New Year, New Tax Rules? An OECD Tax Reform Project Update

Tax Notes reporters Stephanie Soong Johnston and Ryan Finley recap the OECD’s latest public consultation on its two-pillar approach to taxing the digital economy.

For additional coverage, read the article in Tax Notes:

• Stakeholders Push for ‘Angel List’ in OECD Minimum Tax Plan
• U.S. Must Rethink Stance on Global Tax Reform Deal, Harter Says
• Delivering on Tax Certainty Is Critical to Pillar 1’s Success
• OECD Navigates Calls for Simplifying Global Tax Reform Plan
• OECD Opens Global Tax Meeting to Public for the First Time

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This episode is sponsored by Avalara. For more information, visit avalara.com/taxnotes.

This episode is sponsored by University of California, Irvine Law School’s Graduate Tax Program. For more information, visit law.uci.edu/gradtax.

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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 Wilder

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: new year, same digital economy. The OECD digital economy project continues to move forward and the group recently held a public consultation on its two pillar approach. What did we learn from it? And how likely are we to see an agreement this year? Here to give us an update on the digital economy project are Tax Notes chief correspondent Stephanie Soong Johnston and Tax Notes legal reporter Ryan Finley. Stephanie, Ryan, welcome back to the podcast.

Ryan Finley 1:36

Thanks.

Stephanie Soong Johnston 1:37

Thanks. Good to be here again.

David Stewart 1:38

All right. So, before we get started on recent consultation, Ryan and Stephanie, can you give listeners a brief overview of the digital economy project and where it stands now?

Ryan Finley 1:47

Yeah, sure. So, the project consists of two pillars. The first pillar, according to the most recent blueprint report, basically designed to give market jurisdictions greater taxing rights over the profits of multinationals that fall within that scope. Right now that includes companies that provide automated digital services or are consumer-facing businesses. They haven't quite worked out the definitions of those terms yet. It would do this reallocation through something called amount A, which would essentially be the multinational's profit in excess of some deemed routine return. And the proposal's explicit that this whole allocation method is not based on the arm's-length principle. There would also be something called amount B, which would fix the returns associated with kind of basic sales and distribution activities. This return is supposed to more or less reflect what the outcome would be under the arm's-length principle, but the return would be fixed for the sake of administrability. Then with pillar 2 — pillar 2 is also called the global anti-base erosion proposal. It would basically be a global minimum tax regime that shares some features with the United States' GILTI and BEAT rules. As it's proposed pillar 2 consists of a set of ordered rules. The first is an income inclusion rule and that's the part that's similar to GILTI. So, income tax below whatever minimum threshold hasn't been agreed yet would be taxable in the ultimate parent entity's jurisdiction. And then this rule will be backed up by something called the undertax payments rule, which would either deny a deduction or allow taxation at source for payments that aren't taxed at this minimum threshold. And there would also be something called the subject to tax rule, which would allow withholding or source-based tax for other types of payments that are not taxed at the minimum rate.

Stephanie Soong Johnston 3:30

So, just a few words on the political aspect of these two pillars — so delegates from the 137 jurisdictions in what's called the inclusive framework on BEPS are ultimately responsible for deciding whether they want to sign up to the two pillars or not. But because pillar 1 calls for this departure from the arm's-length principle, it requires more of a coordinated response and therefore a consensus is more necessary among the countries. So, pillar 1 is generally considered more of the politically fraught of the two pillars for a lot of reasons. The biggest being the United States. The U.S. doesn't want pillar 1 to ring-fence digital companies, the majority of which are American. And it also wants pillar 1 to be implemented on what's called a safe harbor basis, meaning that companies could opt-in in exchange for greater tax certainty. So, this political challenge has dogged the inclusive framework negotiations for some time now. So, where things stand now, countries are waiting for the U.S. to put in a new Treasury team in place under the Biden administration to resume those discussions. And hopefully come up with agreement on both pillars by mid-2021, which I understand means effectively end of June for the inclusive framework and July 9 and 10 for the finance ministers of the G-20. So, countries hope that pillar 1 would effectively mean avoiding a patchwork of different measures to tax digital activity. Since pillar 1 would call on countries with so-called unilateral measures to withdraw them. There's no list yet dividing what kind of measures would be considered unilateral measures, but it would likely include digital services taxes and the like. So, that is where things stand now politically.

David Stewart 5:03

So, let's turn to the consultation that was just held. And on sticking to the subject of pillar 1, what did we learn from this consultation?

