On October 8, 2021, all but four of the 140 member jurisdictions of the Organisation for Economic Co-operation and Development/Group of 20 (OECD/G20) Inclusive Framework on Base Erosion and Profit Shifting (IF) agreed by consensus to the revised blueprint of the two-pillar solution “to address the tax challenges arising from the digitalisation of the economy”, dubbed Pillar One and Pillar Two.
This monumental achievement was immediately echoed by G20 finance ministers in their October communique on plans to sign the multilateral convention (MLC) in mid-2022, followed by global enforcement in 2023.
This means that in less than two years, all member jurisdictions, including Indonesia, must prepare all necessary measures to implement both pillars while coordinating with the OECD’s Task Force on the Digital Economy (TFDE) to finalise the rules.
What do we know of these initiatives so far? And what impacts are anticipated on Indonesia’s current tax regime? The two-pillar solution has been the long-anticipated outcome of Action 1 of Base Erosion and Profit Shifting (BEPS) 2015, which issued an urgent call for global solutions on tax issues in dealing with the digital economy.
Pillar One introduced the novel concept of nexus and share of income taxing rights that does not rely on a company’s physical presence in a market jurisdiction, hence addressing the gap in existing tax treaties on tackling the free rider problem.
Pillar Two, meanwhile, focused on addressing the remaining BEPS issues by introducing global minimum tax through several new rules, including the Income Inclusion Rule, Undertaxed Payment Rule and Subject to Tax Rule.
Focusing on Pillar One, the October 2021 statement updated several building blocks divided into three components called Amount A, Amount B and Tax Certainty. Amount A is the manifestation of the new nexus and taxing rule that covers only multinational enterprises (MNEs) with global revenues of more than €20 billion ($22.6 billion) and profitability of more than 10 per cent. If an MNE derives revenue of at least €1 million from a particular jurisdiction, it has a nexus pursuant to Pillar One and the jurisdiction will be entitled to taxing rights proportionate to 25 per cent of the residual profit of the covered MNE.
Any potential or emerging dispute from the application of Amount A will be addressed using the Tax Certainty mechanisms. Additionally, Amount B introduces a simplified application of the arm’s length principle for baseline marketing and distribution activities.
With this breakthrough, the market jurisdictions from which foreign businesses have derived revenue via their digital presence in the “cloud” will be able to tax the profits of such companies, irrespective of their physical presence (ie, subsidiaries or permanent establishments) in those jurisdictions, which has been a primary requirement under existing tax treaties and even domestic laws.
However, given that the scope of Pillar One does not only ring-fence digital companies, its application will capture all types of businesses insofar as the revenue, profitability and nexus thresholds are met, excluding some industries such as the extractive industry and regulated financial services.
Applying this rule will thus affect Indonesia’s entire corporate income tax (CIT) regime as regards MNEs. The anticipated effects include additional tax revenue from the reallocation of Amount A, whereby the OECD stated in October 2021 that more than $125 billion of profits will be reallocated to market jurisdictions each year through Pillar One.
However, given that the rule’s scope may also cover registered foreign subsidiaries and permanent establishments already paying taxes in Indonesia, if the taxing rights calculated under Amount A results in a lower amount than that of the current domestic regime, it will create forgone revenue. Therefore, the government needs to mitigate both potentials carefully through accurate impact assessments.
In addition, supposing that the administration of Amount A follows the model to be developed under the Pillar One initiative, this will also affect the applicable administrative rules in Indonesia as well as the tax administration system used by the Directorate General of Taxation and taxpayers. Indonesia must tackle any necessary changes or upgrades in tax administration to ensure swift transition in the remaining months.
Another anticipated effect regards the removal of unilateral measures. Prior to the October 2021 consensus, many European jurisdictions tried to capture the potential revenue of nonresident digital businesses by unilaterally enforcing the Digital Services Tax (DST), eg, Austria, France, Italy, Spain and the UK.
However, given that the existing tax treaties do not acknowledge such a measure, the taxes so charged would not be creditable against the payable CIT in the residence jurisdiction of a company and thereby lead to a significant risk of double taxation.
To eradicate this risk, one of the agreed terms of the October 2021 consensus is the removal of all unilateral measures and that no digital service tax or other similar measures may be enacted from October 8, 2021 until December 31, 2023. This is in line with the suspended enforcement of Indonesia’s electronic transactions tax under Law No 2/2020, even though its legal status is now under question after the October 2021 decision upon judicial review.
To conclude, the development of the two-pillar solution is an incredible illustration of international coordination in addressing the global challenges of taxation. It demonstrates massive political and economic compromise among the 140 participating jurisdictions in finding a global taxation model that responds to the challenges of the digital era.
The high expectations and amount of preparatory work that need to be done within the short time that remains will surely create high pressure on the TFDE in pursuing its timely implementation. The challenges are also significant at the domestic level, particularly in terms of risk mitigation, impact assessments and implementation.
Muh Ichwanuddin is a senior transfer pricing analyst at the Indonesian Finance Ministry’s Directorate of International Taxation and a graduate of advanced international tax law at Leiden University. The views expressed are personal.
THE JAKARTA POST/ASIA NEWS NETWORK