David Stewart: Welcome to the podcast, I'm David Stewart, editor in chief of Worldwide Tax Daily. This week, let's get digital. One of the trickiest issues in taxation today is how to tax the digital economy. We've had a couple of episodes on this, but now that the OECD has held a new consultation in its efforts to reach consensus, it's time to check back in. A little later we'll get to an interview with Grace Perez-Navarro, the deputy director of the Centre for Tax Policy and Administration (CTPA) at the OECD. But right now I'm joined in the studio by Worldwide Tax Daily legal reporter Ryan Finley. And on the phone by Worldwide Tax Daily chief correspondent Stephanie Johnston. Ryan, Stephanie, welcome to the podcast.
Ryan Finley: Thank you.
Stephanie Johnston: Thanks for having me. Always a pleasure.
David Stewart: The OECD released a consultation document on the digital economy in February. What did they have to say about their ideas for how to tax this area?
Stephanie Johnston: So countries are trying to hammer out the best approach to address the long-term challenges of digitalization, and right now there are four proposals organized under two pillars that are currently on the table. The first pillar is focused mostly on proper allocation issues and nexus issues, and under that pillar there are three options. One proposal would give more taxing rights to you, the jurisdiction, based on active user contribution. Another option would give more taxing rights to market jurisdictions based on marketing tangibles. And then the third one calls for reconsideration of nexus concept, like significant economic presence. And then under pillar two, that's mostly focused on addressing remaining base erosion and profit-shifting issues that were addressed in the original BEPS project, and under this pillar there is an income inclusion rule that was functioned essentially as a minimum tax along with a tax on base-eroding payments. The income inclusion rule has been loosely based on the U.S. GILTI provision — a global intangible low-taxed income provision of the Tax Cuts and Jobs Act. While the tax on base-eroding payments is modeled loosely on the BEAT, the base erosion and antiabuse tax also in the TCJA.
David Stewart: Ryan, back in December it seemed that the U.S. signaled some openness to this marketing intangibles concept. Can you tell us a bit more about that principle?
Ryan Finley: Sure, the marketing intangibles approach is based on the idea that there are these marketing intangibles, which include trademarks, brand names, general customer perceptions, that are associated with particular markets. And that some element of what they call the non-routine profit of a multinational group should be attributed to market jurisdictions, because of the existence of these intangibles. Now, the proposal's very general, but it suggests that this could be done using the residual profit-split method, or a variant thereof, which would essentially take a multinational group, assign the parties in different jurisdictions what's called a routine return, and then split what's called the residual profit — the profit that's left over after subtracting the routine returns between marketing intangibles and other intangibles. The preference seems to be for making this distinction on the basis of some sort of set formula instead of a kinda case-by-case, you know, very specific, transfer pricing analysis.
David Stewart: So would this be a move away from the arm's-length standard?
Ryan Finley: It is a move away from the arm's-length standard. I think people would differ on how much of a move away it is. I think probably the bigger change, though, would be from the existing nexus rules based on a permanent establishment, because the marketing intangibles approach would establish a taxable presence in a country without regard to whether there's a permanent establishment or not. The deviation from the arm's-length standard is a little bit more subtle, but U.S. officials, for example, have stressed kind of the continuity between this marketing intangibles approach and a traditional transfer pricing approach. It uses a variant of the residual profit-split method, which is not very commonly applied under the arm’s-length standard now, but it does sort of still fall within the realm of existing transfer pricing methods.
David Stewart: Alright. So let's turn to the consultation as it took place, as we're recording this it was last week in Paris. Stephanie can you give us the general impressions that you got in the room there?
Stephanie Johnston: Sure. It might be useful to think back on the OECD's other big consultation on this issue. That was in November 2017 at the University of California, Berkeley campus, and there they were talking mostly about the interim report — you know, taking stock of where the conversation's going about how to tax digitalization. At that consultation, there were maybe 100 people in the room; it was kind of a small room. There was an overflow room with people who couldn't find a seat. And they got 50 submissions, so it wasn’t really making that big of a splash, I guess. So by contrast, the Paris consultation was very different. This time around, the OECD got way more responses: about 200 submissions to their consultation, and about 400 delegates came to participate in this consultation. So there were so many people that the OECD had to combine several rooms to make a giant auditorium and kinda set it up like a concert-style kind of seating for the public and for delegates, the Task Force on the Digital Economy, for governments. It was really interesting to be there because people kept talking about how historic this moment was, you know. And I heard one delegate compare the consultation to the Estates General meeting in [1789], which I think marked the start of the French Revolution. Not sure if that's a good thing or a bad thing in this context, but there you have it. And another delegate compared it to the Congress of Vienna from 1814 to 1815, where governments were discussing the geographic shaping of Europe. So people really kind of were talking about this in very historic terms as unprecedented. So that was kind of exciting to see in person and to feel this energy in the room that change is coming. So that was pretty cool.
