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Navigating Transfer Pricing in the Digital Economy: A Guide for US Businesses

On October 8th, 2021, 136 member countries of the OECD/G20 Inclusive Framework on BEPS (Base Erosion and Profit Shifting), including the US, joined the Statement on the Two-Pillar Solution to Address the Tax Challenges Arising from the Digitalisation of the Economy. The Statement finalised the agreement concluded in July 2020 to reform international tax rules.

Pillar One aims to re-allocate some taxing rights over multinationals from their home countries to the market jurisdictions where they conduct business and earn profits, even if they do not have a physical presence there. This would apply to multinational enterprises (MNEs) with global turnovers of more than EUR 20 billion and with profitability above 10%. The agreement provides that 25% of the profit above the 10% threshold will be allocated to the market jurisdictions. The turnover threshold is expected to reduce to EUR 10 billion after a successful implementation of the provisions, with the relevant review planned to begin seven years after the agreement comes into force. Extractives and regulated financial services are excluded from the Pillar One provisions. The nexus rule will permit the allocation of an amount (Amount A) to a market jurisdiction if an MNE obtains at least EUR 1 million in revenue from the market jurisdiction. For countries whose GDP is lower than EUR 40 billion, the nexus is to be set at EUR 250,000. Dispute prevention and resolution mechanisms are to be put in place to avoid double taxation.

Pillar Two provides for a global minimum corporate tax rate of 15% applicable to MNEs with revenue above EUR 750 million. An Income Inclusion Rule (IIR) will operate to impose a top-up tax on the parent entity in relation to the low taxed income of a constituent entity of the multinational enterprise. An Undertaxed Payment Rule (UTPR) will deny a tax deduction or require an equivalent adjustment where the low tax income of a constituent entity is not subject to tax under the IIR. A treaty-based Subject to Tax Rule (STTR) would permit source jurisdictions to impose some source taxation on certain related party payments that are subject to tax below a minimum rate.

To give effect to the agreed reforms, a multilateral convention is to be signed by countries during 2022, with effective implementation in 2023. Further details are to be developed on the interaction between the Global Intangible Low Taxed Income (GILTI) and the global minimum tax.

The US has opposed unilateral digital services taxes introduced by some countries due to their discriminatory effect on US businesses. However, the US has reached an agreement with some European countries, including the UK, France, and Italy, that they will withdraw their unilateral digital service taxes when the OECD proposals on the taxation of the digital economy (Pillar One) take effect. In the interim period before the OECD proposals take effect, a tax credit will be available to taxpayers if the amount of digital service tax in a period exceeds the amount that would have been payable under the Pillar One proposals. The US has agreed to drop its proposed trade actions in relation to the unilateral digital service taxes until the end of the interim period.

On November 24th, 2021, the US concluded a similar agreement with India in relation to the Indian E-commerce Equalization Levy (EL). Under the agreement, India will collect the tax until March 31st, 2024, or until the implementation of Pillar 1 of the OECD agreements on the taxation of multinational companies and cross-border digital transactions, whichever is earlier. The US will suspend its trade tariff measures against India. A similar agreement has also been reached with Turkey, which will remove its existing DST before the entry into force of Pillar 1 of the OECD proposals.

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