Pillar One – the new taxing rights reform

On 12 October 2020 the OECD released a proposal, comprising Pillar One and Pillar Two Blueprints for a breakthrough reform in the international tax arena. They represent a structural shift in international taxation and transfer pricing through a reallocation of both taxing rights and non-routine profits in favour of ‘market jurisdictions’ for digital services and consumer-facing businesses deviating from the arm’s length principle.

The current review discusses the key takeaways of Pillar One Blueprint only, as it is the OECD’s response to the recent proliferation of unilateral digital taxes introduced and/or contemplated by some jurisdictions. It is envisaged that the process of finalising all aspects surrounding Pillar One will be completed by June 2021.

1. Background

The question ‘how to tax e-commerce’ was first addressed at the November 1997 conference entitled “Dismantling the Barriers to Global Electronic Commerce”, held in Turku. Following the conference, it took the Members of the OECD's Committee on Fiscal Affairs four years to reach a consensus on how to apply conditions that, under tax treaties, determine a country's right to tax profits from electronic commerce.

The consensus related to the interpretation, as regards e-commerce, of the conditions under which business activities of an enterprise in a given country are or are not carried out through a permanent establishment, is the basic criterion that determines the country's right to tax. The main elements of the consensus reached by the Members of the Committee are as follows:

► a web site cannot, in itself, constitute a permanent establishment (“PE”);   

► a web site-hosting arrangement typically does not result in a PE for the enterprise that carries on business through that web site;   

► an Internet Service Provider will not, except in very unusual circumstances, constitute a dependent agent of another enterprise so as to constitute a PE of that enterprise;   

► while a place where computer equipment, such as a server, is located may in certain circumstances constitute a PE, this requires that the functions performed at that place be significant, and an essential or core part of the business activity of the enterprise.

Despite their efforts, the OECD and its member countries were not able to envisage the expansion of e-commerce and the shift towards digitalised commerce in the following years. This development turned e-commerce into one of the main focus areas of the OECD/G20 Base Erosion and Profit Shifting (BEPS) project, leading to the 2015 BEPS Action 1 report.

In March 2018, the need for a global solution was addressed in the Inclusive Framework on BEPS and it was not until 31 January 2020 that the conceptual framework for Pillars One and Two was outlined in the OECD’s “Statement by the OECD/G20 Inclusive Framework on BEPS on the Two-Pillar Approach to Address the Tax Challenges Arising from the Digitisation of the Economy”.

2. The “consensus”:

(a) Unified approach:

The core idea of Pillar One is to revisit the current tax allocation of jurisdictions by expanding the taxing rights of ‘market jurisdictions’ in respect of residual profits of MNEs. This residual profit will likely be generated by capital, risk management functions, and/or intellectual property, and it will thus be taxed in the jurisdiction where revenue is sourced.

This approach would cover businesses that are able to profit from sustained interaction with customers and users in the market jurisdiction, i.e. automated digital services and consumer-facing businesses.

(b) Components of blueprint of Pillar 1:

The key components can be grouped into three categories:

► Amount A – first part of Pillar 1 Blueprint – it is not necessary for the technical aspects of the new taxing right of market jurisdictions over the share of the residual profit at multinational enterprise group level to be in line with the arm’s length principle;   

► Amount B – second part of Pillar 1 Blueprint - a fixed return for certain baseline marketing and distribution activities taking place physically in a market jurisdiction in line with the arm’s length principle; and   

► Tax Certainty – third part of Pillar 1 Blueprint - improving tax certainty through effective dispute prevention and resolution mechanism.      

(c) Amount A:    


The scope of Pillar 1 Blueprint applies an “activities test”, pursuant to which automated digital services (ADS) and consumer facing businesses (CFB) would be subject to tax on Amount A;

► Consumer-facing businesses: economic operators generating revenue from the sale of goods and services sold to consumers, including those operating selling indirectly to intermediaries and by way of franchising and licensing;

► At this stage, the Blueprint carves out certain industry sectors. Currently, natural resources, the financial services sector, international airlines and shipping businesses…etc. are outside of its scope.

