Interview: The Beginning of the End? An Update on the OECD Tax Reform Plan
Tax Notes chief correspondent Stephanie Soong Johnston recaps the historic agreement reached by the majority of the OECD's inclusive framework countries on its two-pillar corporate tax reform proposal.
This transcript has been edited for length and clarity.
David D. Stewart: Welcome to the podcast. I'm David Stewart, editor in chief of Tax Notes Today International. This week: two-pillar progress report.
On July 1 the OECD inclusive framework announced that a majority of countries, including those from the G-7 and G-20, had reached a broad agreement on its two-pillar corporate tax reform plan. Governments from countries agreeable to the proposal viewed it as an important milestone while the plan's critics have not been swayed — at least not yet.
Will a consensus be reached on the OECD two-pillar plan? What are the next steps for the inclusive framework and countries across the globe?
Here to talk more about this is Tax Notes chief correspondent Stephanie Soong Johnston. Stephanie, welcome back to the podcast.
Stephanie Soong Johnston: Good to be here. It's been a minute.
David D. Stewart: Since it has been, could you first remind listeners about what this digital economy project is all about?
Stephanie Soong Johnston: Sure. This project follows up on action 1 of the OECD G-20 base erosion and profit shifting project, the BEPS project for short, from 2015. That was aimed at addressing the tax challenges of a digital economy.
One problem is that the existing tax rules aren't keeping up with how business is carried out anymore. Companies are taxed based on physical presence in a jurisdiction, but with globalization and digitalization, they can now profit from activities in jurisdictions without physical presence, which has frustrated governments. There are also persistent concerns about multinationals' ability to shift their profits into low-tax jurisdictions and minimize their tax liabilities.
So, the G-20 directed the OECD to set up the inclusive framework on BEPS in 2016 to follow up on the BEPS project, especially on action 1. This group, as you'll remember, has 139 countries represented. The goal was to come up with a multilaterally agreed solution to address the problems of digitalization by the end of 2020.
But the inclusive framework was unable to do so for a couple of main reasons. First, the challenges of the coronavirus pandemic, which upended everything. Second, political difficulties, including the U.S. election in November 2020. Although countries were unable to reach political consensus by the end of 2020, the inclusive framework approved publication of blueprints in October 2020, which gave us an idea of what the two-pillar solution might look like.
David D. Stewart: All right. Could you also remind us about what these two pillars are?
Stephanie Soong Johnston: Very briefly, pillar 1 would change profit allocation and nexus rules that would give market jurisdictions a new taxing right, called amount A, over a portion of multinational corporate residual profits based on sales to consumers in those jurisdictions. It's widely seen as the part of the plan that will address the taxation of digital activity. It will require countries to withdraw unilateral measures like digital services taxes, and refrain from introducing new ones in the future.
Pillar 2, meanwhile, calls for a global minimum taxation system. The core of that is the global anti-base erosion [GLOBE] proposal, which effectively imposes a top-up tax using an effective tax rate test based on a jurisdictional blending basis. The elements of the GLOBE proposal draws inspiration from the global intangible low-tax income regime and the base erosion anti-abuse tax of the Tax Cuts and Jobs Act. It proposes that large multinational enterprises pay a minimum level of tax based on a global minimum tax rate of at least 15 percent on a country-by-country basis.
David D. Stewart: Where did countries leave negotiations at the end of 2020?
Stephanie Soong Johnston: A key outstanding issue was the scope of pillar 1. That's been described as the mother of all issues holding up agreement. At the end of 2020, the idea was that amount A would affect MNEs that were consumer-facing businesses and those that offered automated digital services.
But the question was which companies would be in or out of scope and what factors would be used to identify them? There was also a question about how to segment out company business lines that might fall under scope.
Then the U.S. under the Trump administration wanted pillar 1 to be implemented on a safe harbor basis, which was wildly interpreted to mean that companies could opt into the new rules, which of course other countries did not like. At the root of this issue was tension between the United States, which didn't want a solution to ring-fence digital companies, which were mostly American, and other countries, like France, that want to target these digital companies.
There was that tension between these two groups that needs to be resolved. To that end, pillar 1 calls for the rollback and standstill of unilateral measures to tax digital activity like digital service taxes, which as you all know, the United States also dislikes because the government thinks they discriminate against U.S. business interests.
As for pillar 2, there was a big question about what the global minimum rate would be and how the U.S. GILTI regime and BEAT would coexist with the new system, since the GLOBE rules share similarities with those two regimes. Other issues under pillar 2 include details about how a proposed formulaic substance carveout and industry exemptions would work out.
There are also standing questions for both pillars about how countries would implement these new rules.
David D. Stewart: Now, there've been several events lately where progress has been made on this project. I suppose the first thing to happen was the Biden administration getting its team in place. What's the new administration's approach been to these negotiations?
Stephanie Soong Johnston: A lot has happened since I was on the podcast in January. At the time, we were all waiting for what the Biden administration would do when Treasury resumed its place at the negotiating table at the OECD's inclusive framework.
