Delays Ahead: An Update on the OECD’s Global Corporate Tax Reform

Tax Notes Talk host David D. Stewart chats with Tax Notes chief correspondent Stephanie Soong Johnston and Tax Notes contributing editor Nana Ama Sarfo about recent developments on the OECD’s work to rebuild the international corporate tax system for the digital age.

For additional coverage, read these articles in Tax Notes:

• G-20 Ministers Greenlight New Deadline for OECD Global Tax Accord
• OECD Now Aiming for Global Corporate Tax Reform Deal by Mid-2021
• EU Will Respect New OECD Deadline for Reaching Global Tax Deal
• OECD Chief to Push G-20 Ministers to Step Up on Global Tax Deal
• Countries Push U.S. to Curb BEAT in OECD Minimum Tax Proposal
• BEPS 5 Years Later: Action 1 and the Quest to Tax Digital Activity

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Credits
Host: David D. Stewart
Executive Producers: Jasper B. Smith, Faye McCray
Showrunner: Paige Jones
Audio Engineers: Derek Squires, Jordan Parrish
Guest Relations: Nicole White

Transcript

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David Stewart 0:01

Welcome to the podcast. I'm David Stewart, editor in chief of Tax Notes Today International. This week: digital divide. The OECD announced on October 12 that the 137 jurisdictions participating in the inclusive framework had narrowed down the options for taxing the digital economy. However, due to significant issues that remain, the deadline for the digital economy project has been pushed back from the end of 2020 to mid-2021. Here to talk more about this highly anticipated package of reports just published by the OECD is Tax Notes chief correspondent Stephanie Soong Johnston and contributing editor Nana Ama Sarfo. Stephanie, Ama, welcome back to the podcast.

Stephanie Soong Johnston 0:42

Always a pleasure. Thank you.

Nana Ama Sarfo 0:43

Thanks for having us, Dave.

Speaker 1 0:44

Why don't we start off from a brief background on how we got here?

Stephanie Soong Johnston 0:48

If you've been tracking developments in the taxation of the digital economy space, you're aware that the OECD has been leading efforts to rebuild the international tax system to ensure that 1) digital tech activity is taxed, and 2) corporations pay a minimum amount of tax no matter where they operate. And this project is sometimes called BEPS 2.0 because it follows up on action 1 of the BEPS project, which had focused on addressing the tax challenges of the digital economy. And to reach that goal, the OECD has been trying to herd the 137 member countries of the inclusive framework on BEPS toward agreement on a two-pillar proposal for updating the corporate tax rules for an increasingly digital and globalized world. And so pillar 1 is generally considered the more radical of the two pillars because it proposes amending profit allocation and nexus rules to give market jurisdictions, i.e. where consumers are, the ability to tax residual profits of multinationals, and it signals the departure from the arm's-length standard. And pillar 2 calls for global minimum corporate taxation, which in itself is pretty radical and we wouldn't have been talking about this maybe 20 years ago. Governments were hoping that this two-pillar solution that's now on the table would give them the right to tax digital companies that don't have physical presence in their jurisdictions and ensure that all corporations pay some tax somewhere. So that is where we are now. And along the way, it's been a very long process. This has been a question that has dogged governments for years since the 1990s. And a big problem is that most of the companies that governments want to target are American. And when you are a country at the negotiating table, and everyone wants to tax your companies, it's a lot harder to come to some agreement in that way. So, and the U.S. is a pretty major player in the space, so it's been a pretty politically fraught process.

Nana Ama Sarfo 2:28

Stephanie described all of that so perfectly. And I just wanted to add that just a few months ago it wasn't even clear as to whether or not the OECD would be able to release these blueprints this month, given all of the controversy with the U.S. and its objections to pillar 1. And then also a lot of the stress that governments have been facing due to the coronavirus pandemic.

Stephanie Soong Johnston 2:50

Right? And if you look at this whole process, how many challenges can there be in the process? Seems like there's always something that's kind of slowing it down. So on Monday we did get confirmation that this timeline would be pushed back to mid-2021, when governments really wanted something by the end of 2020.

David Stewart 3:08

So I guess that brings us to what happened on Monday, October 12?

Stephanie Soong Johnston 3:11

Monday, October 12 was a very busy day, which started for me at five in the morning because the OECD held a press conference where they finally released the final versions of the two pillars. They call them blueprints. They started using a lot of this architectural jargon to kind of describe that they're using these blueprints that build this architectural, beautiful international tax system.

David Stewart 3:33

It's a blueprint that provides a foundation, I believe was the mixed metaphor they were using?

