The aftermath of the global financial crisis of 2008 saw governments emphasizing the need to generate additional tax revenues to stimulate their economies. This drive, especially relating to international tax, raised a potential issue where countries come up with unilateral tax measures to drive revenue growth, which if not implemented in a coherent manner could hurt Multinational Enterprises (MNEs) and thereby curb international trade. Due to this and other reasons, the G20 countries mandated the Organisation for Economic Co-operation and Development (OECD) to review the existing international tax rules and come up with new rules that were fit for purpose. This birthed the OECD's Base Erosion & Profit Shifting (BEPS) initiative in October 2015 that resulted in 15 Action Points. Although Action 1 focused on addressing the tax challenges associated with the digital economy, it has been one of the few action points that has taken a while to address. After years of work on Action 1, in October 2021, the OECD/G20 Inclusive Framework (IF) on BEPS [comprising of 137 members as at 4 November 2021] came up with a Two-Pillar solution to address the tax challenges associated with globalization and the digital economy.
A number of jurisdictions including Nigeria while waiting for the OECD IF to complete their work on Action 1, went ahead to unilaterally introduce Digital Services Taxes (DSTs). This is clearly in variance with one of the key goals of the OECD BEPS initiative – achieving coherence in the international tax rules. Nigeria is also among the four countries who are members of the OECD IF that have refused to sign on to the Two-Pillar Solution.
This article focuses on the potential implications of the DST for the Nigerian economy and businesses and the implications of the Two-Pillar Solution.
The Two-Pillar Solution
The Two-Pillar solution comprises of Pillar 1 and Pillar 2. Pillar 1 addresses the fundamental premise of international tax rules requiring a physical presence in a country before the country has a right to tax. Subject to certain thresholds, profits of large MNEs will now be allocated to market jurisdictions that they generated material sales irrespective of a lack of physical presence in those jurisdictions. On the other hand, Pillar 2 seeks to curb incentives for MNEs to shift profits from high tax jurisdictions to tax friendlier jurisdictions by introducing a global minimum tax regime (15%) through a series of interlocking rules.
Nigeria's refusal to sign up to the Two-Pillar Solution stems primarily from the perception that tax revenue from the application of the DST would be maximized compared to under the Two-Pillar Solution. There is the concern that the in-scope MNEs under the Two-Pillar solution will be limited because of the strict minimum thresholds for its application. Pillar 1 will apply to MNEs with global turnover above €20billion and profitability above 10% while Pillar 2 will apply to MNEs with global turnover above €750m. Also under Pillar 1, MNEs must have derived at least €1 million in revenue in any financial year and only 25% of their residual profit i.e. profit in excess of 10% of revenue, will be allocated to market jurisdictions with nexus using a revenue-based allocation key.
This means that very few MNEs in Nigeria will be in-scope despite the fact that they have footprints in Nigeria with few MNEs having a portion of their residual profits allocated to Nigeria. Hence, there is a clear incentive for Nigeria to opt for a unilateral DST to maximize tax revenue.
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