The past few years have been tumultuous for the international tax system. First, the OECD shook things up with its base erosion and profit-shifting project, which the organization said would help end multinational companies’ practice of playing one country’s tax system off another’s to reduce global taxes paid. That project produced reams of paper, and perhaps even a fundamental change to the international tax landscape with the introduction of a multilateral instrument to ensure that tax treaties aren’t being used to facilitate tax avoidance. Further, some countries have adopted BEPS-recommended reforms in their domestic laws. And just when the tax world seemed to be quieting down from BEPS frenzy, the U.S. Congress passed the most comprehensive reform of its tax system in decades that involved a rewrite of international tax rules that had been fundamental to cross-border planning since the 1920s.
The enactment of the Tax Cuts and Jobs Act (P.L. 115-97) in late 2017 meant that most multinationals spent much of 2018 trying to make sense of the new law and understand how it would apply to existing structures, or how those structures would need to be modified as a result. But it’s not just taxpayers that have been affected — tax administrations and finance ministries worldwide have been trying to figure out how their own systems might have to adapt in light of the new law.
While tax directors might be hoping for a new year that’s a little more settled, that wish seems unlikely to be granted. Instead, 2019 appears just as likely to bring seismic changes. This article highlights some international tax themes to keep track of in 2019.
Global Trends
The hottest topic in worldwide tax is the initiative — happening both multilaterally and unilaterally — to develop solutions for taxing the digital (or as the OECD calls it, digitalized) economy. But that’s not the only item on the global tax agenda. BEPS implementation, transparency initiatives, and responses to U.S. tax reform are all part of the mix.
Digital
The BEPS project was supposed to address taxation of the digital economy (as action item 1), but it failed to reach consensus on how to address the complex problems — and competing agendas — leaving those for the OECD to take on in BEPS 2.0. There were various developments on that front in 2018, including the European Union’s push for an aggressive approach to tax the profits of U.S. digital companies and the OECD’s March issuance of its summary report, which it released in an attempt to avoid losing the edge in this area. (Prior coverage.)
Proposed solutions for taxing the digital economy are split into short and long term. In the short-term camp is the EU’s proposed digital services tax, which amounts to a gross basis tax on large (U.S.) tech companies. At the latest European Council meeting on the topic, the proposal was met with opposition, with countries arguing that the tax base was either too broad or narrow, or being against any specific EU solution. (Prior coverage.) The European Commission is refining its latest proposal in the hope of reaching agreement next year.
The European Council’s recent rejection of the gross basis tax isn’t the end of the story, however. Several countries have created their own versions of the tax: Prominent among them is the U.K. proposed digital services tax on domestic revenue of digital businesses considered to derive significant value from user participation. The U.K. version is scheduled to be effective in April 2020 but would be revoked if what the country calls an “appropriate” global solution is agreed to and implemented.
The United Kingdom isn’t unique in deciding to go it alone absent global consensus. At an event hosted by Georgetown University on December 3, Dmitri Jegorov of the Estonian Ministry of Finance said quite a few EU countries intend to proceed with a unilateral digital services tax if there’s no agreement at the EU level. (Prior coverage: Tax Notes Int’l , Dec. 10, 2018, p. 1095.)
Led by the United States and Germany, the OECD has been trying to head off such drastic short-term measures, with aggressive targets to meet in 2019. The recent G-20 meeting in Buenos Aires resulted in a communique stating that G-20 countries would “continue to work together to seek a consensus based solution to address the impacts of the digitalization of the economy on the international tax system with an update in 2019 and a final report by 2020.” At a conference hosted by the IRS and George Washington University on December 13, Brian Jenn of the U.S. Treasury laid out a project timeline that includes a January meeting of the OECD’s task force on the digital economy to develop a draft outline of work, a public consultation in the spring, and possibly a draft consensus document later in the year.
The OECD is working on three ideas that it hopes to provide more details on in January. (Prior coverage: Tax Notes Int’l , Dec. 17, 2018, p. 1226.) Those solutions, which could perhaps be consolidated, include a digital permanent establishment (favored by the United Kingdom), a minimum tax (favored by Germany and France), and a novel U.S. proposal that involves revising source rules for profits from marketing intangibles to allocate more taxable profits to market jurisdictions. The difficulty lies in developing solutions that are administrable (according to Jenn, most OECD members consider the U.S. ideas too complex) and that address the concerns of the European jurisdictions that want to get more taxes from profitable U.S. tech companies without going too far in assigning profits to market jurisdictions (which would face significant opposition from large exporting countries). The challenges aren’t insurmountable, but solutions aren’t guaranteed, particularly in a global economic environment that has been putting pressure on multilateral approaches generally. (For more details on those ideas, see Itai Grinberg, “International Taxation in an Era of Digital Disruption: Analyzing the Current Debate” (Oct. 29, 2018).)
