In the latest episode of Tax Notes Talk, Tax Notes contributing editor Robert Goulder discusses the Biden administration’s approach to the OECD’s two-pillar solution to taxing the digital economy and the potential for global consensus.
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: the U.S. and the inclusive framework. We're a little over a month away from the OECD inclusive framework's self-imposed deadline to reach a political agreement on its two-pillar plan for modernizing global corporate tax rules by the end of June.
The big question that remains is: Will they reach a consensus by then? There's still much to be hashed out, especially as the Biden administration settles into the OECD talks. Here to talk more about this is Tax Notes contributing editor Robert Goulder. Bob, welcome back to the podcast.
Robert Goulder: Thanks, Dave. It's great to be here.
David Stewart: Let's start off with a brief overview of pillars 1 and 2. Where do the OECD talks stand today?
Robert Goulder: That's a great idea. It's important to understand what these things are about. To me the dynamics behind pillar 1 and pillar 2 are a bit different, although their ultimate fate will be closely linked.
Pillar 1 fundamentally is about changing the source rules that we use for determining how corporate profits get taxed by different countries. When you step back and you think about the international consensus that we have had for about 100 years or so, it's heavily dependent on this thing called the permanent establishment doctrine, which basically comes down to relying on a company's physical presence.
If you don't have a branch or a subsidiary in another country, it's going to be hard for that country to tax the profits of the corporate multinational. Pillar 1 is a way around that. It's comprised of a new nexus concept and a new profit allocation rule.
Who is going to benefit from that? Who's really the beneficiary of pillar 1? Well, it's going to be all the market countries out there that really aren't benefiting under the current regime. That's not necessarily the United States. The U.S. could be very ambivalent frankly about pillar 1. But these other countries, the source countries, are a big fan of that.
Then you have pillar 2, which really comes down to being a form of a global minimum tax on corporations. They talk about having an income inclusion rule and an undertaxed payment rule. That's something where the U.S. becomes very interested in tweaking the design of what's out there for pillar 2.
Where do these things stand today? I think they're in a really exciting place because the new Treasury Department under the Biden administration is putting the pedal to the metal. They're moving forward on this. Whereas under the Trump Treasury, you had this whole idea of distancing the U.S. from being a participant in the process.
You might recall it was big news at the time that former Treasury Secretary Steven Mnuchin said he wanted pillar 1 to be a safe harbor. What he meant by that is he wants it to be optional so that basically all the U.S. companies could just opt out of it if they wanted to. In one fell swoop, he kind of takes pillar 1 off the table.
For pillar 2, you'd look at it and say, "Well, because of the Tax Cuts and Jobs Act, the tax reform bill we had in 2017, we already have something that looks like an income inclusion rule with global intangible low-taxed income. We already have something that looks like an undertaxed payment rule with the base erosion and antiabuse tax, so we're just going to check that box and say we've already got pillar 2." We were in a situation as of last year where the U.S. didn't care about pillar 1 and basically said we already have pillar 2.
Now all that's changed. That's what makes this very exciting. A lot is happening. Are they going to get it done by June? We can circle back around to that later. But you may have to be flexible on the timing here because I think there's real negotiations going on.
David Stewart: You mentioned U.S. ambivalence on pillar 1. Recently there was a slide deck prepared by Treasury discussing scoping and simplification issues. Could you tell us about that?
Robert Goulder: That was extraordinary. The document we're talking about is a slide deck that was prepared by folks from the U.S. Treasury Department and presented to a steering committee meeting of the OECD inclusive framework.
What they did is they basically said, "OK. We're back in the game now. We want to be an active participant in designing this thing because the U.S. really is not happy with what was in the October 2020 blueprint. And for starters, right out of the gate, who is subject to pillar 1 and who is not?"
You can come up with the best tax scheme policy reform proposal in the world. But if you can't figure out which corporations are subject to it and which ones aren't, have you really accomplished much?