David Stewart: What sort of things did people talk about at the consultation in Paris?
Stephanie Johnston: The event was organized over two days. The first day was focused mostly on pillar one, and there people discussed general observations about the three options on the table under pillar one and also the design and administration considerations that should be taken into account for those options. And the second day focused on pillar two, same issues. You know, general observations and design and administration considerations. And so for the first day, pillar one seemed to draw more points of agreement among stakeholders, and you're talking business, civil society, academics, business groups, and also tax practitioners. So, there were some points of very strong agreement. Most people agreed that any option that is chosen should not ring-fence highly digitalized businesses. Many called for a principled approach based on economic impacts and assessments — just making sure that whatever option is selected is thoroughly considered from a data point of view, an economic impact point of view. A common mantra I heard from businesses was we don't care where we pay tax, as long as we don't pay it twice. There were calls for simplicity — for whatever is adopted — but also some called for an industry-specific approach because not all companies are engaged in the same kind of highly digitalized activities as say Uber or, you know, or Google. And the marketing intangibles approach, as Ryan mentioned, seems to be one approach that many of the stakeholders were talking about and agreed on. And one thing that struck me was the change in attitude by business. Will Morris is the chair of the tax committee at the Business and Industry Advisory Committee to the OECD. He made it clear pretty early on in this consultation that business is all-in; they're committed to debating and advising delegates on this issue. And so he said change is coming. There's not going to be a return to the golden age of tax. So that was kind of interesting to see that businesses have pretty much accepted the fact that change is coming, and they're actually willing to move ahead and contribute constructively.
David Stewart: Ryan, did anything stick out to you in the discussions on pillar one?
Ryan Finley: Well, I would definitely second what Stephanie said about there being in general, a tone of resignation among practitioners, which you wouldn't have seen necessarily during the BEPS project. It seemed that practitioners were willing to accept that there would be a move away from the arms-length standard in it's pure form but were kinda trying to contain and limit the extent of that change. The one specific proposal that received the most attention during a consultation was a proposal by Johnson & Johnson, which, while it was based on the marketing intangibles approach, it wasn't really a residual profit-split analysis. It was based on basically assuming a certain operating margin for local affiliates and then adjusting that upward based on how high the global groups operating margin is and how high the local affiliates own marketing expenses are, and even though that's not a residual profit split, it would provide market jurisdictions the ability to tax some of that nonroutine profit that exceeds the set margin the affiliates would get. Generally, I would say that practitioners were interested in a system that would be as simple and administrable as possible. And because of that, it seemed like there was a preference for a more formulaic approach to the marketing intangibles proposal rather than a highly facts-and-specific traditional transfer pricing approach.
Stephanie Johnston: Many at the consultation called for a principled approach based on assessing economic impacts of the solutions on the table. And so some companies have started looking into modeling what these three options under pillar one might mean for their operation. For example, LafargeHolcim Group. It's a concrete company. They started doing a little modeling and found that under the three options the results varied for them. They either paid tax in the same jurisdictions — no change where they paid — or they saw that same 5 percent of the tax they did pay would be actually moved to developing countries like China and India and away from more established markets like the U.S. and the EU, so that was an interesting data point that came up during the conversation.
David Stewart: What did we hear last week about pillar two?
Stephanie Johnston: So the discussions on pillar two were far less harmonious. There were fewer points of agreement I found among the delegates who spoke. So some concerns that business got raised was that any minimum tax should really apply to on a global basis rather than a country-by-country basis That seemed to be a key point in the consultation document, whereas civil society targets for the opposite, having it applied to a country-by-country basis. So there was not much agreement there. There was also some disagreement about whether there was a link between the two pillars. Some thought there was. Some thought there wasn't. Some thought, “You really only need pillar one. You don't need pillar two.” Some other stakeholders were unsure about what pillar two was really trying to achieve. There was just far less agreement among delegates on pillar two.
David Stewart: Ryan, what did you find interesting about the discussions on pillar two?
