(This blog was first published in Swedish on November 1, 2021)
Introduction
Most delegates participating in OECD meetings mainly act as spectators. Either they say nothing or they read out prepared talking points when a certain agenda item is dealt with. Their participation is primarily aimed at being able to report back home on what is going on internationally.
Ultimately, only a handful of countries are active in the meetings and contribute to the development of solutions to the problems addressed. Despite that the OECD's membership has increased in recent years and despite the fact that a large number of non-OECD countries now participate in the OECD's work, it is essentially the same group of countries that run the discussions at the meetings.
The above, however, applies with one notable exception - India. The Indian delegates have really added value to the OECD. They are knowledgeable, constructive and able to analyze arguments and proposals at a sitting meeting.
It is therefore no coincidence that India is behind the recently adopted Article 12B of the UN Model Agreement on the Avoidance of Double Taxation.
2. Article 12B
Like the G20/OECD Pillar 1 agreement, Article 12B aims at taxing digital companies operating in source states without (or with minimal) physical presence.
In comparison with the OECD Pillar 1, which in terms of complexity is a complete nightmare, Article 12B is brilliant in its simplicity.
Article 12B is a classic gross-based withholding tax - comparable to the withholding tax provisions on dividends, interest and royalties in tax treaties (1) - which is levied on payments for "automated digital services". Furthermore, the following applies with regard to the treaty provision:
the withholding tax rate is to be negotiated between the contracting states but is recommended not to exceed 3-4 percent;
the term “automated digital services” refers to digital transactions that do not require the service provider to participate in person in the conclusion of the contract. Examples of such transactions are subscriptions to various types of streaming services or the purchase of advertising space on digital platforms;
it differs from traditional digital taxes in that it only focuses on where the payer - not the user - resides. It does not matter where the contract is concluded. There are also no threshold levels that must be reached for the provision to apply (e.g., that the total payments during the year exceed a certain amount). The provision can thus not be accused of targeting only US GAFAM-companies, which has been the reason why the US has found other variants of digital taxes discriminatory; and
it enables the digital company to alternatively be taxed on a net basis on a certain calculated share of the profits derived in the source state. The net taxation rule primarily aims to avoid loss-making companies paying tax on a gross basis.
3. Brilliant in its simplicity
In comparison with the OECD Pillar 1, which in terms of complexity is a complete nightmare, Article 12B is brilliant in its simplicity. Radhakishan Rawal (India) noted in an article in the Asia-Pacific Tax Bulletin (2) that it took a group of UN delegates less than a month to draft the treaty provision. This can be compared to pillar 1, which after six years of work is still not completed.
OECD delegates to the UN Committee on Taxation voted against the inclusion of Article 12B in the UN Model Agreement
In fact, Article 12B is all that Pillar 1 is not:
While pillar 1:
covers a wide range of activities, Article 12B focuses only on "automated digital services";
prevents countries from adopting other types of digital taxes, Article 12B leaves countries' tax sovereignty intact;
contains a series of threshold levels that must be met in order for the rules to apply, Article 12B covers all payments for automated digital services, which in administrative terms makes it easy to apply; and
assumes that a large number of countries participate in the calculation of the multilateral tax base (which may include the establishment of both multilateral "Early Certainty Panels" and arbitral tribunals), the source state itself calculates the amount subject to withholding tax (gross taxation) or the tax base (net taxation).
Despite the foregoing, the OECD countries' delegates in the UN Tax Committee voted against introducing Article 12B in the UN Model Agreement. (3) Simply put, developing countries voted for and industrialized nations against the proposal. This inevitably raises the question why the rich countries are so critical of Article 12B.
4. Money and power end up in the wrong place
The official reasons why "a large minority" (read: industrialized countries) are critical of Article 12B can be found in the official Commentary to the provision. The criticism is mainly aimed at the fact that established international tax rules do not allow countries taxing rights solely on the grounds that a foreign company sells goods and services within a territory. The company must also have established a physical presence in order for taxing rights to arise. However, this criticism has since become obsolete because the OECD itself - via the Pillar 1 agreement - now also accepts the principle that "the market" and "sales" in themselves can (in relation to a certain category of income) establish legitimate tax claims for a state.
It is accordingly pure self-interest driving the OECD countries' criticism of Article 12B
Other criticism raised consists of shedding crocodile tears over the adverse effects that developing countries may suffer in the form of new administrative burdens, increased consumer prices for digital products, a deteriorating investment climate and businesses relocating out of their countries.
Such criticism may have some relevance in the individual case. It is therefore not self-evident that all developing countries should include such a provision in their tax treaties.
Nevertheless, these arguments are only smoke screens that hide the primary reasons for the resistance. When tax treaties are negotiated with developing countries, the OECD countries' goal is to ensure that their multinational enterprises (MNEs) pay as little tax as possible in the developing country. Insofar their MNEs have to pay tax somewhere, the OECD countries prefer to collect the tax themselves. OECD countries justify this objective by arguing that lower tax rates in developing countries promote the investment climate. However, the inclusion of Article 12B in a tax treaty has the exact opposite effect. It leads to an increased tax burden for the digital companies concerned and that the developing country's right to tax a certain industrial sector increases at the expense of the OECD country.
Admittedly, the purpose of OECD Pillar 1 is also to improve countries' ability to tax digital activities. But what is basically sought under Pillar 1 is to bring about a redistribution of the global digital tax cake between the rich countries. From the point of view of the OECD countries, Article 12B leads to the redistributed tax revenues falling into the wrong pockets.
It is accordingly pure self-interest driving the OECD countries' criticism of Article 12B. They have no interest in contributing to developing countries being given greater opportunities through Article 12B to tax the OECD countries' digital companies. Such a provision could theoretically only be acceptable if the developing country had a corresponding digital industry that could be taxed in the OECD country. But no such industry exists in developing countries.
This is the first time that the UN has succeeded in reaching agreement on an international tax issue that is in direct conflict with the position tasken by the OECD
Another reason for the opposition to Article 12B is that the OECD and its member countries (especially the United States) want at all costs to retain control over international tax issues. During my 10-year period at the OECD, we tried systemically to undermine all attempts by the IMF, the World Bank, the EU and the UN to establish themselves in the international tax area. The larger the influence other organizations have on international tax issues, the more diluted the OECD's control become over “the rule-making process”.
It is against this background that the OECD and the United States worked in tandem to kill the European Commission's digital tax proposal. This also explains why the OECD completely ignores the UN Tax Committee's decision to include Article 12B in the UN Model Agreement.
5. Concluding remarks
Article 12B is particularly suitable for developing countries with limited resources and skills in the international tax field. Notwistanding, it is highly unlikely that any OECD country (and in particular United States) will ever enter into tax treaty with a developing country that includes such a provision. But this reality is really beside the point.
Article 12B is a major political success for the UN Tax Committee because this is the first time it has managed to agree on a position on an international tax issue that is in direct conflict with the position taken by the OECD. Through the adoption of the provision, the UN is taking up more space in the international arena and at the same time advancing developing countries' interests on issues concerning the (re)distribution of the global tax cake.
It will be interesting to see whether the UN action on this issue will set a precedent also regarding future work in this area.
(1) The provision is in fact most similar to Article 12A (Technical Fees) of the UN Model Agreement.
(2) Radhakishan Rawal, "Taxation of Digitalized Economy - Proposed UN Solution", Asia-Pacific Tax Bulletin, No. 3, Volume 26 (2020).
(3) The delegates do not represent their countries but only themselves in the UN Committee on Taxation because the Committee does not have the status of an intergovernmental body. In practice, however, the delegates always defend the interests of their respective countries.
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