Stephanie Soong Johnston 3:37

Yes. Exactly. So what they published on Monday were the two blueprints for pillar 1 and pillar 2, plus an updated economic assessment of the two pillars. And how much is this going to bring in? So the OECD also published a public consultation document for a consultation period that runs until December 14 with a public consultation event in January 2021.

David Stewart 3:58

Now that we have the blueprint, what do we now know about pillar 1?

Stephanie Soong Johnston 4:02

As you might remember, we used to refer to the proposals in pillar 1 as the unified approach, which drew from competing countries views on how to tax in-scope multinationals and digital activity. The unified approach used to refer to three components: Amounts A, B, and C. And pillar 1 does retain that three-part structure, but slightly differently. And now we're talking about Amount A, which gives new taxing rights to market jurisdictions over a portion of residual profits of in-scope MNE groups that have active and sustained participation in that market jurisdiction. You've got Amount B, which represents a fixed return for the baseline marketing and distribution activities occurring in market jurisdictions that are in line with the arm's-length principle. And the we've got dispute prevention and resolution mechanisms to enhance tax certainty. And there are still a lot of outstanding issues on the scope of Amount A, like the quantum, which refers to the amount of residual profits to be allocated to a market jurisdiction to be taxed, and the scope, meaning what companies will be affected . But the blueprint does confirm some aspects of Amount A in particular. It'll apply to companies providing automated digital services and it'll also apply to consumer-facing businesses, but again, there are outstanding questions about what that actually means and what those cover. Amount A will also have new nexus rules for determining which market jurisdictions get to tax Amount A. It'll have revenue threshold based on annual consolidated group revenue, along with a diminimous for an in-scope revenue's carveout. Amount A would also have a loss carryforward regime. And it'll also have a dispute resolution panel mechanism that will ensure that there's agreement among tax administrations about how Amount A would apply to a particular MNE group. And pillar 1 would also require countries to remove unilateral measures and refrain from introducing such measures in the future, but it's not clear what this means yet. Do they mean digital services taxes? Or other kinds of measures like significant economic presence provisions, equalization levies, withholding taxes? Does it mean diverted profits taxes like they have in the U.K. and Australia? This remains to be determined. And as I mentioned before, pillar 1 is actually the more politically fraught of the two pillars for a lot of reasons. The biggest reason being the United States. Again, the U.S. doesn't want pillar 1 to ringfence digital companies, which are mostly American, but a lot of other countries want to really just focus on digital companies like Google, Facebook, and Apple. And the U.S. also wants pillar 1 to be implemented on a safe harbor basis, meaning companies could opt in, in exchange for greater tax certainty. So those are two pretty big obstacles for agreement on pillar 1, but in general countries hope that pillar 1 will discourage the proliferation of digital services taxes and ensure greater tax certainty, which is pretty important now that we're all dealing with economic follow the coronavirus pandemic.

David Stewart 6:33

Ama, what are your thoughts on what we know about pillar 1 now?

Nana Ama Sarfo 6:36

I also wanted to add that I think it's important to note that the OECD makes a pretty strong case within the pillar 1 blueprint as to why the revenue thresholds should not dip below €750 million. As we know, that proposed threshold amount has been pretty controversial for developing countries who say that number is simply too high and could cut out a lot of economic activity and their jurisdiction. But the OECD mentions pretty strongly here that the benefits of reducing that threshold may not be very robust.

David Stewart 7:15

Let's turn now to the pillar 2 draft. What new information do we have about that?

Stephanie Soong Johnston 7:42

Pillar 2 was supposed to ensure that large multinational businesses pay a minimum level of tax no matter where they're headquartered or where they operate. Countries are proposing to do this through interlocking rules. And these are an income inclusion rule that gives a country the ability to include some foreign income in its tax base if that income is taxed below a minimum rate. Now this is often described as being similar to the U.S. global intangible low-taxed income regime, or GILTI regime. It also includes the undertaxed payment rule that gives a country the ability to deny deduction or apply withholding tax, a payment tax below a minimum rate. And this is sometimes described as being similar to the U.S. base erosion and anti-abuse tax, or the BEAT. There's also a subject-to-tax rule that will change treaty benefits for some income items where payments are under tax relative to the minimum rate. And there's also a switchover rule that would give a country the ability to change tax treaty implications for the profits of entities that are taxed below minimum rate . So, basically nothing's going to be taxed under a minimum rate. So what's different about this — we're no longer talking about the switchover rule as a separate component of pillar 2 because now it's thought to support the income inclusion rule. So that's something different. And the blueprint reflects some key points that makes it clear that the income inclusion rule and the undertax payment rule are now grouped together to make up what we call the GLOBE rules, the global anti- base erosion rules. And we also know now that the income inclusion rule and the undertax payment rule would rely on a common tax base, which will be calculated using financial accounts prepared with accounting standards like international financial reporting standards or another standard that the MNE group parent uses for its consolidated financial statements. MNEs would determine effective tax rate, applying the tax base and cover taxes on a jurisdictional basis. And it will rely on that €750 million threshold that Ama mentioned earlier, just for the sake of simplicity and for administrative ease. The pillar 2 blueprint also makes clear that there will not be any book-to-book and limited book to tax adjustments. And there won't be consensus agreement without a separate tax rule as part of pillar 2, that's something that developing countries want. Even though pillar 2 is coming more sharply into focus, there's still a lot of outstanding issues like the minimum rate. What's the minimum rate going to be? We've heard that maybe it'll be 12.5 percent to align with Ireland. It could be higher than that. I know that developing countries want it higher. And another big outstanding issue is how the GILTI regime will coexist with pillar 2 given the similarities between GILTI and the income inclusion rule, and the similarities between the BEAT and the undertax payment rule . So how are those going to coexist together? So that's going to be very interesting for countries to hammer out.

