Tax Notes chief correspondent Stephanie Soong Johnston recaps the historic agreement reached by the majority of the OECD's inclusive framework countries on its two-pillar corporate tax reform proposal.
For additional coverage, read these articles in Tax Notes:
In our “In the Pages” segment, Lewis Greenwald, managing director with Alvarez and Marsal Taxand, chats about his Tax Notes piece, “On the Exceptional Importance of Intercompany Agreements That Can Be Readily Produced.”
***
Credits
Host: David D. Stewart
Executive Producers: Jasper B. Smith, Paige Jones
Showrunner and Audio Engineer: Jordan Parrish
Guest Relations: Christa Goad
Tax Notes chief correspondent Stephanie Soong Johnston recaps the historic agreement reached by the majority of the OECD's inclusive framework countries on its two-pillar corporate tax reform proposal.
For additional coverage, read these articles in Tax Notes:
In our “In the Pages” segment, Lewis Greenwald, managing director with Alvarez and Marsal Taxand, chats about his Tax Notes piece, “On the Exceptional Importance of Intercompany Agreements That Can Be Readily Produced.”
***
Credits
Host: David D. Stewart
Executive Producers: Jasper B. Smith, Paige Jones
Showrunner and Audio Engineer: Jordan Parrish
Guest Relations: Christa Goad
Welcome to the podcast. I'm David Stewart, editor in chief of Tax Notes Today International. This week: two pillar progress report. On July 1st, the OECD inclusive framework announced that a majority of countries, including those from the G-7 and G-20 had reached a broad agreement on its two pillar corporate tax reform plan. Governments from countries agreeable to the proposal, viewed it as an important milestone while the plan's critics have not been swayed, at least not yet. So will a consensus be reached on the OECD two pillar plan and what are the next steps for the inclusive framework and countries across the globe? Here to talk more about this is Tax Notes chief correspondent Stephanie Soong Johnston. Stephanie, welcome back to the podcast.
Stephanie Soong Johnston:Good to be here, it's been a minute.
David D. Stewart:Well, since it has been, could you first remind listeners about what this digital economy project is all about?
Stephanie Soong Johnston:Sure. So this project follows up on action 1 of the OECD G-20 base erosion and profit shifting project, the BEPS project for short, that's from 2015, and that was aimed at addressing the tech challenges of a digital economy. One problem is that the existing tax rules aren't keeping up with how business is carried out anymore. Companies are taxed based on physical presence in a jurisdiction, but with globalization and digitalization, they can now profit from activities in jurisdictions without physical presence, which has frustrated governments. And there are also persistent concerns about multinationals ability to shift their profits into low tax jurisdictions and minimize their tax liabilities. So the G-20 directed the OECD to set up the inclusive framework on BEPS in 2016 to follow up on the BEPS project, especially on action 1. And this group, as you'll remember, has 139 countries represented. And the goal was to come up with a multilaterally agreed solution to address the problems of digitalization by the end of 2020. But the inclusive framework was unable to do so for a couple of main reasons. First, the challenges of the coronavirus pandemic, which up-ended everything, and to political difficulties, including the U.S. election in November, 2020, although countries were unable to reach political consensus by the end of 2020, the inclusive framework approved publication of blueprints in October 2020, which gave us an idea of what the two pillar solution might look like.
David D. Stewart:Okay could you also remind us about what these two pillars are?
Stephanie Soong Johnston:So very briefly pillar one would change profit allocation and NEXUS rules that would give market jurisdictions and a new taxing, right called Amount A, that's over a portion of multinational corporate residual profits based on sales to consumers in those jurisdictions. And it's widely seen as the part of the plan that will address the taxation of visual activity. It will require countries to withdraw unilateral measures like digital services taxes, and refrain from introducing us in the future pillar two, meanwhile calls for a global minimum taxation system. And the core of that is the global antibase erosion proposal, which effectively imposes a top-up tax using an effective tax rate test based on a jurisdictional blending basis. And the elements of the globe proposal draws inspiration from the global intangible low tax income regime and the base version antiabuse tax of the Tax Cuts and Jobs Act. It proposes that large multinational enterprises pay a minimum level of tax based on a global minimum tax rate of at least 15 percent on a country by country basis.