The type of scoping that they had — and by scoping we mean who's covered by the proposal. Who's actually going to have their profits taxed differently as a result of pillar 1? They came up with this double concept of companies that provide automated digital services. They're going to have to figure out what the definition of that is. There's a second standard called consumer-facing businesses. What's that? What's that designed to be? It had a very qualitative feel to it.
Companies were spending a lot of time saying, "We can't figure out if we're subject to this." It's not about whether you're a company that relies on intellectual property or intangibles. Right? Because pharmaceuticals are not an automated digital service. Are Apple computers going to be covered by this thing? I don't know. They sell lots of phones and laptops, but those are tangible devices.
They had this thing in the blueprint for pillar 1 called segmentation. Market line segmentation. If you're a company like Walt Disney, you might have to break down your company segment by segment and think, "We have theme parks, but they're not going to be covered because they're not providing a digital service." But now Disney also has its hand in a streaming service, so part of the company could be subject to pillar 1, and part of it might not be. Then you're going to have to take all the profits and start to put them into different bins, baskets, or silos to figure out which ones are going to be shared or the taxing rights are shared with the source countries and which ones aren't. It was just a nightmare.
Also because of these different business lines within the corporate multinational, they're going to have very different profit margins. Part of the architecture and part of the design of pillar 1 was very contingent on measuring the company's profit margin to see how much of the profits were going to be subject for the so-called Amount A allocation.
Treasury comes out and they're like, "Scoping has got to change. Segmentation's got to go away. We're in this. We want pillar 1 to work. We're stakeholders who are invested in the success of this project, but make no mistake. This thing is way too complicated. It's going to sink under its own weight. You have to simplify it." The OECD got the message. They got the message loud and clear, and that's the direction that we are racing in.
David Stewart: While the U.S. is somewhat ambivalent about pillar 1, it seems to be all in on pillar 2. Is that a fair read?
Robert Goulder: That's a fair read. I would say that as things stand right now, the U.S. Treasury Department has become the global cheerleader in chief for pillar 2. The reason is it just happens to coincide with some domestic policy priorities that the Treasury Department is advancing. If you go and you look at some of the material that has come out of the Biden administration, they're talking about changing the GILTI regime. They're talking about changing it in some significant ways.
The three things that pop to mind are first they're talking about trying to get rid of the whole qualified business asset investment rules for. Maybe just remove that from GILTI. That's a purely domestic measure, the U.S. changing the Internal Revenue Code to get rid of all that QBAI stuff.
They're also changing how you do the blending under GILTI. You can't have a high-tax country blended with a low-tax country so you'd have something called per-country alignment of GILTI for their foreign earnings and that's to prevent blending.
Then the other thing is the rate. Right now we've got a 21 percent corporate rate and there's a GILTI deduction that's set at 50 percent, so that turns out to be an effective nominal GILTI rate of 50 percent of the statutory rate, or 10.5 percent.
What Biden's Treasury is talking about doing is increasing the statutory rate to 28 percent and then reducing the GILTI deduction from 50 percent down to 75 percent. If you do the math, the nominal GILTI rate would turn out to be three-quarters of the statutory rate. Now I know that's a lot of words, but when you cut down to it what that means is you'd have a U.S. statutory corporate rate of 28 percent and then a GILTI rate of 21 percent.
That is an eye-opener. That is a very, very robust global minimum tax. That's not just a little hint or whiff of a global minimum tax. That is a Godzilla-shaped global minimum tax. The concern is that if a country does that in isolation, it would have a very anti-competitive effect. Would you see another wave of inversions? Would you see companies saying they have an out from under problem? For serving the U.S. market, yeah, they can be a U.S. corporation. But in terms of generating foreign profits in other countries, maybe it doesn't pay to be a U.S.-based multinational anymore.
All sorts of people are really worried about the anti-competitiveness associated with a 21 percent global minimum tax. And that is exactly where pillar 2 comes into this and why the U.S. is being such a cheerleader for this.