We started seeing some action in February when the new Treasury team said it had abandoned the safe harbor idea, which was a big deal for the other countries in the inclusive framework.
In April the inclusive framework steering group met with the new U.S. negotiator, Itai Grinberg, and a slide deck happened to leak out showing that the U.S. had a new proposal to help unblock the scoping issues of pillar 1.
This was called the comprehensive scoping proposal. It called for designing quantitative criteria linked to revenue and profit margins to narrow the scope of pillar 1 rules so they only apply to the largest and most profitable MNE groups, regardless of industry classification or business model. Of course, this raised questions about how the rules would apply to profitable segments of otherwise unprofitable companies, like Amazon and its cloud business.
The inclusive framework steering group met again in May, and there Treasury proposed the 15 percent global minimum tax rate floor for pillar 2, as an opening offer that stressed that the rate should be higher in line with what the Biden administration is trying to do in terms of reforming the international provisions of the Tax Cuts and Jobs Act, which primarily calls for doubling the GILTI rate to 21 percent, among other things.
There has been a lot of talk about how the Biden administration has signaled a return to multilateralism. Sources I've talked to have said that its engagement with the inclusive framework has rebooted the negotiations. But I really don't think the U.S. has ever really stopped engaging with others in the inclusive framework under the Trump administration. It's just that the Biden administration has been publicizing that work more and framing it as part of the United States' return to multilateralism in general.
What has been especially interesting to me is that Treasury has been carrying out the Biden administration's domestic agenda in parallel with the OECD tax reform talks, particularly under pillar 2.
David D. Stewart: Now, you mentioned these unilateral DSTs a few minutes ago. On a separate track from the OECD process, there have been U.S. trade representative investigations into DSTs. Can you give us an update on that?
Stephanie Soong Johnston: The Office of the U.S. Trade Representative [USTR] confirmed in early June that it wrapped up its investigations into the DSTs of Austria, India, Italy, Spain, Turkey, and the United Kingdom. It said that they would impose 25 percent tariffs on more than 2 billion worth of imports from those countries after they found that their DSTs discriminate against U.S. businesses. But it also said in the same breath, they will suspend these tariffs for up to 180 days until November 29, to give more room to the OECD negotiations to conclude.
France, you might remember, faces some retaliatory tariffs as well. I think that the USTR is going to just wait until all of these negotiations are concluded before moving ahead with these tariffs.
Even though these DSTs issues are sort of separate from what's going on with the OECD, it's very much tied into what's happening with the OECD. It provides motivation for countries to get to some kind of agreement to avoid having this all out trade war between the United States and other countries.
David D. Stewart: All right. Now, turning back to that agreement, it seems that the G-7 was the first to make news on this lately. Can you tell me what happened there?
Stephanie Soong Johnston: The G-7 finance ministers met June 4 and 5 in London under the U.K. presidency where they gave political backing to the two pillars. They also offered a few more details about what had been negotiated.
Specifically on pillar 1, they agreed that market jurisdiction should have taxing rights on at least 20 percent of profit exceeding a 10 percent margin for the largest and most profitable MNEs. On pillar 2, they agreed on a minimum tax rate of at least 15 percent.
To those who had been following these negotiations very closely, the G-7 agreement represented an incremental step to a broader agreement within the inclusive framework and in the G-20. But you wouldn't know it from the media frenzy surrounding it.
David D. Stewart: Now, of course, following that, that led into the much anticipated, at least among us tax people, inclusive framework meeting. Did they come to an agreement?
Stephanie Soong Johnston: The inclusive framework met June 30 and July 1 to see if they could reach some kind of agreement on the two pillars. They nearly got there. 130 out of the 139 countries ended up signing on.
There were nine holdouts at the time. Those were Barbados, Estonia, Hungary, Ireland, Kenya, Nigeria, Peru, Sri Lanka, and St. Vincent and the Grenadines. However, Peru and St. Vincent and the Grenadines later joined the agreement, leaving seven.
They also published a statement with the elements that the countries were able to agree to.
David D. Stewart: What did they decide on pillar 1?
Stephanie Soong Johnston: The statement was very brief. It was five pages, but it did say a lot. It did reveal a lot about what the two pillars are starting to look like. I'll just pull out a few details that I thought were interesting.
There's now a phasing in period for amount A. According to the agreement, amount A would apply to MNEs' global turnover exceeding €20 billion and profitability above 10 percent. That turnover threshold would eventually be halved depending on the successful implementation of amount A rules. That assessment will be based on a review set to begin seven years after the agreement is enforced. About 100 of the largest, most profitable companies are expected to be in scope.
On nexus, there's going to be a new, special purpose nexus rule, permitting allocation of amount A to a market jurisdiction when the in-scope MNE derives about at least €1 million in revenue from that jurisdiction. For smaller jurisdictions with GDP lower than €40 billion, the nexus will be set at €250,000.