David D. Stewart:So where did countries leave negotiations at the end of 2020?
Stephanie Soong Johnston:A key outstanding issue was the scope of pillar one. And that's been described as the mother of all issues holding up agreement. And at the end of 2020, the idea was that Amount A would affect MNE's that were consumer-facing businesses and those that offered automated digital services. But the question was which companies would be in or out of scope and what factors would be used to identify them. There was also a question about how to segment out company business lines that might fall under scope. Then the U.S. under the Trump administration wanted pillar one to be implemented on a safe Harbor basis, which was wildly interpreted to me that the companies could opt into the new rules, which of course other countries did not like. And at the root of this issue was tension between the United States, which didn't want a solution to ring fence digital companies, which were mostly American and other countries like France that want to target these digital companies. So there was that tension between these two groups that need to be resolved. To that end, pillar one calls for the roll back and stand still of unilateral measures to tax digital activity like digital service taxes, which as you all know, the United States also dislikes because the government thinks they discriminated against U.S. business interests. And as for pillar two, there was a big question about what the global minimum rate would be and how the U.S. GILTI regime and BEAT would co-exist with the new system. Since the globe rules share similarities with those two regimes and other issues under pillar two include details about how a proposed formulaic substance carve-out and industry exemptions would work out. And there also standing questions for both pillars about how countries would implement these new rules.
David D. Stewart:Now there've been several events lately where progress has been made on this project. And I suppose the first thing to happen was the Biden administration getting its team in place. What's the new administration's approach been to these negotiations?
Stephanie Soong Johnston:A lot has happened since I was on the podcast in January. At the time we were all waiting for what the Biden administration would do when Treasury would resume its place at the negotiating table at the OECD's inclusive framework. We started seeing some action in February when the new Treasury team said it had abandoned the Safe Harbor idea, which was a big deal for the other countries' inclusive framework. And then in April, the inclusive framework steering group met with the new U.S. negotiator Tigran Berg and a slide deck happened to leek out showing that the U.S. had a new proposal to help unblock the scoping issues of pillar one. This was called the comprehensive scoping proposal and it called for designing quantitative criteria, linked to revenue and profit margins to narrow the scope of pillar one rules. So they only apply to the largest and most profitable eMoney groups, regardless of industry calcification or business model. Of course, this raised questions about how the rules would apply to profitable segments of otherwise unprofitable companies like Amazon and its cloud business. So the inclusive framework steering group met again in May and their treasury proposed the 15 percent global minimum tax rate floor for pillar two, as an opening offer that stressed that the rate should be higher in line with what the Biden administration is trying to do in terms of reforming the international provisions of the Tax Cuts and Jobs Act, which primarily calls for doubling the GILTI rates 21 percent among other things. There has been a lot of talk about how the Biden administration has signaled a return to multi-lateralism and sources I've talked to have said that its engagement with the inclusive framework has rebooted the negotiations, but I really don't think the U.S. Has ever really stopped engaging with others and inclusive framework under the Trump administration. It's just that the Biden administration has been publicizing that work more and framing it as part of the United States returned to multi-lateralism in general. And what has been especially interesting to me is that the Treasury has been carrying out the Biden administration's domestic agenda in parallel with the OECD tax reform talks particularly under pillar two.
David D. Stewart:Now you mentioned these unilateral digital services taxes a few minutes ago, and so on a separate track from the OECD process, there has been this U.S. trade representative investigations into digital services taxes. Can you give us an update on that?