If the OECD fails to develop a solution that can achieve consensus, the fallout could include not just short-term digital services taxes on large U.S. tech companies. Both commentators and senior government officials have suggested that the consensus-based 100-year-old fabric of the international tax system itself is at risk. (Prior coverage: Tax Notes Int’l , Dec. 10, 2018, p. 1122.)
BEPS Implementation
In addition to BEPS action 13 (country-by-country reporting), which many countries have already adopted, the most important BEPS implementation topic for 2019 is adoption and ratification of the multilateral instrument. The OECD has been touting that aspect of BEPS implementation with great fanfare, but aside from incorporating an antiabuse test into tax treaties (the principal purpose test), the larger impact ratification will have for taxpayers engaged in cross-border activities seems muted. Only a few bilateral treaties will be modified to fully reflect the recommendations BEPS action 7 made for the PE standard.
The OECD has been diligently pursuing its commitment to conduct peer reviews of countries’ implementation of BEPS action 14 (to introduce minimum standards for dispute resolution) and action 5 (regarding harmful tax practices). According to the OECD, those reviews are making a difference, prompting countries to be more transparent in mutual agreement procedures and eliminate tax preferential arrangements. At the IRS/GWU conference, business representatives on a MAP panel agreed that transparency in that area is a welcome development that’s having positive effects.
But even though Australia, New Zealand, and the United Kingdom have announced that they’re adopting interest expense limitation and anti-hybrid legislation consistent with BEPS actions 2 and 4, and the United States included those provisions in the TCJA, there doesn’t seem to be wide-scale adoption of many of the OECD’s other recommendations (aside from revised transfer pricing guidelines).
Transparency
The BEPS implementation work toward greater transparency included the exchange of tax rulings among tax administrators and proposed mandatory disclosure rules. The EU has introduced a directive on mandatory disclosure rules (EU 2018/822) to go into effect in 2020. Another initiative involves efforts by nongovernmental organizations to introduce more public transparency into corporate taxpayers’ information.
In the EU, advocates have mostly abandoned the effort to make CbC filings public, turning instead to an accounting directive to advance the proposal for making that tax data public. Similar U.S. efforts are underway: Advocates have written to the SEC asking that that information be made public, and investors continue to ask the Financial Accounting Standards Board for more transparency in taxpayers’ CbC tax information. (Prior analysis: Tax Notes Int’l , Nov. 26, 2018, p. 862.) Some Democratic lawmakers have introduced bills that include similar proposals. (Prior analysis: Tax Notes Int’l , Dec. 10, 2018, p. 1049.)
There have also been efforts to get companies to voluntarily commit to additional public disclosure. On December 13 the Global Reporting Initiative released an exposure draft for reporting standards on tax and payments to governments; there is a 90-day public comment period. Companies that agree to be bound by those standards would commit to publicly releasing information about their CbC profits and taxes paid. That initiative is part of a larger trend for greater environmental, social, and governance investing worldwide, which seems likely to continue in 2019.
Reactions to U.S. Reform
Aside from digital initiatives, perhaps the biggest item on countries’ tax agendas for 2019 is how to respond to U.S. tax reform. At the IRS/GWU conference, Alexandra MacLean, director general of the Canada Revenue Agency, said the TCJA was the foremost item on the CRA’s agenda for 2018. She said Canada has already responded by enacting provisions to allow for full expensing of some assets and accelerated depreciation for others.
Canada isn’t alone in realizing that it must respond to U.S. tax reform. Depending on how other countries are positioned relative to the United States — some see themselves as alternative locations for investment, while others have historically enhanced their economies by serving as favorable jurisdictions for holding companies for U.S.-headquartered companies or by providing incentive regimes for intangibles assets — in 2019 they will have to continue to ensure they retain the investments and tax-favored structures that benefited from U.S. multinational investment pre-TCJA.
U.S. Landscape
U.S. developments continue to be important for taxpayers and governments worldwide.
Congressional
With the U.S. House controlled by the Democrats and the Senate controlled by Republicans, the general consensus is that no tax bill can be passed in 2019.