Ryan Finley 5:10

Pillar 1, in addition to being fraught among delegates to the inclusive framework , it's also somewhat fraught among the practitioners that participated. If there was an overarching theme in this consultation, it was that there needs to be a greater emphasis on things like simplification, certainty, and particularly having strong mechanisms to prevent double taxation and resolve disputes. So, a lot of these concerns are tied to the way these different amounts interact and whether you could have double counting. Some practitioners and business representatives are worried that these amounts A and B may overlap, leading to double taxation. Another double counting risk that came up was the potential for transfer pricing adjustments under the current rules to be made such that they capture part of what is included in amount A. And so, if you don't have some dispute resolution mechanism to either reduce the reallocated piece of amount A or the transfer pricing adjustment, you could have double taxation. Generally, the practitioners are pretty strong that you're going to need to have some sort of mandatory binding arbitration mechanism to deal with this. But, of course, that remains very controversial, particularly among developing countries. The other thing would be that multinationals are concerned about the scope. Their views differ actually. Some multinationals argue for a narrower scope, I guess hoping that their particular business will fall outside the scope of automated digital services or consumer-facing businesses. But others have argued that having this limited scope essentially reproduces this ring-fencing problem, where you're essentially imposing a new system arbitrarily on some companies without any clear policy basis. So, those were the main themes and it didn't seem like there was any consensus yet.

Stephanie Soong Johnston 6:53

Just jumping off on what Ryan said, what I heard from companies too was that some of them really calling for the scope issue to be solved by tying the calculation process for amount A liabilities in a given market jurisdiction, tying that to a more objective criteria rather than relying on positive and negative lists of what an automated digital service is and what a consumer facing businesses is. So, Netflix, for example, called for using objective metrics like group operating profit thresholds. Instead of focusing on who's in and who's out, focusing on financial accounts and hard data. So, that was something that I thought was interesting. I also thought it was interesting that this pillar in particular is so complicated that I was kind of joking with my colleagues and my suggestion would be to simplify it so much that you can describe it in 35 words or less in a lede in a story. Because one stakeholder during the consultation made a great point. She said, "The more complicated this is, the less likely the public will understand it, and tax administrations and policymakers will have to understand it. So, therefore, lack of understanding makes it harder to trust it. And at a time where there's so little trust in government and in systems and institutions, it's crucial that simplification is a big part of this process." So, I agree with that. It would be really hard for mainstream journalists, let alone trade journalists to explain all this to an audience and get the support of a general audience. So, simplification is a really important issue here and the OECD has acknowledged time and time again that yes, we do need to simplify not just pillar 1, but also pillar 2. So, that was very interesting to me. So, while all of this was going on, the pillar 1 consultation, Chip Harter, who was the former top negotiator for Treasury at the OECD, he spoke publicly for the first time since stepping down his post at the end of November. He basically disavowed the U.S. stance on implementing pillar 1 on a safe harbor basis and actually recommended that the Biden administration consider a little-known informal proposal that Germany had floated in mid-2020, which would "abandon activities-based scoping, and instead of scope amount A on a quantitative basis." Which sounds a lot like what all the stakeholders were calling for during the consultation. I had never heard about this proposal before. And so, when I looked into it further, I asked Chip, "What's the proposal?" Apparently it was something that the Germans had floated in the inclusive framework. It got a little bit of support, but it was basically abandoned because the U.S. was already — was still stuck on the safe harbor proposal. So, basically Chip told me that under this proposal multinational enterprises that would meet that agreed revenue threshold and have residual profits would be subject to amount A reallocation if it met two criteria: 1) profits per employee exceeded a specific high threshold, and 2) its return on tangible assets exceeded a specified high threshold. So, he said during the conference that the U.S. wasn't able to support the compromise because of the safe harbor proposal. That was the official line. And so, he actually straight up said the U.S. position never had international support and is not a basis for agreement. So, this is very interesting to me because all along the Germans have this proposal that could have provided a basis for agreement had it not been for the safe harbor proposal that the U.S. had. So, Chip Harter said that German proposal could "provide a viable basis for compromise in 2021 if the Biden administration were to throw its weight behind it." So, this is a very interesting development to me because in the political space because maybe there is a way to unlock this negotiation process. Maybe there is some hope if the Biden administration decides, "Maybe we should give another look at this proposal." So, again, it's a wait and see game to see what the Biden administration will do.

David Stewart 10:28

That's an interesting idea coming from outside the consultation. Were there any new ideas that came from inside the consultation that you heard?

Speaker 4 11:28

OK. So, there were a few new proposals. I mean, for example, Johnson & Johnson. They had — that team had come up with some innovative solutions to solve the simplification problem in the past. This time, they came back with a proposal for pillar 1 to be redesigned to replace the concepts of amount A and amount B with a return on sales target called amount Z, which would depend on a global enterprise operating margin, which would be derived by using objective metrics like Orbis data. And it's basically a formulaic approach that kind of gets around the scope issue and alleviates the administrative burden for INSCO companies.