David Stewart 10:09

So on Monday, we also got to see the impact assessments that we'd been promised for a long while now. So how much money are we talking about these proposals raising?

Stephanie Soong Johnston 10:17

The numbers are very heavily caveated. I mean, the sources for data — how do you estimate how much money two theoretical pillars are going to bring into a government coffer? The OECD did its best and carried out some economic analysis with the economics department and found that broadly pillar 1 and pillar 2 will bring in a total of $47 billion to $81 billion, or 1.9 percent to 3.2 percent of global corporate income tax revenues. That's excluding the GILTI regime. So if you take into account the GILTI regime, those estimates increased slightly. We're looking at $56 billion to $102 billion, or 2.3 percent to 4 percent of corporate income tax revenue raised. It's also worth noting that pillar 1 doesn't really raise money per se. It just reallocates profits so countries can tax them. So both pillars are expected to result in some amount of money for most governments, but those numbers aren't really bad precise at this point. What was really interesting though about the economic assessment is that the OECD has estimated a worst case scenario. If digital services taxes were to proliferate and Ama has a little more on that.

Nana Ama Sarfo 11:24

So obviously no one wants complexity, not multinationals and not the OECD either. But the OECD is saying that unilateral DSTs will be pretty harmful and could shrink worldwide GDP by over 1 percent. So in pure dollars and cents terms, we're looking at at least $1 trillion and that's a really startling amount. But on the other hand, they're estimating that pillars 1 and 2, despite all the complexity, will have what they say a very slight negative impact on GDP. They're saying that the proposals will shrink that by less than a tenth of a percent. So really the OECD is saying here: Which would you rather have? We want to potentially shrink the world economy by $1 trillion, or do we want to generate about a $100 billion in the best case scenario of tax gains. But what I find interesting is that, as Stephanie had mentioned earlier, pillar 2 is expected to generate more revenue than pillar 1. So if we look at the OECD estimates, at the high end pillar 1 will bring in about $12 billion and then pillar 2 will bring in more than three times that amount. The OECD is estimating that at the high end, it could bring in $42 billion in direct revenue gains, and that's excluding gains from GILTI or from reduced profit shifting. And so the OECD consultation asked for simplification on pillar 2. And I think that pillar 1 could also benefit from that kind of discussion as well, especially if it's not doing the heavy lifting here as illustrated by the OECD's revenue estimates. But I also think that whether or not all of this complexity will be worth it, or maybe tolerable, really depends on what the end result will be here. I mean, are pillars 1 and 2 the opening bid for international tax reform? Will these concepts be revised and revisited over time? Or are they the end destination?

David Stewart 13:23

Speaking of the end destination, how much longer is this project going to go on? It started from action 1 of the BEPS project, and that was completed five years ago. And that morphed into this current digital economy project that seems to have its date being pushed back already.

Nana Ama Sarfo 13:38

Mid-2021 is the earliest that we could see an agreement. But from there more technical work will need to be done because the OECD is planning to create a new multilateral convention for pillar 1. And then it's also planning to draft some model legislation and standard documentation and guidance for pillar 2. And then it's also mentioned that it could potentially place some aspects of pillar 2 in a multilateral convention. So all of these things will need to be written. And then of course, inclusive framework countries will need to approve them and incorporate these measures into their national laws. So there will be an extended tail to this work past 2021. But as for when that end date will be, no one knows.