Stephanie Soong Johnston:So the Office of the U.S. Trade Representative confirmed in early June that it wrapped up its investigations into the digital services taxes of Austria, India, Italy, Spain, Turkey, and the United Kingdom, and said that they would impose 25 percent tariffs on more than 2 billion worth of imports from those countries after they found that their DSTs discriminated against U.S. businesses. But it also said in the same breath, they will suspend these tariffs for up to 180 days until November 29th, to give more room to the OTA negotiations to conclude. And so France, you might remember also faces some retaliatory tariffs as well. I think that the USTR is going to just wait until all of these negotiations are concluded before moving ahead with these tariffs. So even though these digital services taxes issues are sort of separate from what's going on with the OECD, it's very much tied into what's happening with OECD because it's provides motivation for countries to get to some kind of agreement to avoid having this all out trade war between the United States and other countries.
David D. Stewart:All right, now, turning back to that agreement, it seems that the G-7 was the first to make news on this lately. Can you tell me what happened there?
Stephanie Soong Johnston:The G-7 finance ministers met June 4th, the 5th in London under the UK presidency where they gave political backing to the two pillars and they also offered a few more details about what had been negotiated. Specifically on pillar one, they agreed that market jurisdiction should have taxing rights on at least 20 percent of profit exceeding a 10 percent margin for the largest and most profitable multinational enterprises. And on pillar two, they agreed on a minimum tax rate of at least 15 percent. And to those who had been following these negotiations very closely, the G-7 agreement represented an incremental step to where broader agreement within the inclusive framework and in the G-20, but you wouldn't know it from the media frenzy surrounding it.
David D. Stewart:Now of course, following that, that led into the much anticipated, at least among us tax people, inclusive framework meeting. Did they come to an agreement?
Stephanie Soong Johnston:The inclusive framework met June 30th and July 1st to see if they can reach some kind of agreement on the two pillars. And they nearly got there, 130 out of the 139 ended up signing on. There were nine holdouts at the time. Those were Barbados, Estonia, Hungary, Ireland, Kenya, Nigeria, Peru, Srilanka, and St. Vincent and the Grenadines, however, Peru and St. Vincent and the Grenadines later joined the agreement leaving seven. They also published a statement with the elements that the countries were able to agree to.
David D. Stewart:What did they decide on pillar one?
Stephanie Soong Johnston:The statement was very brief. I mean, it was five pages, but it did say a lot. It did reveal a lot about what the two pillars are starting to look like. I'll just pull out a few details that I thought were interesting. So there's now a phasing in the period for Amount A. According to the agreement, Amount A would apply to Emoneys global turnover, exceeding 20 billion euros and profitability above 10 percent. And that turnover threshold would eventually be halved depending on the successful implementation of Amount A rules. And that assessment will be based on a review set to begin seven years after the agreement is enforced and about a hundred of the largest, most profitable companies are expected to be in scope. On NEXUS, there's going to be a new, special purpose NEXUS rule, permitting allocation of Amount A t o a market jurisdiction. When the i n-scope e Money derives about at least 1 million euros i n revenue from that jurisdiction. For smaller jurisdictions with GDP lower than 40 billion euros, the NEXUS will be set at 250,000 euros. The special purpose NEXUS rule applies only to determine whether a jurisdiction qualifies for the Amount A allocation. On NEXUS for inspo MNEs, between 20 to 30 percent of residual profits defined as a profit and excess of 10 percent of revenue. So the agreement also revealed a few details about the quantum of Amount A for in scope MNEs between 20 to 30 percent of its residual profit will be allocated to market jurisdictions using a revenue base allocation key. An agreement also said that segmentation would happen only in"exceptional circumstances when a company's segment meets the scoping rules." The pillar one agreement also provides for an appropriate coordination between the application of the new rules and the removal of all DSTs and other relevant, similar measures in all companies. Although there needs to be some more conversations about what these measures will be. There's also tax certainty provision in there. It calls for a dispute prevention resolution mechanisms to avoid double taxation related to Amount A and these provisions were mandatory and binding in nature, but there could be an elective binding dispute resolution mechanism for developing countries that meet certain criteria. That is, if they're eligible to defer their bets, actually 14 peer reviews and have low or no inventory of mutual agreement procedure disputes. And the agreement also talks a little bit about implementation, Amount A will acquire a multilateral instrument that will be developed and opened for signature in 2022 and Amount A is expected to come into effect in 2023.
