The Uber Plan: Taxing Profits in the Digital Economy

Say what you will about the OECD reflecting the economic desires of rich countries. The group's recent work on the digital economy – better known as BEPS 2.0 (that is, the second generation of the base erosion and profit-shifting project) – is notable for its inclusiveness. More than 130 nations have joined the OECD Inclusive Framework, a diverse assortment of jurisdictional stakeholders encompassing both OECD members and nonmembers. 

Corporate interests are also well represented. Beyond the influence of the U.S. Council for International Business, some U.S. companies are promoting their own proposals for a new international tax regime. Among them is Uber, the popular ride-hailing service based in San Francisco. Uber typifies both the digital economy and the sharing economy. In a short time, it has grown to be one of the world’s largest transportation providers. The company is active in more than 700 metropolitan areas worldwide, so it should know something about cross-border taxes.

For all these reasons, we were excited when Uber released its vision for the future of the global tax regime. Tax Notes International published the plan on August 19. The plan is limited to the so-called pillar 1 issues in the OECD’s work program — that is, issues surrounding nexus and profit attribution. Francois Chadwick (the company’s vice president of finance, tax, and accounting) has said that Uber will address the pillar 2 issues such as global minimum taxation in a future article.

 Uber’s Plan for the Future of International Tax

The intricacies of Uber’s plan are beyond the scope of this post; you’ll need to read the Tax Notes article for that level of detail. And you should, in part because the proposal is generally aligned with views expressed by U.S. Treasury Department officials.¹ The takeaway is that Uber endorses a modified residual profit-split approach, with several key simplifications built in. It seeks to distinguish between routine profits — which would be taxed according to existing standards — and profits derived from specified marketing intangibles. Once separated out from other profits, this latter category of profit would be eligible for special treatment with greater taxing rights assigned to source countries. A thumbnail sketch of the proposal follows.

Step One: Determine Total Profits to be Split

This calculation draws from the group’s financial statements, as opposed to being performed on an entity-by-entity basis. The financial statements are audited, so taxpayers can’t easily manipulate the numbers to suit a preferred outcome.

Step Two: Remove Routine Profits

This is also done on a group basis and relies on a convenient formula. Routine profits are deemed to be the greater of 4 percent of worldwide sales revenue or 15 percent of tangible assets. For these purposes, sales are defined as third-party sales, excluding intragroup transactions. Tangible assets are defined as depreciable or amortizable assets other than goodwill. After separating out this approximation of the firm’s routine profits, the remainder is deemed to be the residual profit attributable to intangibles.

Step Three: Remove Product Intangibles

It is not enough to approximate all profit derived from intangibles because not all intangibles are equal in terms of their linkage with juridical taxing rights. Uber would have us distinguish between product intangible profits (PIP) and market intangible profits (MIP). The former (PIP) would be taxed in the conventional manner while the latter (MIP) would be eligible for the new attribution rules.

Calculating the split between PIP and MIP sounds intimidating. Here, Uber would not rely on the modified residual profit-split method to determine the corresponding percentages. Instead, it advocates using a table with predetermined splits based on the ratio of a firm’s research and development expenses over its selling, general, and administrative expense expenses. The table consists of eight tiers, with split values ranging from a low of 30 percent PIP (70 percent MIP) to a high of 77 percent PIP (23 percent MIP).

The rationale for the tiered approach is that the more money a corporation spends on R&D (proportionally to its overall spending) the more likely it is to have a profit profile that relies on product intangibles relative to marketing intangibles. This reflects the notion that hard assets aren’t the central culprit in corporate profit shifting and double nontaxation. To safeguard against firms manipulating the PIP-MIP split, R&D costs would only be included in the ratio if they were fully disclosed and identified in the firm’s audited financial statements. (Note that artificially inflating your R&D spending would have the effect of tilting the split toward more PIP and less MIP.)

Uber did not pull these split percentages out of thin air. It claims to have performed economic analyses to establish that the figures in the PIP-MIP table closely correlate to the result you would achieve from performing an actual residual profit split. The table is a means of simplification, and precision is a natural cost. But simplification is important to ensuring the various stakeholders in the OECD’s Inclusive Framework will find the regime workable. In particular, simplification is a priority for many developing economies that might lack the resources or institutional experience to perform the countless profit-split calculations that would otherwise be necessary.

Step Four: Determine Taxable MIP

Thus far, the steps in Uber’s proposal have been aimed at isolating that narrow slice of profits derived from marketing intangibles. But the plan is not done yet.

The figure Uber refers to as MIP must be further segmented between those profits attributable to market externalities and the profits attributable to so-called DEMPE functions. DEMPE is an acronym for development, enhancement, maintenance, protection, and (commercial) exploitation. Uber’s plan treats 80 percent of MIP as DEMPE-related and taxable under the existing international tax regime. Ultimately, it is only the jurisdiction to tax the remaining 20 percent of MIPs — the residual of a residual — that is shared with source countries. Even then, a source jurisdiction would only be able to claim taxing rights if its prorated share of taxable MIP exceeds a numerical threshold expressed in terms of sales revenues. Uber proposes a threshold of €25 million.

Conclusion

Uber’s simplified tabular approach for determining PIP-MIP splits is bound to draw scrutiny. The same is true for the plan’s proposed 80/20 split favoring DEMPE functions and the calculation Uber uses to approximate routine profit (that is, the greater of 4 percent of sales or 15 percent of hard assets). How one views the Uber plan may largely depend on one’s tolerance for such approximations.

Purists may complain that the plan is a form of rough justice that relies heavily on simplified formulas. So be it. The same characteristics might just as easily be seen as virtues. A solution to BEPS 2.0 that is too complex is no solution at all. In this context, a bit of rough justice might be just what the doctor ordered.