But that’s not to say there will be no tax-related legislative activity. Richard E. Neal, D-Mass., the incoming Ways and Means Committee chair, has promised a series of hearings to review the TCJA; look for those to critique the way the law has benefited the wealthy at the expense of middle-income earners. And while various bills to impose additional tax burdens on multinationals are unlikely to pass, they could result in a shift in political mood that could affect the legislation passed by subsequent Congresses.
Administrative
More significant in 2019 will be the work by the IRS and Treasury in issuing guidance interpreting and applying the TCJA. The U.S. government released an unprecedented amount of interpretive guidance in 2018, including proposed regulations on amended section 163(j) (REG-106089-18); new sections 59A (REG-104259-18), 951A (REG-104390-18), and 965; and section 956 (which the TCJA didn’t change). It also issued a notice (Notice 2019-1, 2019-3 IRB 1) on previously taxed income (PTI). Still to come are proposed regulations on foreign-derived intangible income and section 245A, as well as a more comprehensive revision of the PTI regs. All those proposed rules will be open for public comment before being finalized.
Speaking at the IRS/GWU conference December 14, David Kautter, Treasury assistant secretary for tax policy, outlined three top priorities for his office in 2019: release proposed regulations interpreting crucial TCJA areas not yet addressed; finalize proposed regulations interpreting the TCJA; and review pre-TCJA regulations with an eye to updating them to reflect the law’s changes.(Prior coverage.) Also on Treasury’s plate is a review of regulations under consideration for repeal as a result of Executive Order 13789, including those on sections 385 and 367. It’s an extraordinary agenda for any administrative agency — and one that might upend decades of settled administrative law and shape the international tax landscape for years to come.
The proposed regulations issued to date reflect an assertive approach by Treasury in interpreting the TCJA, indicating that it’s willing to push the limits of administrative authority to provide what it deems the most reasonable and administrable interpretations of congressional intent. Whether subsequent administrations and judges agree is another question.
Judicial
Courts will continue to examine several hot tax topics. Altera Corp. v. Commissioner, 145 T.C. 91 (2015), which involves the scope of IRS authority in issuing regulations, remains under review by the Ninth Circuit. The decision in that case could influence how the IRS proceeds with the reg-writing process in interpreting the TCJA.
Various IRS attempts to enforce transfer pricing rules also continue to make their way through the judicial system, including Amazon.com Inc. v. Commissioner, 148 T.C. 108 (2017), Medtronic Inc. v. Commissioner, 900 F.3d 610 (8th Cir. 2018), vacating and remanding T.C. Memo. 2016-112, and Western Digital Corp. v. Commissioner, No. 18984-18. Comments from IRS officials suggest that the agency will continue to aggressively pursue transfer pricing cases and that it thinks language the TCJA added to section 482 supports its view on how to properly value intangible assets in outbound transfers.
Moving Assets and People
Regardless of an uncertain tax environment, investment decisions must still be made, partnerships must still be struck, and mergers must still be pursued. Will businesses respond to the TCJA by moving intellectual property back to the United States? Or will they respond to measures such as those involving global intangible low-taxed income (with the exception for a return on qualified business asset income) and the base erosion and antiabuse tax by investing more overseas? Next year could provide the first meaningful glimpse of how the TCJA’s international tax changes will change cross-border investment, as well as effects on companies’ earnings and effective rates.
Tax and Trade
Tax professionals often seem to want to operate in a universe that ignores the larger world of international trade law, and vice versa. Tax lawyers don’t generally consider tariffs, while economically a tax on cross-border transactions, to be part of the discussion on tax considerations (even though the WTO has found some tax measures — such as U.S. tax rules characterized as export subsidies — to violate trade law). So far, the highly politicized disputes over trade have largely operated in a sphere separate from those involving international tax. For the most part, that has meant that discussions of international tax rules have focused more on technical considerations than political ones.
The pendulum might be swinging. The EU’s digital services tax, as well as its state aid investigations, highlight the extent to which countries can use cross-border taxation as a political tool to advance their wider trade agendas. If countries become more aggressive in weaponizing international tax rules for political gain, the regime will be at risk of collapsing.
Brexit
Brexit brings many unknowns, with its effect on international taxation being only a small one. But in a world with so many moving parts, the changes that Brexit could introduce, such as to withholding taxes and other tax implications of cross-border transactions and the United Kingdom’s role in EU decision-making, will increase the uncertainty associated with a highly dynamic international tax setting.
Buckle your seat belts for 2019!
Mindy Herzfeld is professor of tax practice at University of Florida Levin College of Law, director of its International Tax LLM program, and a contributor to Tax Notes International. Email: herzfeld@law.ufl.edu
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