David D. Stewart:Where do things stand on pillar two.
Stephanie Soong Johnston:The agreement confirms that's pillar two design, pillar two will have the globe rules comprising an inkling inclusion rule and the inner tax payment role. And there will also be a subject to tax rule. And the agreement also confirms that the global rules will have a common approach status, meaning that countries won't be required to adopt them. But if they do, they'll have to follow the pillar two design, and they'll also have to accept the allocation of global rules that other inclusive framework members apply. It also confirmed that the scope would apply to MNEs with annual revenues exceeding 750 million euros, which we sort of already knew before all this. And again, confirmed that the minimum rate for the global rules purposes will be at least 15 percent, although conversations still have to happen about what exactly that rate will be. The agreement also had a few more details about the formulaic substance based carve-out and here the carve-out will exclude and amount of income that is at least 7.5 percent of the carrying value of intangible assets and payroll. Now that 7.5 percent will apply for about five years as a transition period and then that'll decrease to 5 percent after that.
David D. Stewart:All right. So while the OECD is negotiating this pillar two minimum tax, the U.S. already has the GILTI regime. So how are the two expected to work together?
Stephanie Soong Johnston:That is a very good question. I think there is an acknowledgement in the agreement that's there is going to be a GILTI coexistence. It's just, we don't really know what exactly that will entail. So that's still an open question.
David D. Stewart:What sort of reactions are we hearing to what was announced?
Stephanie Soong Johnston:I think the initial reaction was this was a historic agreement and a lot of ways it is, even though it hasn't been finalized, it's historic in itself, but 130 some countries are able to agree on anything, especially anything on tax. I mean, have you ever tried to organize a dinner party with a hundred people with different dietary needs? I mean, that's a difficult task.
David D. Stewart:I try to order takeout with three people in my house and it nearly causes fights.
Stephanie Soong Johnston:So it is a historic agreement, a lot of ways, but of course there are people, there are stakeholders who are critical of the agreement that it doesn't go far enough for developing countries, that it doesn't do enough to ensure tax certainty for multinationals, that the rules are still very complicated. How are we going to get this through Congress in the U.S. A lot of outstanding questions, but I think generally people can agree that it is a pretty historic agreement.
David D. Stewart:So what's next for the inclusive framework and the OECD.
Stephanie Soong Johnston:Like I mentioned before, a lot of outstanding design questions still need to be answered about pillar one, how does the tax certainty mechanisms work? What kind of multi-lateral convention is going to be needed? And pillar two, what is the tax rate that countries can agree on? Will these holdouts manage to come around to these two pillars? There's a lot of political maneuvering that needs to happen to get those seven hold-out countries to sign on. So the plan now is to finalize the details of the two pillars, as well as an implementation plan by October. And Pascal St Amanda OSU tax chief mentioned on a podcast, that the plan is to complete the multilateral instrument to implement Amount A and to complete[ inaudible] two legislation by the end of 2020, or by early 2022, so that countries can start implementing this stuff in 2023. So a lot of outstanding questions n eed t o b e answered.
David D. Stewart:Seem that we're getting to an agreement, or might this end up getting delayed again.
Stephanie Soong Johnston:So I've been covering this very beginning and thinking about where countries were from the beginning of the project to where they are now, I mean, this is about as close as we've ever gotten to a final agreement, which is huge. Hey, over all of this though, is the question of digital services taxes and unilateral measures. Another huge question is which unilateral measures will be required to be rolled back as part of pillar one? Will that be enough to satisfy the United States and hold off on further tariffs against countries that have digital services taxes? It's the beginning of the beginning and now the real work begins
David D. Stewart:Well. All right, well, Stephanie, thank you for being here.