If you can get every other country in the world to adopt a global minimum tax where the effective rate is around 20 or 21 percent, well then the U.S. is not in an anti-competitive position because everybody else has the same minimum tax. We're already hearing noises from some of the stakeholders here that while people are thrilled to see the Treasury is back at the table here and being an active participant in the deliberations, other countries, especially in Europe, are not comfortable with a global minimum tax as high as 21 percent. I think the finance ministers of France and Germany have already come out and said that that's just crazy. It would put their economies in too much of an uncompetitive position.
What you really have is the U.S. redefining the debate and they're making an opening bid of what they would like a global minimum tax to be, but there's going to be some negotiations there. It might be higher than what we have now with a 10.5 percent, but I can't imagine it actually going to 21 percent. That seems a little bit aspirational.
David Stewart: Now that we have a bit of a sense of the U.S. position, are we expecting this to help or hinder the efforts to reach a consensus?
Robert Goulder: Absolutely the former. U.S. participation will certainly help the process here. I really get the sense that before the U.S. started to put its position out, it's as if the whole world was just waiting for us to intervene and put out a position. There's still differences, so there's a boatload of details that are still going to have to be worked out both on pillar 1 and pillar 2, but that's just a negotiation. As long as you're in the direction of having those negotiations, then it's a good outcome. The U.S. is helping a lot here.
David Stewart: Each of these pillars has its own unique issues, but let's look at pillar 2 specifically. Bob, if I were to give you all of the power to come up with a solution on pillar 2, what would your ideal solution look like?
Robert Goulder: Well, the first thing I would want to do is not only have the superpower as for pillar 2, I would also want to have the same superpower for pillar 1. We'll get to that later.
For pillar 2 I think there's a certain inevitability here about a general notion about what constitutes an acceptable level of tax competition. The U.S. said in these slides — I think it was the very first bullet point — that said, "We wish to end the race to the bottom over multinational corporate taxation." They want to end the race to the bottom. But are you ever really going to be able to do that?
Some degree of tax competition I think is going to be inevitable. In some ways, the world or a part of the world if you look at the EU, has been wrestling with that same dynamic for a long time.
You turn to Ireland, which has this great thriving economy, and it's not a tax haven. It's not even a low-tax country. They have high income taxes on individual income. They have high payroll taxes. They've got VAT. They've got all property taxes. But they have really low corporate taxes and they have a low corporate rate of 12.5 percent. There's a loose de facto sense that that is what tax competition is going to look like. You're not going too far in the direction of harmful tax competition as long as you don't go below the Irish rate.
My prediction for where this is all going to settle is that the U.S. is going to say, "Yeah, we need a threshold rate for a minimum tax that's somewhere around 20 percent." And people will say, "No, no, no, that's too high." You're going to end up splitting the baby somewhere, except it's not really splitting the baby, between like 10 percent and 20 percent. It's going to be a lot less than that. If you were going to split the baby between a minimum tax threshold of 10 percent and 15 percent, the midway point, there would be 12.5 [percent], which just happens to be the Irish rate. That might be just a bitter pill that the U.S. is going to have to swallow.
That doesn't mean that we are going to copy that rate ourselves for the GILTI regime. You could very well have a situation where the whole rest of the world through pillar 2 says, "OK. There's going to be a corporate minimum rate, and it's going to look a lot like 12.5 percent informally based on the Irish rate." Then the U.S. says, "Fine. We're going to have one higher than that." And then you're just going to have these competitive pressures play themselves out.
Some corporations aren't going to be happy with a high U.S. minimum tax. Maybe some of them will try to move, expatriate, or do an inversion. That process will have to play itself out. You can have a country like the U.S. have a higher rate than what's in pillar 2, but I just think it's going to have to coalesce around somewhere.
If I were king for the day, I would say, "Let's do that. Let's just run with the Irish rate and see where that gets us." If any countries such as the U.S. want a higher rate, let them do it and then deal with the inversions as they come up.
