On February 21, 2022 the OECD opened a public consultation on the Draft Rules for Tax Base Determinations under Amount A of Pillar One, which it published on the same date as part of the ongoing work of the OECD/G20 Inclusive Framework on BEPS to implement the Two-Pillar Solution to Address the Tax Challenges Arising from the Digitalisation of the Economy. The consultation period runs until March 4, 2022.

The purpose of the tax base determinations rules is to establish the profit (or loss) of an in-scope MNE that will be used for the Amount A calculations to reallocate a portion of its profits to market jurisdictions. The rules determine that profit (or loss) will be calculated on the basis of the consolidated group financial accounts, while making a limited number of book-to-tax adjustments. The rules also include provisions for the carry-forward of losses.

The OECD notes that although the Inclusive Framework on BEPS has agreed to release this public consultation document (également disponible en français) in order to obtain public comments, the draft rules do not reflect consensus regarding the substance of the document. According to the OECD, the stakeholder input received on the Draft Rules for Tax Base Determinations will assist members of the Inclusive Framework in further refining and finalising the relevant rules.

Introduction

Following years of intensive negotiations to update and fundamentally reform international tax rules, 137 members of the OECD/G20 Inclusive Framework on BEPS (Inclusive Framework) joined the Statement on the Two-Pillar Solution to Address the Tax Challenges Arising from the Digitalisation of the Economy (the Statement) released in October 2021. The Statement sets out the political agreement on the key components of Pillar One and Pillar Two.

Amount A of Pillar One has been developed as part of the solution for addressing the tax challenges arising from the digitalisation of the economy. It introduces a new taxing right over a portion of the profit of large and highly profitable enterprises (hereafter, “Covered Groups”) for jurisdictions in which goods or services are supplied or consumers are located (hereafter, “market jurisdictions”).

The Inclusive Framework has mandated the Task Force on the Digital Economy (TFDE) – a subsidiary body – to advance the work needed to implement Amount A. In particular, the TFDE has been charged with developing the Multilateral Convention (MLC) and its Explanatory Statement as well as the Model Rules for Domestic Legislation (Model Rules) and related Commentary through which Amount A will be implemented.

Model Rules

The Model Rules, once finalised, will reflect the substantive agreement of the members of the Inclusive Framework on the functioning of Amount A and will serve as the basis for the substantive provisions that will be included in the MLC. The Model Rules are also being developed to provide a template that jurisdictions could use as the basis to give effect to the new taxing rights over Amount A in their domestic legislation. They will be supported by a commentary. 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 Model Rules will cover all aspects of Amount A that would be translated into domestic law. They will consist of different titles. This document contains the sections on tax base determinations (which are currently Title 5) as well as relevant definitions (currently included in Title 9) that are referenced in the sections on tax base determinations.

Model Rules on Tax Base Determination

This document contains the draft Model Rules for tax base determinations, which would be contained in Title 5 of the Model Rules described above. It also contains relevant definitions (currently included in Title 9) that are referenced in the sections on tax base determinations. Both the Model Rules for tax base determinations and the relevant definitions will be translated into the MLC and Explanatory Statement.

The Model Rules on Tax Base are designed to calculate the profit (or loss) of a Covered Group that will be used for Amount A calculation purposes. The tax base is therefore the measure of profit that forms the basis for partial reallocation under Amount A rules.

Given that Amount A is a new taxing right that is determined based on the profits of a group (rather than on a separate entity basis), it is necessary to use consolidated group financial accounts as the starting point for computing the Amount A tax base. This approach also has the advantage that the Amount A tax base is less affected by controlled transactions. The draft Model Rules in this document do not include the tax base rules that will be necessary for Covered Groups that are subject to segmentation for Amount A purposes, which will be released at a later date.

Under the Model Rules, Covered Groups would be required to calculate their profits using Qualifying Financial Accounting Standards (which are defined in the Model Rules) to ensure that the profit that is applied for Amount A purposes is not impacted by accounting practices that do not align with common practice. Given that the scope of Amount A includes only a limited number of large and highly profitable enterprises, it is anticipated that most such Covered Groups will be preparing financial accounts using these standards at present for commercial or regulatory purposes. Further, the financial statements of Covered Groups would have to be subject to external audit, thus providing a reliable source of information that is typically readily available to tax administrations.

Subject to specified exclusions, all items within the consolidated P&L statement will be taken into consideration to determine the tax base of the Covered Group. This means the computation of the Amount A tax base will start from the bottom line figure of the P&L statement (i.e. the total for profit or loss). From this point, certain book-to-tax adjustments will be made (such as the deduction of certain items of income and the adding back of certain expenses) to arrive at a standardised Adjusted Profit Before Tax figure. The adjustments adopted reflect instances where the goals of accounting standards and Amount A may differ in some points, including occasions where adjustment is required to prevent potential double counting of income or to prevent the deduction of specified expenses for policy reasons. For ease of administration and compliance, these adjustments will be kept to a minimum in order to limit complexity, and align where possible with adjustments under Pillar Two.

Tax base is also subject to adjustment with respect to profit (or loss) restatements in relation to prior periods. Subject to certain limitations, restatements required under accounting rules are attributed to the tax base of the Covered Group in the period that the restatement is identified and recognised, rather than going back and recalculating tax base for prior closed periods. This is expected to be consistent with the approach taken in relation to other elements of the Amount A calculation.

To limit any reallocation under Amount A to economic profit, tax base determination is also subject to loss carry forward rules. These rules require that unrelieved losses of a Covered Group incurred in a prior period (hereafter, “Net Losses”) are carried forward and offset against any subsequent profit of that Group, following an ‘earn-out’ mechanism. Specific rules apply in a number of instances, such as for (a) pre-implementation losses (i.e. Net Losses incurred prior to the introduction of Amount A), and (b) losses transferred following certain types of defined business reorganisations.

The Model Rules on tax base determination also consider the introduction of time limitations to the utilisation of Net Losses, a question that is still under discussion within the TFDE.

The public consultation document: Pillar One – Amount A: Draft Model Rules for Tax Base Determinations can be found here.

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