David Stewart 12:02

So, are we closer to an agreement on pillar 1 than we were before? Or did the consultation just reinforce existing fault lines?

Stephanie Soong Johnston 12:09

That's a very good question. I would say that at the consultation, it does kind of reinforce some the fault lines as you say. But I think that generally speaking, I think that there is potential for unlocking agreement in mid-2021. I maybe would not have thought so if had it not been for Chip Harter's comments and this mystery proposal that we all need to find out more about. So, it seemed that most stakeholders during the consultation were not giving up, like they were still determined to find ways to make pillar 1 better. And I think the Biden administration signals maybe a renewed hope for progress and for good progress by mid-2021. It's just, again, the timing is going to be a big question because it will take some time for the Treasury to put in a new tax policy team in place. It'll take time to resume negotiations and get everybody up to speed. It'll take time to really consider all of these comments and incorporate them into a revised blueprint. I mean, to do all of that by the end of June is kind of a lot. So, I don't know. I guess I'm hopeful that something will happen. It's like I should be agnostic about what the success or the demise of the project because of my position as a journalist . I think from what I observed , I think that there is a bit of a renewed hope, maybe more so than this time last year.

David Stewart 13:30

You can be hopeful that you'll have something to write about in the middle of the year.

Stephanie Soong Johnston 13:34

True. Yes. Agreed. I think when all of this is going on, I think that almost a breaking point, because there's so much else going on besides the consultations that we can talk about later.

David Stewart 13:42

Well, let's move on to the second of the consultations on pillar 2, this global minimum tax concept. What did we learn from the consultation on pillar 2?

Ryan Finley 13:50

There are a couple of themes that I think emerged from the pillar 2 consultation. One message that came through from business representatives was that they should avoid a situation where multinationals that are already subject to the U.S. GILTI rules would also be subject to this globe minimum tax proposal as well. Obviously, there's a lot of overlap in the intent of both policies, although the mechanism are fairly different. There's a discussion in the blueprint about whether they should essentially allow GILTI to co-exist and basically grandfathered in as a qualifying income inclusion rule. But, the issue hasn't been settled. It's clear from the consultation that business representatives very much think that GILTI should be allowed to co-exist, as they put it, as a qualified income inclusion rule. Another theme that came up, and this wasn't so much from business representatives, more from civil society representatives, was that the stability of this system, its ability to avoid unilateral measures is going to require the buy-in from developing countries. And as things stand now, it doesn't appear that developing countries are going to get any great benefit either under pillar 2 or pillar 1. For one, simply because of the €750 million revenue threshold that you'd need to be subject to the rules in the first place. Not too many multinationals with that much revenue or that fall within the specific sectors that thus far have been identified, at least in the case of pillar 1, are going to have their ultimate parent entities in these developing countries. So, between the revenue threshold and the type of company that it's targeting, it's possible that you're not going to see any great increase in the taxing rights of market countries that are developing countries. And there's also the issue that in the ordering of the pillar 2 rules, the income inclusion rule is the main rule. And the income inclusion rule allocates taxing rights to, again, the jurisdiction where the ultimate parent entity is resident. You only get that source country taxing right if the income inclusion rule isn't applied. So, for those reasons, civil society representatives expressed a lot of concern that A) the system may not be fair as designed if it doesn't adequately cater to the needs of developing countries. And B) it may crumble as matter of stable political compromise if a significant share of the world's countries don't feel like they're getting any benefit out of it.

Stephanie Soong Johnston 16:06

A lot of practitioners took a lot of issue with pillar 2's rejection of deferred tax accounting to adjust timing differences when it comes to including some types of income or expenses in net income calculations for determining tax liability and effective tax rate under the GLOBE. So, a lot of practitioners were really hammering home. We need to have a different tax accounting. We need to be able to use it. It's ironic that the GLOBE really rests on accounting principles. Yet, here we are trying to kind of carve out this very essential tax accounting principle to calculate our tax base and our ETR . So, there was a really loud call for that. And other stakeholders who supported leveraging the work companies already have to do to compile country-by-country reports under action 13 as a starting point for pillar 2 calculations. But some stakeholders pointed out CbC reports are designed for high-level risk assessment and extending the purposes of those reports may pose some risks because the goals of the GLOBE and the CbC reports are so different. So, that was one concern that I heard loud and clear during the consultation as well. I don't think there was any conversation about tax rates. But I think the general consensus is that we're going to be looking at a 12.5 percent tax rate in line with Ireland's corporation tax. Actually on the same day as the pillar 1 consultation, the Irish finance minister published an update to Ireland's corporate tax roadmap, and basically doubled down on the fact that they are not budging on a 12.5 percent rate. And again, calling for a consensus base globally agreed approach to international tax to keep up with the modern economy.

