OECD progresses plans to address the challenges of the digitalised economy

The OECD has set out plans to examine radical changes to the international tax rules which may allocate increased taxing rights to market jurisdictions.


For the OECD's programme to reach a consensus on proposals for the international taxation of the digital economy, see "A consensus solution for the tax challenges of the digital economy: OECD report".

The Organisation for Economic Co-operation and Development (OECD) has released a Policy Note on the work it is taking forwards to address the tax challenges created by an increasingly digitalised economy following meetings held in July and December 2018. The OECD proposes to examine two “pillars” which may form the basis of a future consensus on action to be taken. The first pillar involves a broad review of the allocation of taxing rights and the PE concept, whilst the second pillar focuses on remaining BEPS (base erosion and profit shifting) issues.

Whilst there may not as yet be any positive decision as to what exactly to do, there is, perhaps, a sense of forward direction of travel. Indeed, the proposals are wide ranging and novel and may, if developed, result in a major change to the international tax landscape in years to come.


The tax treatment of the digital economy was specifically addressed by the (OECD in Action Point 1 of its Base Erosion and Profit Shifting (BEPS) Project. In its final Report, the OECD essentially concluded that, because the digital economy is so closely integrated into the economy as a whole, it would not be feasible to ring-fence the digital economy for tax purposes. Since the Action 1 report, focus has shifted back to the tax treatment of the digital economy as a number of jurisdictions concluded that more was needed to ensure fair taxation of businesses acting within that industry. As a result, the G20 mandated the OECD to bring forward delivery of an Interim Report.

The OECD’s March 2018 interim report, entitled “Tax Challenges Arising from Digitalisation” recognised that there was no general consensus among participating jurisdictions as to whether, and if so what, further measures to tackle taxation of digital services were needed. As such, the publication of the Interim Report was in many ways an indication of how much disagreement remained amongst participating members.

In the meantime, the EU Commission has put forward proposals to address the tax treatment of companies operating in the digital economy, seeking to influence developments in relation to the taxation of the digital economy and ensure that the EU acts in a co-ordinated manner. In addition, several jurisdictions have commenced implementation of unilateral, domestic measures, such as the UK’s proposed Digital Services Tax.

These developments appear to have spurred the OECD and participating States into intensifying their work in this area and have led to the publication of the Policy Note.

The Policy Note

The Policy Note explains that the working group has reached agreement to examine proposals across two main areas or “pillars”, which may form the basis of a consensus on the way forward. The first pillar addresses the broader challenges of the digitalised economy and focuses on the allocation of taxing rights including issues of nexus. The second pillar addresses remaining BEPS concerns.

Under the first pillar, the Note explains that proposals have been made that would allocate more taxing rights to market or user jurisdictions “in situations where value is created by a business activity through participation in the user or market jurisdiction that is not recognised in the framework for allocating profits”. These proposals, of which there are three main strands, will be explored on a without prejudice basis.

The first strand would be to revise the international tax rules around profit allocation and nexus to recognise “active user contribution” in relation to “highly digitalised businesses”. The second strand is to recognise the value to the products or services supplied by a business which is created by the market in which a business operates. This second strand is not limited to highly digitalised businesses. The third strand is to explore basing taxing rights on the existence of a “significant economic presence” through, for example, a certain level of sales in a jurisdiction.

It is important to note that the implications of these proposals may affect fundamental aspects of current international tax rules. For example, some of the proposals would require reconsidering the current transfer pricing rules, requiring a move away from the arm’s length principle. Others go beyond the current cornerstone of the current rules, determining taxing rights by reference to a physical presence, including considering changes to the PE concept by, for example, looking at the concept of a “significant economic presence” and giving increasing significance to the destination jurisdiction for goods and services. The Note recognises that any changes to profit attribution and nexus rules would need to be developed contemporaneously “with each playing a key role in any solution ultimately adopted”. Indeed, these changes are likely to require changes to bilateral tax treaties.

Under the second pillar, promoted by Germany and France in particular, the working group will explore on a “without prejudice” basis, strengthening the ability of jurisdictions to tax profits where the other jurisdiction with taxing rights applies a low effective rate of tax to those profits. In particular, the working group will look at proposals for a minimum level of tax. The proposal under this pillar would be designed to address the continued risk of profit shifting to entities subject to no or very low taxation through the development of two inter-related rules: an income inclusion rule (under which low tax profits might be taxed in the hands of a related investor) and a tax on base eroding payments (allowing a source country to deny deductions or tax such payments made to low tax jurisdictions).

The Policy Note stresses that any new rules to be developed should not result in taxation when there is no economic profit nor should they result in double taxation. It also stresses the importance of tax certainty, the need for effective dispute prevention and dispute resolution tools and then need to make any rules as simple as the tax policy context permits.


It is important to note that there is only agreement to explore these proposals on a “no prejudice” basis at this stage. There is a long way to go before any agreement is reached on positive action. The next stage is to set out a detailed programme of work for agreement in May 2019 with a view to reporting progress to the G20 in June 2019 and delivering a solution in 2020.

However, the scope of the issues to be discussed is extensive and holds out the prospect of significantly altering the international tax landscape, including a greater focus on the value created by the market jurisdiction and not only in the context of highly digitalised businesses. Indeed, there is recognition that the changes needed may need to depart from the operation of the arm’s length principle, which is a fundamental feature of the international tax landscape.

This document (and any information accessed through links in this document) is provided for information purposes only and does not constitute legal advice. Professional legal advice should be obtained before taking or refraining from any action as a result of the contents of this document.