateral action in the meantime. Nonetheless, many countries are still advancing unilateral approaches to dealing with digital economy taxation issues. With respect to Pillar One, Canada’s federal Liberal Party recently announced (before it was re-elected on October 21) an intention to introduce a new 3% tax on the “income of businesses in certain sectors of the digital economy”, focused on targeted advertising services and digital intermediation services. This new Canadian tax would be intended to replicate the digital services tax proposal announced earlier by the French government, would become effective April 1, 2020, and would apply only to businesses with at least CAD 1 billion of global revenues and CAD 40 million of revenues from Canada.

Pillar Two is expected to include measures that could deny tax deductibility and treaty benefits for an intercompany payment unless it is taxed at a minimum rate, or more, in the receiving country.

Our firm is closely monitoring the status of this proposal, and the other BEPS initiatives. If you have any questions regarding this or any other transfer pricing issues, please reach out to the Duff & Phelps transfer pricing team.

Read Transfer Pricing Times – October 2019



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