David Stewart 17:36

So, all this is happening in the background of a bunch of digital services taxes being imposed by several countries. And in the closing days of the Trump administration, we saw a lot of activity from the U.S. trade representative on these section 301 investigations into digital services taxes. So, what countries was the USTR looking at and what did they find?

Stephanie Soong Johnston 17:55

So, if you'll remember in June 2020, the USTR opened several investigations into the digital taxes of 10 trading partners, including Austria, Brazil, the Czech Republic, the EU, India, Indonesia, Italy, Spain, Turkey, and the United Kingdom. So, all of these countries either had digital services taxes on the books or equivalent measures, or were thinking about introducing measures like them. So, we were waiting for the USTR to drop its investigations into these 10 countries in the waning days of the Trump administration. We assumed that the Trump administration was going to just pass off the work to the incoming Biden administration to decide on next steps. Despite all the drama on Capitol Hill on January 6, the USTR dropped decisions saying digital services taxes of Italy, Spain, and Turkey discriminate against U.S. businesses, which did not come as much of a surprise to anyone who has been tracking this stuff. And on January 15, Austria, Spain, and the U.K.'s digital services taxes were found to be discriminatory as well. The USTR also published a status update on the DSTs being considered in Brazil, the Czech Republic, EU and Indonesia. So, what was interesting about all of these decisions was that the USTR had held off on announcing any potential retaliatory measures such as extra trade tariffs.

David Stewart 19:14

Well, on the subject of the tariff on the section 301 investigations, the USTR found a while ago that the French DST was discriminatory and we were expecting to see some tariffs there. What's the latest on that?

Stephanie Soong Johnston 19:25

So on January 6, we all expected that these extra 25 percent tariffs would affect $1.3 billion worth of French imports, including purses and cosmetics. You know, all things that I hold dear to my heart. But January 6 came and went and we didn't hear anything. I asked the European Commission like, "Hey, so what has been happening on your end? Have you been seeing a lot of blowback on these tariffs?" And the commission said they had never gotten any notification from the USTR, so we don't know what's going on. And so, January 7, the USTR cleared up the confusion and announced that it was suspending these tariffs until further notice, pending the outcome of decisions and the other digital services tax investigations. So, we're now seeing a reprieve on those tariffs. So, you know, DSTs were always seen to be as a measure that other countries have adopted to kind of pressure countries into agreeing on a multilateral solution at the OECD, to tax digital activity. So, I would predict that digital services taxes are is still going to be a driving factor in this conversation in 2021 as even more countries are considering implementing such measures. Although, I think that countries that do have them are more amenable to giving more time to the companies that are struggling with calculating their liabilities under these new regimes. For example, both Italy and Spain announced that they were delaying payment and filing deadlines for their digital services tax regimes. So, that's going to be interesting to watch in the coming months.

David Stewart 20:57

Well, absolutely. And Stephanie and Ryan, we're going to have to have you back to talk about what we find out from the positions the new Biden administration is going to be taking and how this outcome in June-July period turns out. So, Stephanie, Ryan, thank you for being here.

Stephanie Soong Johnston 21:13

Thanks for having us.

Ryan Finley 21:14

Thank you.

David Stewart 21:17

Now, coming attractions. Each week we highlight new and interesting commentary in our magazines. Joining me now from his home is Executive Editor for Commentary Jasper Smith. Jasper, what will you have for us?

Jasper Smith 21:27

Thanks, Dave. In Tax Notes Federal, Matthew Morris distinguishes general welfare payments from reimbursements and similar types of tax-exempt income. Three Skadden practitioners consider the technical and policy questions that taxpayers should examine when evaluating a worldwide interest apportionment election under section 864(f). In Tax Notes State, Stanley Kaminski and Lauren Ferrante explore the complexities arising from the sourcing of sales of tangible personal property. Also debuting as a new series, The Search for Tax Justice, which is aimed at highlighting tax inequities at the state and federal level. In its inaugural installment, University of Virginia professor Andrew Kahrl explores the history of discriminatory tax practices against Black property owners. In Tax Notes International, Tatiana Falcão discusses a proposed toolkit for tax treaty negotiation and suggests changes to advance the interests of developing countries. Alfredo Guerrero Mackinlay and Carlos Wisniowski examine the CJEU’s decision in Fifth Avenue. And on the Opinions page, Doug Sheppard highlights the legacy of Maureen Pechacek.

David Stewart 22:40

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 @TaxStew, that's S-T-E-W. And be sure to follow @TaxNotes for all things tax. 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 review wherever you download this podcast. We'll be back next week with another episode of Tax Notes Talk.