OECD/G20 Inclusive Framework on BEPS endorsed the Two-Pillar Approach on the Digitalisation of the Economy

On 31 January 2020, the OECD/G20 Inclusive Framework on BEPS (IF) released statement approving the Two-Pillar Approach to Address the Tax Challenges Arising from the Digitalisation of the Economy. The IF members affirmed their commitment to reach a multilateral agreement on a consensus-based solution by the end of 2020 and have therefore agreed upon an ‘Outline of the Architecture of a Unified Approach on Pillar One’ (the Outline) as the basis for negotiations and welcomed the progress made on Pillar Two. The Outline is designed to adapt taxing rights in consideration of new business models and thereby expand the taxing rights of market jurisdictions.

18 Feb. '20 5 min. Nedelina Vasilkova

Profit allocation system

The Outline adopted a three-pronged approach/mechanism on taxable profits, designated as Amount A, Amount B and Amount C, that may be allocated to a market jurisdiction;

  • Amount A (a new taxing right) - As per this mechanism a share of residual profit will be allocated to market jurisdictions using a formula based approach (with no connection to the Arm’s Length Principle) applied at an MNE group/business line level;
  • Amount B - Focus on a fixed remuneration based on the arm’s length principle for defined baseline distribution and marketing functions that take place in the market jurisdiction; and
  • Amount C - Covers any additional profit where in-country functions (with permanent establishment or subsidiary) exceed the baseline activity compensated under Amount B. It also balances the allocation of taxing rights under the preceding two proposals with an emphasis on the need for improved dispute resolution mechanisms.

The Amount A mechanism creates new taxing rights and applies based on the new nexus test with a sustained and significant engagement within market jurisdictions irrespective of, or unconstrained by, the physical presence requirement therein. Whilst the proposals under Amount B and Amount C would not create any new taxing rights; hence the taxable profits that are potentially allocable to the market jurisdiction therein would be based on the existing profit allocation rules (i.e. the rules on physical presence and the arm’s length principle).

Categories of businesses

The new nexus test in the market jurisdiction is mainly intended for large MNE groups falling in one of the following two broad category;

  • Automated digital services: These are digital centric businesses which interact remotely with users, who may or may not be their primary customers, and are able to provide digital services remotely to customers in market jurisdictions using little or no local infrastructure. This category include, but not limited to, business on online search engines, online media platforms, online intermediation platforms-including operation of marketplaces, digital content streaming, online gaming, cloud computing services, and online advertising services; and
  • Consumer-facing businesses: These are businesses for which customer engagement and interaction, data collection and exploitation, and marketing and branding is significant, and can more easily be carried out from a remote location. This category extends to the indirect sell of products to consumers through third party resellers or intermediaries; however it excludes a business to business (B2B) transactions and businesses selling intermediate products and components that are incorporated into finished products sold to consumers. This category of business will include, but not limited to, the following business; businesses on personal computing products, clothes, toiletries, cosmetics, luxury goods, branded foods and refreshments, franchise models, and automobiles.


Despite the broad categories of business to be subject to the new nexus, the Outline also carved out the following business sectors, particularly from the second category of businesses discussed above. These are;

  • Extractive industries and other producers and sellers of raw materials (such as agricultural and forestry products), as taxes on profits of such products could be paid in the state of the resource owner;
  • Financial and insurance services sector, due to prudent regulations and to large extent it is B2B; and
  • Enterprises operating ships and aircraft in international traffic, due to the long standing practice in bilateral tax treaties assigning an exclusive taxing right to the state of residence of the enterprise.

Some of the rationales given to the exclusions do not seem sound enough to make a distinction between the included and carved out businesses.

Other aspects and pending issues

The Outline illustrates, among other things, about the various thresholds to be designed for the Amounts, allocation keys to be used for distribution of the Amount A/residual profits among eligible market jurisdictions, calculations of tax bases, mechanisms to eliminate double taxation, key technical aspects of Amount B, and interactions among Amounts A, B and C.

Nevertheless, there is a lot of work to be done and the proposed reallocation of taxing rights under Pillar One would require, inter alia, improved tax certainty and effective dispute resolution mechanism. Consequently the IF members have noted the technical challenges and some critical policy differences, such as the US Treasury proposal to implement Pillar One on a ‘safe harbour’ basis and the continued application of Digital Services Taxes (DST) by some jurisdictions, which have to be resolved to reach a multilateral agreement.

Taking account of the progress that has been achieved so far, IF members reaffirm their commitment to bridge the remaining differences and reach agreement on a consensus-based solution by the end of 2020.

On February 10, 2020, the Dutch State Secretary of Finance stated that the Netherlands is as open as possible in the discussion on the further elaboration of the Unified Approach. The State Secretary further stated that with an open attitude the Netherlands is also willing to consider the US Treasury proposal to implement Pillar One on a ‘safe harbour’ basis and to consider the advantages and disadvantages of such an approach. The State Secretary however noted that in first instance a safe harbour approach is less appealing to him.

Impacts on MNEs

The outline will have the following potential impacts on MNEs, if agreed upon as its:

  • Separate developments next to the Arm’s Length Principle (ALP). MNEs need to consider the interplay between the Unified Approach and the ALP in designing their transfer pricing policies;
  • In principle only large MNEs are affected (comparable to CbC thresholds). This development will however resonate towards smaller MNEs;
  • It has also an impact broader than digitalisation having extended to businesses which have not adopted highly digitalized business models, such as consumer-facing business;
  • This may fuel Tax Authorities to widen the scope of the ALP (increase mark-up for profits on sales/distribution income or apply profit split methods);
  • Potential duplications, in different jurisdictions, over the three profit allocation approaches, will create a great uncertainty and give rise to proliferation of tax disputes; and
  • The “ring fence” in general and the carve outs in particular will de-incentive/ incentive businesses to move away into certain activities;


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Nedelina Vasilkova

Nedelina Vasilkova is an associate and applicant member of the Dutch Association of Tax Advisers (NOB)

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