Ryan Finley: Well, there were a couple things that were interesting. I would agree with Stephanie that there was a lot less resignation among practitioners than there was under pillar one. I think, generally, there was a strong preference among practitioners to apply the elements of pillar two, which are the income inclusion rule and the tax on base-eroding payments. To apply them on a very general basis, without having to make fine distinctions between countries or recipients of a payment. I think this came up in particular with the second proposal, the one, the tax on base-eroding payments, practitioners really emphasized that it's very difficult to establish the tax burden on a particular payment, versus the tax burden on an entity. And that tracing a payment all the way through a multinational group to its recipient or recipients and calculating what the tax liability on that was would be a very, very burdensome process.
David Stewart: So, Stephanie, we're about to get to the phone interview you did with Grace Perez-Navarro, the deputy director at the OECD Centre for Tax Policy and Administration. Just before we get started, can you just give an overview of what you talked about?
Stephanie Johnston: Sure. We talked about just her general impressions of the consultation itself. She was basically in listening mode like most of the OECD was. And so I just wanted to get her impressions about how things went, and what she found most useful, and what the OECD's next steps are.
Thanks, Grace, for speaking with us today. And for a download of last week's public consultation. I just wanted to get a few, your thoughts on how things went, and in general. What was the most valuable aspect of this consultation for you at the OECD?
Grace Perez-Navarro: First I would just say that for us, we thought it was a big success, because one, we had such great participation. It was the largest public consultation we've ever had. And not only that, we had participation from a diverse group of people, so not just business participants and advisers, but also civil society representatives, a lot of academics. And so I think that made for a very rich and interesting discussion. In terms of what I thought was the most valuable thing coming out of it, of course, we would have liked to have seen, you know, a single solution emerge out of the discussion, but we never actually expected that. I think the most important thing was that in contrast to, say, with some of the BEPS public consultations here, I felt like a lot of people were trying to make very constructive comments and find a path forward. So that I think was the most useful thing.
Stephanie Johnston: The task force on the digital economy had a meeting right after the consultation to debrief on what happened. What was the general mood of the TFDE at the time?
Grace Perez-Navarro: I think they also felt that it was one of the most successful public consultations that we've had. There's obviously a lot of work now for us to do. I think they certainly heard the message loud and clear that just about everybody, I think, who spoke, that it is important to have a solution that is administrable and is simple to apply by taxpayers and also administrations, and so I think that was a big take away. There clearly remain divergent views and so, we need to now within the task force, and within the secretariat and within the inclusive framework, now have to work on the different proposals on the table, try to narrow and refine them, and provide more detail to those proposals so that countries can assess what they think is the best way forward.
Stephanie Johnston: What did you think about the delegates’ interventions, on an individual basis.? Was there any one particular intervention that stood out for you?
Grace Perez-Navarro: Um, no. Not really.
Stephanie Johnston: OK. Well, what surprised you most then during the consultation?
Grace Perez-Navarro: You know, maybe it wasn't the comments made at the actual consultation. Let's keep in mind that we asked for written comments, and we had, I think, over 200 written comments and thousands of pages of comments. And I think there what was welcome was the fact that Johnson & Johnson, for example, put forward a concrete proposal of how to move ahead with this. And so that was why I said earlier that I think that was one of the most useful things coming out of the conference. The fact that companies and advisers are trying to be constructive in this process.
Stephanie Johnston: Now that there are a couple of concrete proposals in these written submissions, how might that feed into the four proposals that are on the table? I mean, the Johnson & Johnson proposal was sort of a variation on pillar one. So I mean could we see another, like say, fifth option up for discussion in the future consultations?
Grace Perez-Navarro: Um, I don't think so. I think this is a variation, but not, you know, it's something that goes towards simplification in a sense. And so we will take this, along with other proposals that came forward, and try to come up with something that we think is administrable, and that will achieve consensus. So that's kind of the process we're in now, is, you know, digesting all of this input that we got in writing. So don't forget, it wasn't just the public consultation last week. And trying to put all of this together and flesh out these proposals and see where we can find commonalities and narrow them. So that instead of moving towards five, we're narrowing the number of proposals we have on the table.
Stephanie Johnston: How far has CTPA the gotten in reviewing the 2,000 pages since the consultation closed?
Grace Perez-Navarro: I can't tell you which page we're on. We have different people looking at different parts, so I think now pretty much everybody has read all of the comments Selectively, I don't think there's a single individual who has read all of them. But we have divided it up between the pillar one, pillar two teams, and then others have looked at the key aspects of those. So we've got that, we've now got to take that and continue to work on the various proposals so that we can develop a work program that the inclusive framework can consider at the end of May. So that's quite a daunting task. We will have, as we mentioned at the consultation, two meetings of the steering group that really helps to provide the strategic direction for the inclusive framework. We'll have one on April 8 to 9 and then another one on May 2 and 3. And by May 2 and 3, we need to have some kind of outline of the work program going forward, so it doesn't mean that we will have resolved every issue or narrowed all of these proposals, but at least to identify all of the issues that would have to be addressed, and the streams of work that would have to be carried out so that we can reach a solution in 2020.