David Stewart: You've asked for the superpower on pillar 1, too. I saved it for the second part because I think that that's the trickier of the two to come to a consensus on. I'm granting you that superpower again. You now have the power to choose how pillar 1 looks at the end of the day. What's your ideal design?
Robert Goulder: All right, Dave. Well here I'm going to turn not to the rest of the world, but I'm going to be very sort of provincial here and just look at the U.S. and what the U.S. states have done. They used to have this thing called a multistate tax convention where they said, "Hey, here's how we're going to tax corporate profits between and among the different state revenue bodies. We're going to have a three-factor system where we're basing jurisdictional taxing rights on a sales factor, a people factor, and a property factor."
You could even set those up where one-third of the tax base is determined by your investments in property, like whether you have a factory or not. The other third could be your people. How much payroll do you have? If you've got a jurisdiction that has 50 percent of your employees and they'd have 50 percent of your tax base for that segment of the formula. And then sales, you have to put sales in here. That's your classic three factors: sales, people, and property. The problem is that that did not have a clinginess. It didn't stick around long enough at the state level.
The experience of the U.S. states is very informative here. The states pushed back against this because they realized if you tax property, then you're taxing investment and you're discouraging investment when you do that. Why would you discourage some company building a factory in your state? You don't want to do that.
They would start to minimize that property factor, so it would kind of wither and go away. And then they thought, "Well, we don't want to tax payroll either. We want companies to hire lots of people in our jurisdiction." If you're a local politician, those are your constituents. They're your voters. If you have a three-factor formula and you're not taxing people, that's being diminished, and you're not taxing property, that's being diminished. All you're left with is the sales factor.
If I were king for the day, I would really think about just kind of getting away from the arm's-length standard and saying, "We have to do something for these resident countries. Let's look at sales." And it might not purely be sales because one attribute of the digital economy is you have the user experience. The people using Facebook are not technically the customers of Facebook because they're not paying for anyone. The customers of Facebook are the people who are paying for the banner ads and the advertisements. Same thing with Google, right? The customers of Google are not necessarily the users of Google.
You'd have to have a sales factor that looked to the user experience as well. I think you have to look at something like that. There's a guy named Bill Parks who's been writing for Tax Notes on and off for many years, who's written intelligently about the relevance and the compelling argument for sales factor apportionment. That's what I would do. It's a formulary apportionment and anyone out there who is a disciple or a devotee of arm's-length analysis is going to be very upset. It's going to wreak havoc on the world of transfer pricing, but that's what I would do.
David Stewart: Well, I will forgive your blasphemy this one time. In your opinion, what do you think is the likelihood that we will see an agreement on this two-pillar approach by the end of June? And what would it mean if they weren't able to make that date?
Robert Goulder: I am just not that concerned about the deadline for the simple reason that any deadline set by a bureaucratic process can be reset by the same bureaucratic process. There's nothing etched in stone about the end of June. Let's just kick it to the end of the year and you have a perfectly good excuse for that.
One, there's been a global pandemic. I know we can do Zoom meetings, virtual meetings, and all that, but it's been a delay. It hasn't been a good recent year and a half for having international tax conferences or international tax dialogues, so that's a legitimate reason for pushing the deadline back.
Also, the Biden Treasury just got up and running. These slides that are dated as of early April are really sort of the first sign of involvement here because it takes a while for the operation there to get up and running for them to have the necessary coordination meetings and saying, "OK. We've been thinking about this. Let's start doing it."
June is too soon. You could push it back to October. Even then, why not just push it back to the end of the calendar year? Then say 2020 was the year where we waited around to see what was going to happen with the election in the U.S., and then 2021 is the year where we try to forge this new international consensus.
David Stewart: Once we find out what we have in June, then we'll have to have you back, Bob. But this has been great. Thank you for being here.
Robert Goulder: My pleasure, Dave. Anytime.