Stephanie Soong Johnston:Thank you for having me.
David D. Stewart:Now coming attractions each week, we highlight new and interesting commentary in our magazines. Joining me now is Acquisitions and Engagement Editor in Chief Paige Jones. Paige, what will you have for us?
Paige Jones:Thanks, Dave. In Tax Notes Federal, four practitioners consider the green book’s proposals to buttress the anti-inversion rules and recommend changes to better achieve the proposals’ goals. Lawrence Zelenak discusses Treasury’s disclosures of the income tax payments of plutocrats almost a century ago. In Tax Notes State, George Isaacson and Nathaniel Bessey criticize the Multistate Tax Commission’s proposed revision to its Statement of Information Concerning Practices of Multistate Tax Commission and Signatory States Under Public Law 86-272. Edward Dennehy and Stephen Ehrlich review the United States’ income taxation of foreign corporations. In Featured Analysis, Roxanne Bland revisits litigation surrounding excise tax on billboards, as Ohio becomes the latest state to consider the issue. On the Opinions page, Robert Goulder questions whether the American electorate will ever see the virtue in the federal gasoline tax. And now for a closer look at what’s new and noteworthy in our magazines, here is Tax Notes Executive Editor for Commentary Jasper Smith.
Jasper B. Smith:Thanks, Paige. I'm here with U.S. and International Tax Attorney Lewis Greenwald to discuss his recent Tax Notes piece titled"On the Exceptional Importance of Intercompany Agreements That Can Be Readily Produced." Welcome to the podcast, Lew.
Lewis Greenwald:Thank you, Jasper. I'm glad to be here with you.
Jasper B. Smith:Wonderful. To begin, can you give listeners a preview of this article?
Lewis Greenwald:I have practice as a U.S. international tax lawyer for decades and have assisted taxpayers in putting intercompany agreements in place. Usually in tandem with transfer pricing, that services are being rendered or assets are being transferred from one party to another, pricing those transactions, and then assisting the taxpayer in putting in place an agreement that memorializes the intent of the parties. About a year ago now, the fall of 2020, there was a very important transfer pricing case, Coca Cola v. The Commissioner. And the case really is a transfer pricing case, that is to say, the amount of compensation that an off shore affiliate had received and the government's drive to reallocate a portion of that profit back to the United States. So the case is really about the appropriate profit level of both the U.S. parties and the offshore parties, but the judge almost in dictum, but not really in dictum, sort of identified the need to have very clear and concise and current inner company agreements. And that's what was the impetus for me to write the article to again, highlight to taxpayers that their intercompany agreements should be in line with their intent. They should clearly and concisely describe the legal relationships that they seek to establish and the pricing of those relationships that the agreement should be current, and that the agreement should be readily available to be handed over to the IRS when the IRS asks for them under exam. And that the IRS will certainly ask for those intercompany agreements under examination.
Jasper B. Smith:Thank you, Louie. We certainly appreciate that. It was a very nice summary of the article and I hope their readers have, and will continue to find it interesting and informative for them. So before we let you go, can you tell listeners where they can find you online?
Lewis Greenwald:Certainly. My email address is lgreenwald@alvarezandmarsal.com and certainly anyone should feel free to pick up the phone and call my direct dial these days is 1.617.875.2415.
Jasper B. Smith:Excellent. Thank you so much again for coming on the podcast today, Lou.
Lewis Greenwald:Thank you Jasper so much for having me.
Jasper B. Smith:And you can find Lew's article online at taxnotes.com. Please be sure to subscribe to our YouTube channel Tax Analysts for more in-depth discussions on what's new and noteworthy in Tax Notes. Again, that's Tax Analysts with an S. Back to you, Dave.
David D. Stewart: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.