Stephanie Johnston: During the pillar one discussions, there seemed to be more points of agreements. While under pillar two, there really wasn't that much of agreement among delegates. How is the OECD going to take this into account when moving the work forward?
Grace Perez-Navarro: I think on pillar two we are advancing in terms of identifying and narrowing the scope. We still have more work to do on that. I mean, if you're asking the question, are we going to get consensus on pillar two? I don't know that yet. You should not see pillar one and pillar two as alternatives, but more as complementary solutions. At least that's how some countries are thinking of it, that they would want both pillars. And so I think there's just more work to be done in terms of understanding what the consequences would be of the application of these. I think the more challenging area we have in a way is in the pillar one space. Where we have currently three different proposals, what we're trying to do is see how far we can merge them so countries don't have to choose because obviously that won't make getting consensus easier, while the three proposals have certain commonalities, they start from different places. And so that's part of the work that we are doing right now, is trying to see how far we can converge these.
Stephanie Johnston: And I understand that the IMF and the World Bank, they had delegates at the consultation. And I think the U.N. is also gonna be working on this subject as well. And there have been calls for a platform for a collaboration on tax to take this work forward together. Can you maybe speak about that, how the international organizations are all going to work together as well?
Grace Perez-Navarro: All of the organizations that you mentioned, and many more, so all of the regional tax organizations like ATAF, the African Tax Administration Forum, CIAT, the [Inter-American Center of Tax Administrations], IOTA [the Intra-European Organisation of Tax Administrations]. We have, I don't know, almost 20 international or regional organizations participating in these discussions. And so that is, I think, very helpful, in that they have access to all of the papers that we're working on, to the discussions that we're having. The U.N. has set up a subgroup. We are not part of that subgroup, but there I don't know how many countries are in it. But we have participated in their most recent meeting. So I think what we're all trying to do is share information as far as possible. The IMF, as you know, put out a paper recently on international taxation, specifically focused on the digital area, so that is additional food for thought for everyone, so we are just trying to work as far as we can together. The platform for collaboration on tax doesn't have as such a body that meets regularly. We are planning a follow-up conference to the one we had last February, but that's what makes it a bit challenging because here what we have to do is get consensus among countries within the inclusive framework. But I think we are doing our best to stay in touch. I was just in New York, and I met with the U.N. people to talk about this, and we are certainly both in agreement that we need to keep each other informed as to where things are going to make sure that we come out with the best proposals possible.
Stephanie Johnston: Well, thanks so much for the insight and the extra tidbits of information. This has been very fascinating and helpful.
Grace Perez-Navarro: Stay tuned.
Stephanie Johnston: Yeah.
David Stewart: Stephanie, Ryan, thank you for being here.
Stephanie Johnston: Thanks for having me.
Ryan Finley: Thank you.
David Stewart: And now, Coming Attractions. Each week, we preview commentary that will be appearing in the next issue of the Tax Notes magazines. We are joined by executive editor for commentary, Jasper Smith. Jasper, what will you have for us?
Jasper Smith: In Tax Notes, Michael Knoll considers whether the TCJA encourages business owners to convert their passthrough entities to C corporations and whether the resulting savings are more apparent than real. Also, Jack Cummings writes about how Chevron deference in the [Administrative Procedure Act] applied to federal tax guidance.
In State Tax Notes, Jared Walczak from the Tax Foundation launches a new column with the discussion of states legalizing and taxing sports betting. While Joseph Carr, Michael Kenehan, and Sara Lima examine the gross and net methods of calculating unclaimed property liabilities.
And in Tax Notes International, Eduardo Brandt examines OECD and U.S. approaches to counteracting treaty shopping and abuse. And Pia Dorfmueller discusses Germany's approach to taxing online advertising services.
David Stewart: You can read all that and a lot more in the March 25 editions of Tax Notes, State Tax Notes, and Tax Notes International. That's it for this week. You can follow me on Twitter @TaxStew, that's S-T-E-W. If you have any comments, questions, or suggestions for a future episode, you can email us at podcast@taxanalysts.org. And as always, if you like what we're doing here, please leave a rating or a review wherever you download this podcast. We'll be back next week with another episode of Tax Notes Talk.
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