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Interview: New Year, New Tax Rules? An OECD Tax Reform Project Update

Posted on Jan. 25, 2021

Tax Notes reporters Stephanie Soong Johnston and Ryan Finley recap the OECD’s latest public consultation on its two-pillar approach to taxing the digital economy.

This post has been edited for length and clarity.

David Stewart: Welcome to the podcast. I'm David Stewart, editor in chief of Tax Notes Today International. This week: new year, same digital economy. The OECD digital economy project continues to move forward and the group recently held a public consultation on its two-pillar approach. What did we learn from it? How likely are we to see an agreement this year?

Here to give us an update on the digital economy project are Tax Notes chief correspondent Stephanie Soong Johnston and Tax Notes legal reporter Ryan Finley. Stephanie, Ryan, welcome back to the podcast.

Ryan Finley: Thanks.

Stephanie Soong Johnston: Thanks. Good to be here again.

David Stewart: Can you give listeners a brief overview of the digital economy project and where it stands?

Ryan Finley: Sure. The project consists of two pillars. According to the most recent blueprint report, the first pillar is basically designed to give market jurisdictions greater taxing rights over the profits of multinationals that fall within that scope. Right now that includes companies that provide automated digital services or are consumer-facing businesses. They haven't quite worked out the definitions of those terms yet.

It would do this reallocation through something called amount A, which would essentially be the multinational's profit in excess of some deemed routine return. The proposal's explicit that this whole allocation method is not based on the arm's-length principle. There would also be something called amount B, which would fix the returns associated with kind of basic sales and distribution activities. This return is supposed to more or less reflect what the outcome would be under the arm's-length principle, but the return would be fixed for the sake of administrability.

Pillar 2 is also called the global anti-base erosion (GLOBE) proposal. It would basically be a global minimum tax regime that shares some features with the United States' [global intangible low-taxed income] and [base erosion and antiabuse tax] rules. As it's proposed, pillar 2 consists of a set of ordered rules.

The first is an income inclusion rule, and that's the part that's similar to GILTI. Income tax below whatever minimum threshold hasn't been agreed yet would be taxable in the ultimate parent entity's jurisdiction. This rule will be backed up by something called the undertax payments rule, which would either deny a deduction or allow taxation at source for payments that aren't taxed at this minimum threshold. There would also be something called the subject to tax rule, which would allow withholding or source-based tax for other types of payments that are not taxed at the minimum rate.

Stephanie Soong Johnston: Delegates from the 137 jurisdictions in the inclusive framework on the base erosion and profit-shifting project are ultimately responsible for deciding whether they want to sign up to the two pillars or not. Because pillar 1 calls for this departure from the arm's-length principle, it requires more of a coordinated response and therefore a consensus is more necessary among the countries.

Pillar 1 is generally considered the more politically fraught of the two pillars for a lot of reasons, the biggest being the United States. The U.S. doesn't want pillar 1 to ring-fence digital companies, the majority of which are American. It also wants pillar 1 to be implemented on a safe harbor basis, meaning that companies could opt in in exchange for greater tax certainty. This political challenge has dogged the inclusive framework negotiations for some time now.

Where things stand now, countries are waiting for the U.S. to put a new Treasury team in place under the Biden administration to resume those discussions and hopefully come up with agreement on both pillars by mid-2021. I understand that means effectively end of June for the inclusive framework and July 9 and 10 for the finance ministers of the G-20. Countries hope that pillar 1 would mean avoiding a patchwork of different measures to tax digital activity. Pillar 1 would call on countries with so-called unilateral measures to withdraw them. There's no list yet dividing what kind of measures would be considered unilateral measures, but it would likely include digital services taxes and the like. That is where things stand now politically.

David Stewart: Let's turn to the consultation that was just held. Sticking to the subject of pillar 1, what did we learn from this consultation?

Ryan Finley: In addition to being fraught among delegates to the inclusive framework, pillar 1 is also somewhat fraught among the practitioners that participated. If there was an overarching theme in this consultation, it was that there needs to be a greater emphasis on things like simplification and certainty, particularly on having strong mechanisms to prevent double taxation and resolve disputes.

A lot of these concerns are tied to the way these different amounts interact and whether you could have double counting. Some practitioners and business representatives are worried that these amounts A and B may overlap, leading to double taxation.

Another double counting risk that came up was the potential for transfer pricing adjustments under the current rules to be made such that they capture part of what is included in amount A. If you don't have some dispute resolution mechanism to either reduce the reallocated piece of amount A or the transfer pricing adjustment, you could have double taxation.

Generally, the practitioners are pretty strong that you're going to need to have some sort of mandatory binding arbitration mechanism to deal with this. But, of course, that remains very controversial, particularly among developing countries.

The other thing that multinationals are concerned about is the scope. Their views differ actually. Some multinationals argue for a narrower scope, I guess hoping that their particular business will fall outside the scope of automated digital services or consumer-facing businesses. But others have argued that having this limited scope essentially reproduces this ring-fencing problem, where you're essentially imposing a new system arbitrarily on some companies without any clear policy basis.