Stephanie Soong Johnston 14:22

I think Ama, you're right, that there's a lot of work to be done, even if they do get agreement in mid-2021 because countries need revenue now. They're looking to raise revenues to pay for their coronavirus economic recoveries. So if you think about getting political agreement on the solution in mid-2021, what does that mean for implementation? Maybe earliest in 2021 for the really ambitious countries? Maybe 2022? If you implement in 2022, then you won't really see revenues until 2023. And in the meantime, where are you going to do with the public? Our tolerance of tax avoidance and corporate tax shenanigans, I guess you call it, will be very tested during this time when people are struggling. It's going to be very difficult, I think, to kind of stave off these unilateral measures and the temptation to implement unilateral measures in the meantime while this global corporate tax overhaul is being implemented. I don't think this is going to be the last chapter of this saga.

David Stewart 15:19

Speaking of the unilateral measures, we have seen a number of countries implementing digital services taxes, even though the U.S. strongly opposes them and is promising retaliation for them. But a lot of their plans have pushed the digital services tax to the end of this year, waiting on the OECD to come to some sort of agreement. Now with that agreement being pushed, what does that mean for all these countries that have been waiting in the wings to implement their digital services taxes?

Nana Ama Sarfo 15:44

Well, over the next few weeks and months, I think we could see a couple of things go into play here. So 1) some governments may continue to keep these proposals on hold. Governments are still analyzing these proposals that were just issued on Monday, so not many have spoken about what their future plans will be. But that's definitely a possibility keeping them on hold. Others may continue forward with the taxes that they've enacted. And then others thinking about DSTs may go ahead and enact that legislation. As Stephanie mentioned, we're looking at maybe 2023 for implementation, and a lot of countries do have revenue needs in light of the pandemic and even before that. So they may decide to go ahead and introduce those temporary measures. So we know that the European Union said that it will respect the OECD's new timeline, which is a departure from what President Ursula von der Leyen said at the beginning of September. She said that if the OECD failed to generate a solution, the EU would move forward with its own unilateral digital services tax. That being said, I'm not surprised that the EU said that it will hold off and respect the OECD's timeline because the European Parliament last month released a list of tax measures that they would like to implement to fund the broader EU budget. And they included with that a timeline for when those revenue sources should be active. And within that timeline, they said that they were looking at 2023 for an EU-wide DST. So they already left a pretty healthy cushion for the OECD to implement a solution. Then we have the U.K., which has its own DST. And on Monday, the U.K. House of Lords met right after the OECD released its blueprints. And a U.K. official, who is the undersecretary of state at the Department for Digital Culture, Media and Sport, said that the U.K.'s DST will remain for the time being. She said good progress is being made on those negotiations. And once we reach common ground, then we can remove the DST. So for the U.K., we're looking at business as usual. And then France announced that it will collect its DST in December. We're seeing a mixed bag of reactions to the OECD's announcement. But beyond that, we know that some but not all African countries are thinking about implementing their own DSTs while we wait for an OECD solution. So I think movement on that continent will definitely be something to watch. The African Tax Administration Forum just released a suggested approach to digital service taxation for governments that are thinking about embarking on that path, so now it's really time for governments to engage in a cost-benefit analysis.

David Stewart 18:44

Now this project is all being done under the mandate of the G-20. How have they responded to the blueprints that came out this week?

Stephanie Soong Johnston 18:52

So the G-20 finance ministers and central bank governors met yesterday, October 14, and discussed the two pillars among other things, and eventually issued a communique in which they expressed support for the ongoing work at the OECD and the new mid-2021 deadline. They vowed to keep working and to resolve their political differences and actually placed the blame for the delay on the pandemic alone, which is interesting because in the documents released on Monday, the OECD cited the pandemic as well as political differences. So that was interesting that that political differences aspect didn't get into the communique. So there were no fireworks in that regard, which I was kind of hoping for. But Bruno Le Maire, the finance minister of France, held a press conference later that same day of the G-20 conference. He said basically France was ready to agree to pillar 1 and pillar two, and it was the U.S.'s fault that this is not happening and really placed the blame squarely on the United States for this. So in response, France said, "We're going to resume collecting our digital services tax by mid-December." And if you recall, the U.S. and France are sort of locked in this dispute over France's digital services tax . When France introduced the DST, the U.S. was very offended because the U.S. thinks the DSTs are discriminatory against U.S. companies. So when France adopted theirs , the U.S. launched a section 301 investigation into this tax to see if it is discriminatory and if so, they would go ahead and impose retaliatory taxes on some French imports. The U.S. and France went back and forth for quite some time. And then they finally reached an agreement where they said the U.S. will not impose tariffs and France will not collect digital services tax on American companies as long as the OECD can get to an agreement by the end of 2020. Wow that that's not happening, France is going to resume collection and presumably the United States will follow through on imposing 25 percent tariffs on $1.3 billion worth of French goods. So if you really need your Lancome, your Louis Vuitton purses, go out there and get them right now because it's going to be expensive starting next year.