► Automated digital services: these are services provided on an automated and standardised basis to a large and global customer and user base and provided remotely to customers in markets with little or no local infrastructure. These services are comprised of a positive list and a negative list.

Positive list activities: online search engines, social media platforms, online intermediation platforms, digital content streaming, online gaming, cloud computing services, and online advertising services.

Negative list activities: customised professional services, online teaching services, online sale of goods and services other than automated digital services, revenue from the sale of physical goods irrespective of network connectivity, and services providing access to the internet.

New nexus rules:

Under the present structure of Pillar One Blueprint, the new nexus rules could apply differently for automated digital services when compared with consumer facing businesses. For ADS, the nexus is sufficient if the revenues exceed a certain threshold. For CFB, a nexus is sufficient if the revenues exceed a certain threshold and there is a “plus factor” to indicate a significant and sustained engagement with the market (e.g. having a subsidiary or a permanent establishment that provides distribution or sale support services).

Takeaway for Amount A:

Pillar One Blueprint opts to define the taxpayers within the scope of the above-mentioned categories, while at the same time limiting red-tape. However, it omits to take into account the fact that there are certain multinationals with complex business models, both in and out of scope. These would have obstacles when applying the rules of Amount A. Consequently, compliance with the new international tax system would require additional costs.

(d) Amount B:

Amount B would standardise the related-party remuneration provided for distributors performing baseline marketing and distribution functions that occur in each market jurisdiction based on the arm’s length principle. Pillar 1 Blueprint suggests that the Transactional Net Margin Method (TNMM) which has return on sales as profit level indicator would be the most appropriate transfer pricing method associated with the adequate remuneration for the above activities.

However, taxpayers, could easily confute Amount B under local Bulgarian rules if they prove that another TP method is applicable under the hierarchy of methods. For instance, if the taxpayer has been involved in a similar transaction with a third party and this comparable uncontrolled transaction is reliable, the taxpayer could rely on the Comparable Uncontrolled Price (CUP) method rather than on TNMM.

3. Has a consensus been reached?

Finding a harmonised solution which would serve home jurisdictions and market jurisdictions in an equitable manner has proven to be mission impossible for the past 20 years.

Based on the current state of the blueprint, it could be concluded that the amount of resources necessary in order for tax authorities to apply and manage the new taxing rights along with the already existent taxing rules, will likely result in high administrative cost.

Yet, the OECD has proposed dispute prevention mechanisms in this direction – APAs and MAP procedure. However, Bulgaria has not yet implemented APA in its tax legal framework, which would prove challenging for local tax authorities and operators.

Lastly, the proposal published on 12 October 2020 does not reflect a consensus view, leaving a number of technical issues, which must be resolved through political discussions open.

4. Is there an alternative and is it suitable?

The “unilateral approach” of Pillar One proposal is designed to shift from the existing arm's length principle, an important basis of Bulgaria’s existing TP approach, to formulary apportionment. As a result, its implementation in Bulgaria would require a comprehensive tax law reform.

Currently, some countries are promulgating unilateral measures in the form of digital tax reforms. The outcome of such “initiatives”(1), although understandable in terms of need to generate revenue, will result in double taxation for multinationals. It is still arguable whether the unilateral digital taxes fall within the scope of double tax treaties and thus, are subject to credit/exemption. 

(1) In Europe, France has implemented its digital services tax - “Les GAFA” — 3% tax on digital revenues from targeted advertising and sale of data. UK and Italy already tax companies, which have passed on the burden to consumers in those countries. India imposes a 2% Equalisation Levy on foreign e-commerce operators as of April 2020.

For more information on the above, please reach out to Dennitsa Dimitrova and Nikol Nikolova

Kambourov and Partners