Those were the main themes. It didn't seem like there was any consensus yet.

Stephanie Soong Johnston: What I heard from companies, too, was that some of them are really calling for the scope issue to be solved by tying the calculation process for amount A liabilities in a given market jurisdiction to more objective criteria, rather than relying on positive and negative lists of what an automated digital service is and what a consumer facing business is.

For example, Netflix called for using objective metrics like group operating profit thresholds. Instead of focusing on who's in and who's out, it would focus on financial accounts and hard data. That was something that I thought was interesting.

Pillar 1 in particular is so complicated that I was joking with my colleagues about simplifying it so much that you can describe it in 35 words or less. One stakeholder during the consultation made a great point. She said, "The more complicated this is, the less likely the public, tax administrations, and policymakers will understand it. A lack of understanding makes it harder to trust it. At a time where there's so little trust in government, its systems, and institutions, it's crucial that simplification is a big part of this process."

I agree with that. It would be really hard for mainstream journalists, let alone trade journalists, to explain all this to a general audience. Simplification is a really important issue here. The OECD has acknowledged that time and time again, saying we do need to simplify not just pillar 1, but also pillar 2.

While the pillar 1 consultation was going on, [Lafayette G.] "Chip" Harter, the former top negotiator for the U.S. Treasury Department at the OECD, spoke publicly for the first time since stepping down his post at the end of November. He basically disavowed the U.S. stance on implementing pillar 1 on a safe harbor basis and actually recommended that the Biden administration consider a little-known informal proposal that Germany had floated in mid-2020, which would "abandon activities-based scoping, and instead of scope amount A on a quantitative basis." It sounds a lot like what all the stakeholders were calling for during the consultation.

I had never heard about this proposal before. When I looked into it further, I asked Harter, "What's the proposal?" Apparently it was something that the Germans had floated in the inclusive framework. It got a little bit of support, but it was basically abandoned because the U.S. was still stuck on the safe harbor proposal.

Harter told me that under this proposal, multinational enterprises that meet the agreed revenue threshold and have residual profits would be subject to amount A reallocation if it met two criteria: 1) profits per employee exceeded a specific high threshold, and 2) its return on tangible assets exceeded a specified high threshold. He said during the conference that the U.S. wasn't able to support the compromise because of the safe harbor proposal. That was the official line. Now, he said the U.S. position never had international support and is not a basis for agreement.

All along the Germans have had this proposal that could have provided a basis for agreement had it not been for the safe harbor proposal that the U.S. had. Harter said that German proposal could "provide a viable basis for compromise in 2021 if the Biden administration were to throw its weight behind it."

This is a very interesting development to me in the political space because maybe there is a way to unlock this negotiation process. Maybe there is some hope if the Biden administration decides to give this proposal another look. Again, it's a wait-and-see game to see what the Biden administration will do.

David Stewart: Are we closer to an agreement on pillar 1 than we were before? Or did the consultation just reinforce existing fault lines?

Stephanie Soong Johnston: That's a very good question. I would say that at the consultation, it did reinforce some fault lines, but I think there is potential for unlocking agreement in mid-2021. I maybe would not have thought so if had it not been for Harter's comments and this mystery proposal that we all need to find out more about. It seemed that most stakeholders during the consultation were not giving up and were still determined to find ways to make pillar 1 better. I think the Biden administration signals maybe a renewed hope for progress and for good progress by mid-2021.

Again, the timing is going to be a big question because it will take some time for Treasury to put a new tax policy team in place. It'll take time to resume negotiations and get everybody up to speed. It'll take time to really consider all of these comments and incorporate them into a revised blueprint. To do all of that by the end of June is kind of a lot.

I guess I'm hopeful that something will happen. It's like I should be agnostic about what the success or the demise of the project because of my position as a journalist. I think from what I observed, I think that there is a bit of a renewed hope, maybe more so than this time last year.

David Stewart: You can be hopeful that you'll have something to write about in the middle of the year.

Let's move on to the second of the consultations on pillar 2, this global minimum tax concept. What did we learn from the consultation on pillar 2?

Ryan Finley: There are a couple of themes that I think emerged from the pillar 2 consultation. One message that came through from business representatives was that they should avoid a situation where multinationals that are already subject to the U.S. GILTI rules would also be subject to this global minimum tax proposal as well. Obviously, there's a lot of overlap in the intent of both policies, although the mechanism are fairly different.

There's a discussion in the blueprint about whether they should essentially allow GILTI to coexist and be grandfathered in as a qualifying income inclusion rule, but the issue hasn't been settled. It's clear from the consultation that business representatives very much think that GILTI should be allowed to coexist, as they put it, as a qualified income inclusion rule.

Another theme that came up, and this wasn't so much from business representatives but more from civil society representatives, was that the stability of this system and its ability to avoid unilateral measures is going to require the buy-in from developing countries. As things stand now, it doesn't appear that developing countries are going to get any great benefit either under pillar 2 or pillar 1.