David Stewart 20:56

I should point out more expensive.

Stephanie Soong Johnston 20:58

Right. More expensive. It's going to be very interesting to see what other countries will do in response to this new timeline and obviously what will happen if the timeline is missed again, which could happen. Anything could happen.

David Stewart 21:12

So at this point, are we any closer to solving the question of taxing the digital economy or have we just effectively kicked the can down the road?

Nana Ama Sarfo 21:20

There has been some progress since January, but we're definitely kicking the can down the road. And I can't blame the OECD for that given the coronavirus pandemic and then of course, some of the political skirmishes that have occurred. I really don't think that it would have been possible for the OECD to have attained a consensus by Monday. So for the progress part, in January the OECD flagged several unresolved technical and policy issues regarding pillars 1 and 2. They included things like the scope of Amount A, the new nexus rules for Amount A, the quantum of Amount A, revenue sourcing, and then dispute resolution and prevention, which has been hotly contested because the OECD suggested mandatory arbitration. And that is something that developing countries have been very hesitant about. Some of those issues have been addressed by the blueprints, but there are still a ton of open issues as highlighted by the public consultation document. And so the pillar 1 blueprint says that further technical work or political decisions need to be made on the scope of Amount, A, the amount of profit to be reallocated under that amount. Also the scope of Amount B and how baseline marketing and distribution activities would be defined under that amount. And then of course, the scope of mandatory binding dispute resolution. So as Stephanie mentioned, the pillar 1 safe harbor issue looms very large. It looms large with the current Trump administration, but it's also unclear how the U.S. might respond to pillar 1 if President Trump's opponent Joe Biden wins the election next month. So that is something that will need to play out. Furthermore on a pillar 2, there are many open questions, particularly as to how pillar 2 and GILTI might coexist, questions regarding the scope of the rules, and how the individual components will be designed. So yes, we are definitely kicking the can down the road. There's a lot that needs to be done within these next few months, and we will see how that will play out.

David Stewart 23:32

All right . Well, it sounds like we're going to have a lot more to talk about in the future. Stephanie, Ama, thank you for being here.

Stephanie Soong Johnston 23:38

Thanks for having us.

Nana Ama Sarfo 23:38

Thanks again, David .

Coming Attractions with Faye McCray

David Stewart 23:41

And now, coming attractions. Each week, we highlight new and interesting in our magazines. Joining me now from her home is Acquisitions and Engagement Editor in Chief Faye McCray . Faye, what will you have for us?

Faye McCray 23:51

Thank you, Dave. In Tax Notes Federal, Matthew Beard writes that a grantor could actually reduce income tax by reacquiring appreciated property transferred to a trust. Jasper Cummings, Jr., considers the general welfare exclusion from gross income. In Tax Notes State, Arthur Rosen and Tyler Moses examine dubious opinions and decisions in state and local tax cases. Jonathan Williams and Thomas Savidge address pension plan reform and what needs to be done to enhance the sustainability of existing pensions. In Tax Notes International, Jeffrey Owens and Bernd Schlenther discuss the impact of the coronavirus pandemic on human trafficking and modern slavery, and how tax administrations, customs officials, and private entities together can address these elements of the illicit economy. Andrew Hughes considers recent movements in the stock market and the challenges tax practitioners face regarding foreign exchange and supply chain risk. On the Opinions page, Joseph Thorndike argues that Wall Street analysts are woefully lacking in making predictions based on fiscal politics, as displayed in their wishful thinking regarding a COVID relief bill. Benjamin Willis and Victor Fleischer discuss possible post-election tax reform.

David Stewart 25:06

You can read all that and a lot more in the pages of tax notes, federal, state, and international, that's it for this week, you can follow me online at tax due that's S T E w, and be sure to follow at tax notes for all things tax. If you have any comments, questions, or suggestions for a future episode, you can email us@podcastattaxanalysts.org . And as always, if you like what we're doing here, please leave a rating or review wherever you download this podcast, we'll be back next week. Another episode of tax notes, talk tax notes talk is a production of tax notes. You can learn more about us by visiting www.tax notes.com/podcast. When major media wants the straight story, they turn to tax notes. Thank you for listening and join us again for another edition of tax notes. Talk tax analyst , inc, does not provide tax advice or tax preparation services, nothing in the podcast constitutes legal accounting or tax advice. A full disclaimer is included in the transcript.