The United States wants further public consultation on full draft rules for pillar 1 of the OECD-brokered global tax reform plan once rolling consultations on pillar 1’s main features conclude, a U.S. official said.
“We've been pushing for more and better consultation for a while now, and clearly, once all the [consultation] drafts are out, stakeholders will need to be given time to look at the whole picture and provide full input, at least from our perspective,” Michael Plowgian of the Treasury Office of Tax Policy said May 5. He spoke at a conference sponsored by the District of Columbia Bar Taxation Community.
The OECD is holding a series of public consultations on various building blocks of pillar 1 because of the global tax reform project’s tight timeline. Nearly 140 countries in the G-20/OECD inclusive framework on base erosion and profit shifting, the group responsible for developing and agreeing on the new rules, are trying to finalize the two pillars so they can start taking effect in 2023.
Pillar 1 provides new rules for the formulaic reallocation of residual profits that the largest multinational enterprises earn in countries where their consumers are located, even if they lack a permanent establishment. Market jurisdictions would then be able to tax those profits under a taxing right called amount A.
Amount A rules apply to MNEs with consolidated group revenue exceeding €20 billion and profitability above 10 percent. That turnover threshold could eventually decrease to €10 billion pending a review of the amount A rules. Pillar 1 also provides for amount B, a fixed return for baseline marketing and distribution activities in market jurisdictions, in line with the arm’s-length standard. In addition to the extractives carveout, regulated financial services are excluded from the scope of amount A.
Countries that implement pillar 1 also agree they won’t introduce any unilateral measures they may have adopted in the absence of a multilateral approach to taxing the digital and globalized economy, such as digital services taxes. They also promise to refrain from introducing new unilateral measures in the future. Pillar 2 would ensure that large MNEs pay an effective tax rate of 15 percent in the jurisdictions in which they have operations.
So far, the OECD’s consultations have focused on amount A: its scope, revenue sourcing and nexus rules, tax base determination, and extractives carveout. Future consultations will focus on issues like double taxation relief under amount A, unilateral measures to be withdrawn under pillar 1, and a marketing and distribution profits safe harbor.The inclusive framework has directed the Task Force on the Digital Economy to develop the amount A model rules and related commentary, as well as a multilateral convention and explanatory statement. Business stakeholders have repeatedly asked for a chance to look at the pillar 1 rules in their entirety.
“Our view continues to be that input from business is critically important to this process,” Plowgian said, noting that the United States’ goal for pillar 1 is to stabilize the tax system. Stabilization is not just about eliminating DSTs but also addressing the rise in transfer pricing and business profits disputes, according to Plowgian. Amount B and the marketing and distribution profits safe harbor can be stabilizing features, he said. “Our goal here is to stabilize the system, and we can't do that without input from businesses,” Plowgian added.
Lost in Translation?
When asked whether there might be a delay in implementing the new rules, Plowgian said countries are working as hard as they can to meet the agreed-upon implementation timeline, but “there do remain a number of political and technical issues to be resolved.”
One issue under the proposed amount A rules is that revenues must be sourced on a transaction-by-transaction basis, a transaction being an income-generating item, such as an inventory item or “clicks” on an online advertisement. The main idea behind using clicks as a revenue-sourcing indicator is particularly important to the United States because there are often higher prices for goods and services than in other markets, according to Plowgian. If that isn’t taken into account, then the United States will be at a significant disadvantage, he added.
“Now, that does not mean that it actually has to be done on a transaction-by-transaction basis, and we are trying to provide clarification that there are other ways that taxpayers can take those into account,” Plowgian said, adding that the United States has heard stakeholder comments about the transaction-by- transaction approach “loud and clear.”
Another issue is linked to the amount A profitability test to determine if an MNE is in scope. Under the profitability test, a group must have a pretax 10 percent profit margin in two of four of the immediately preceding periods, and on average across the current period and the four immediately preceding periods. Stakeholders have questioned whether the averaging test could be applied to the revenue test as well, and they have shown strong support for the idea, according to Brian Jenn of McDermott Emery.
Interestingly, the English version of the draft rules is “potentially ambiguous” about whether averaging would apply to the revenue threshold, while in the French version, it’s written in a way that says averaging only applies to the profitability test, Plowgian said. “That's one of the considerations being addressed in negotiations,” he added.
The OECD has received many comments during its consultation on amount A’s tax base, including whether the same tax base could be used under the two pillars, according to OECD Senior Adviser Jesse Eggert. “We're in the process of working through those and working through as well how we can best leverage the work that's already been done with respect to pillar 2 and the book-to-tax adjustments identified there, recognizing the policies of the two pillars are not identical,” he said.
The policy goals of pillar 1 and pillar 2 are different, so it’s not surprising each may have different tax bases, according to Plowgian. But “we are . . . reexamining that in light of the comments and seeing where we can create some alignment,” he added.