That's simply because of the €750 million revenue threshold that you'd need to be subject to the rules in the first place. Not too many multinationals with that much revenue or that fall within the specific sectors that thus far have been identified, at least in the case of pillar 1, are going to have their ultimate parent entities in these developing countries. Between the revenue threshold and the type of company that it's targeting, it's possible that you're not going to see any great increase in the taxing rights of market countries that are developing countries.

There's also the issue that in the ordering of the pillar 2 rules, the income inclusion rule is the main rule. The income inclusion rule allocates taxing rights to, again, the jurisdiction where the ultimate parent entity is resident. You only get that source country taxing right if the income inclusion rule isn't applied.

For those reasons, civil society representatives expressed a lot of concern that A) the system may not be fair as designed if it doesn't adequately cater to the needs of developing countries, and B) it may crumble as matter of stable political compromise if a significant share of the world's countries don't feel like they're getting any benefit out of it.

Stephanie Soong Johnston: A lot of practitioners took issue with pillar 2's rejection of deferred tax accounting to adjust timing differences when it comes to including some types of income or expenses in net income calculations for determining tax liability and effective tax rate (ETR) under the GLOBE. A lot of practitioners were really hammering home, "We need to have a different tax accounting. We need to be able to use it."

It's ironic that the GLOBE rests on accounting principles. Yet, here we are trying to carve out this very essential tax accounting principle to calculate our tax base and our ETR. There was a really loud call for that.

Other stakeholders who supported leveraging the work companies already have to do to compile [country-by-country] reports under action 13 as a starting point for pillar 2 calculations. But some stakeholders pointed out CbC reports are designed for high-level risk assessment and extending the purposes of those reports may pose some risks because the goals of the GLOBE and the CbC reports are so different. That was one concern that I heard loud and clear during the consultation as well.

I don't think there was any conversation about tax rates. I think the general consensus is that we're going to be looking at a 12.5 percent tax rate in line with Ireland's corporation tax.

On the same day as the pillar 1 consultation, the Irish finance minister published an update to Ireland's corporate tax roadmap and doubled down on the fact that they are not budging on a 12.5 percent rate. The minister again called for a consensus base globally agreed approach to international tax to keep up with the modern economy.

David Stewart: All this is happening in the background of a bunch of DSTs being imposed by several countries. In the closing days of the Trump administration, we saw a lot of activity from the Office of the U.S. Trade Representative (USTR) on these section 301 investigations into DSTs.

What countries was the USTR looking at and what did they find?

Stephanie Soong Johnston: If you'll remember in June 2020, the USTR opened several investigations into the digital taxes of 10 trading partners, including Austria, Brazil, the Czech Republic, the EU, India, Indonesia, Italy, Spain, Turkey, and the United Kingdom. All of these countries either had DSTs on the books or equivalent measures, or were thinking about introducing measures like them.

We were waiting for the USTR to drop its investigations into these 10 countries in the waning days of the Trump administration. We assumed that the Trump administration was going to pass off the work to the incoming Biden administration to decide on next steps.

Despite what happened on Capitol Hill January 6, the USTR dropped decisions saying the DSTs of Italy, Spain, and Turkey discriminate against U.S. businesses, which did not come as much of a surprise to anyone who has been tracking this stuff. On January 15 Austria, Spain, and the U.K.'s DSTs  were found to be discriminatory as well.

The USTR also published a status update on the DSTs being considered in Brazil, the Czech Republic, the EU and Indonesia. What was interesting about all of these decisions was that the USTR had held off on announcing any potential retaliatory measures such as extra trade tariffs.

David Stewart: On the subject of the tariff on the section 301 investigations, the USTR found a while ago that the French DST was discriminatory and we were expecting to see some tariffs there. What's the latest on that?

Stephanie Soong Johnston: On January 6 we all expected that these extra 25 percent tariffs would affect $1.3 billion worth of French imports, including purses and cosmetics. But January 6 came and went and we didn't hear anything.

I asked the European Commission, "Hey, so what has been happening on your end? Have you been seeing a lot of blowback on these tariffs?" The commission said they had never gotten any notification from the USTR and didn't know what's going on. On January 7 the USTR cleared up the confusion and announced that it was suspending these tariffs until further notice, pending the outcome of decisions and the other DST investigations. We're now seeing a reprieve on those tariffs.

DSTs were always seen to be a measure that other countries have adopted to pressure countries into agreeing on a multilateral solution at the OECD and to tax digital activity. I would predict that DSTs are still going to be a driving factor in this conversation in 2021 as even more countries are considering implementing such measures.

Although, I think that countries that do have them are more amenable to giving more time to the companies that are struggling with calculating their liabilities under these new regimes. For example, both Italy and Spain announced that they were delaying payment and filing deadlines for their DST regimes. That's going to be interesting to watch in the coming months.

David Stewart: Absolutely. Stephanie and Ryan, we're going to have to have you back to talk about what we find out from the positions the new Biden administration is going to be taking and how this outcome in June-July period turns out. Stephanie, Ryan, thank you for being here.

Stephanie Soong Johnston: Thanks for having us.

Ryan Finley: Thank you.

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