The special purpose nexus rule applies only to determine whether a jurisdiction qualifies for the amount A allocation. On nexus, for in-scope MNEs, between 20 to 30 percent of residual profits are defined as a profit in excess of 10 percent of revenue.
The agreement also revealed a few details about the quantum of amount A. For in-scope MNEs, between 20 to 30 percent of its residual profit will be allocated to market jurisdictions using a revenue base allocation key. The agreement also said that segmentation would happen only in "exceptional circumstances" when a company's segment meets the scoping rules.
The pillar 1 agreement also provides for an appropriate coordination between the application of the new rules and the removal of all DSTs and other relevant, similar measures in all companies. Although, there needs to be some more conversations about what these measures will be.
There's also tax certainty provision in there. It calls for a dispute prevention resolution mechanisms to avoid double taxation related to amount A. These provisions would be mandatory and binding in nature. But there could be an elective binding dispute resolution mechanism for developing countries that meet certain criteria. That is, if they're eligible to defer their BEPS action 14 peer reviews and have low or no inventory of mutual agreement procedure disputes.
The agreement also talks a little bit about implementation. Amount A will require a multilateral instrument that will be developed and opened for signature in 2022. Amount A is expected to come into effect in 2023.
David D. Stewart: Where do things stand on pillar 2?
Stephanie Soong Johnston: The agreement confirms the pillar 2 design. Pillar 2 will have the GLOBE rules comprising an income inclusion rule and the undertaxed payment rule. There will also be a subject to tax rule.
The agreement also confirms that the GLOBE rules will have a common approach status, meaning that countries won't be required to adopt them. But if they do, they'll have to follow the pillar 2 design. They'll also have to accept the allocation of GLOBE rules that other inclusive framework members apply.
It also confirmed that the scope would apply to MNEs with annual revenues exceeding €750 million, which we sort of already knew before all this. Again, it confirmed that the minimum rate for the GLOBE rules purposes will be at least 15 percent, although conversations still have to happen about what exactly that rate will be.
The agreement also had a few more details about the formulaic-substance-based carveout. Here the carveout will exclude an amount of income that is at least 7.5 percent of the carrying value of intangible assets and payroll. That 7.5 percent will apply for about five years as a transition period, and then that'll decrease to 5 percent after that.
David D. Stewart: All right. While the OECD is negotiating this pillar 2 minimum tax, the U.S. already has the GILTI regime. How are the two expected to work together?
Stephanie Soong Johnston: That is a very good question. I think there is an acknowledgement in the agreement that there is going to be a GILTI coexistence. We don't really know what exactly that will entail. That's still an open question.
David D. Stewart: What sort of reactions are we hearing to what was announced?
Stephanie Soong Johnston: I think the initial reaction was this was a historic agreement. In a lot of ways it is. Even though it hasn't been finalized, it's historic in itself that 130 some countries are able to agree on anything, especially anything on tax. Have you ever tried to organize a dinner party with 100 people with different dietary needs? That's a difficult task.
David D. Stewart: I try to order takeout with three people in my house, and it nearly causes fights.
Stephanie Soong Johnston: Yeah. It is a historic agreement in a lot of ways. But, of course, there are people and stakeholders who are critical of the agreement that it doesn't go far enough for developing countries. That it doesn't do enough to ensure tax certainty for multinationals. That the rules are still very complicated. How are we going to get this through Congress in the U.S.?
A lot of outstanding questions. But I think generally people can agree that it is a pretty historic agreement.
David D. Stewart: What's next for the inclusive framework and the OECD?
Stephanie Soong Johnston: Like I mentioned before, a lot of outstanding design questions still need to be answered about pillar 1. How does the tax certainty mechanisms work? What kind of multilateral convention is going to be needed?
On pillar 2, what is the tax rate that countries can agree on? Will these holdouts manage to come around to these two pillars?
There's a lot of political maneuvering that needs to happen to get those seven holdout countries to sign on.
The plan now is to finalize the details of the two pillars, as well as an implementation plan by October. Pascal Saint-Amans, the OECD tax chief, mentioned on a podcast that the plan is to complete the multilateral instrument to implement amount A and to complete pillar 2 legislation by the end of 2021, or by early 2022, so that countries can start implementing this stuff in 2023.
A lot of outstanding questions need to be answered.
David D. Stewart: Does it seem that we're getting to an agreement, or might this end up getting delayed again?
Stephanie Soong Johnston: I've been covering this since the very beginning. Thinking about where countries were from the beginning of the project to where they are now, this is about as close as we've ever gotten to a final agreement, which is huge.
Hanging over all of this, though, is the question of DSTs and unilateral measures. Another huge question is which unilateral measures will be required to be rolled back as part of pillar 1? Will that be enough to satisfy the United States and hold off on further tariffs against countries that have digital services taxes?
It's the beginning of the beginning. Now the real work begins.
David D. Stewart: Well, Stephanie, thank you for being here.
Stephanie Soong Johnston: Thank you for having me.