On February 14, 2019, the following panelists discussed the highly-anticipated OECD consultation document released the previous day on several multilateral proposals to better address the tax challenges of the digitalization of the economy, during the 20th annual conference hosted by the Tax Council Policy Institute (TCPI):
- Will Morris, Deputy Global Tax Leader, PwC (Moderator)
- Pam Olson, US Deputy Tax Leader & Washington National Tax Services Practice Leader, PwC (Moderator)
- Barbara Angus, Former Chief Tax Counsel of the House Committee on Ways and Means
- Chip Harter, Deputy Assistant Secretary (Int’l Tax Affairs), U.S. Treasury
- Mindy Herzfeld, Of Counsel, Ivins, Phillips & Barker
- Brian Jenn, Deputy Int’l Tax Counsel, U.S. Treasury
- Paul Nolan, VP – Tax & Government Affairs, McCormick & Company, Inc.
- Paul Oosterhuis, Of Counsel, Skadden, Arps, Slate, Meagher & Flom LLP
- Vicki Perry, Deputy Director, Fiscal Affairs Department, IMF
Editor’s Note: A member of the BEPS Global Currents team attended the morning panels.
The purpose of the OECD consultation is for members of the Task Force on the Digital Economy (TFDE) to obtain feedback from the public, which must be submitted in writing (Word format) to the OECD by March 6, 2019. The TFDE will then hold a public hearing on the consultation proposals on March 13-14th at the OECD headquarters in Paris.
While not stated in the consultation document, the Director of the OECD Centre for Tax Policy and Administration, Pascal Saint-Amans, said during a “Tax Talks” webcast on January 29th that the results of the public consultation would be evaluated by members of the TFDE to prepare an updated digital tax interim report during their May 2019 meeting, before being delivered at the G20 Finance Ministers meeting in June 2019 in Japan.
Ms. Olson moderated the first TCPI panel, and said that the OECD BEPS project started from governmental dissatisfaction with corporate tax rules and decreased revenue collection. Allocation of taxing rights was discussed during the BEPS project negotiations, but did not become a part of the OECD recommendations in 2015. She added that countries began implementing unilateral measures to address allocation of taxing rights as a result (e.g., the U.K. diverted profits tax (DPT)).
As moderator of the second TCPI panel on digital tax developments, Mr. Morris said that economic analysis shows that larger, developed countries tend to do better with digital-related tax measures, than developing countries. Also, the OECD digital tax consultation document comes as a result of general country dissatisfaction of corporate tax rules, not with any specific group of taxpayers.
Ms. Angus discussed the legislative history of the U.S. Tax Cuts and Jobs Act (TCJA), whose goal was to address corporate tax planning based on location advantages. Other countries became more aggressive in taxing corporate profits, since they felt the U.S. did not effectively tax foreign source income under the pre-TCJA international tax rules. U.S. concern of base erosion previously was addressed only by the Subpart F rules, said Ms. Angus. Also, the excise tax proposal in U.S. House tax reform bill in 2017 was a form of refinement of the permanent establishment (PE) standard, but Congressional focus was on a different basis for allocation of taxing rights in the lead up to passage of the TCJA.
OECD Consultation: Allocation of Taxing Rights Proposals
Regarding the allocation of taxing rights, Mr. Harter said that the OECD consultation document sets out the following proposals considered by member of the TFDE: user participation; marketing intangibles; and significant economic presence. All three proposals have the same goal of modifying current international tax rules to expand taxing rights of source and residence jurisdictions, to include activities that do not require a physical presence in a jurisdiction.
While the TCJA is not driving the current OECD digital tax work, the legislation has inspired several countries to the join the multilateral discussion on allocation of taxing rights, according to Mr. Harter. If there is OECD consensus to be had, it will likely be far more modest than a form of formulary apportionment. Also, he added that there is little multilateral support for a narrow approach to focus only on digital companies (e.g., social media). Instead, the OECD negotiations will likely result in a modest reallocation of some non-routine items of income. Mr. Harter added that there is likely to be convergence around one of the options in pillar one of the OECD consultation document, but it will likely be modest, given the divergence of interests in the OECD negotiations. The range of options for convergence is very narrow.
Mr. Harter said that the OECD digital tax initiative is a high priority of Treasury, to further the stability of the international tax system, and to pivot the multilateral discussion on how to address issues with tax system. It is not likely that the OECD will release anything else on the topic between now and the end of May 2019. Treasury officials will be visiting the OECD in Paris monthly through the end of May for digital tax negotiations, according to Mr. Harter. It is difficult to reach consensus at the OECD, but there is widespread acceptance that the digital tax issue needs to be resolved. Negotiations can only move incrementally with so many stakeholders involved, so pragmatism will be required, said Mr. Harter. Mr. Oosterhuis also said that the OECD digital tax negotiations should be done in baby steps, to be more palatable.
Ms. Herzfeld said that her tax LL.M. students at the University of Florida agree with the U.K. “user participation” proposal that users do create unique value. See added that it is interesting to see the discussion on free email and search engine services in the OECD consultation document as creating value under the user participation proposal.
Regarding the “marketing intangibles” proposal, Mr. Oosterhuis asked Mr. Jenn (Co-Chair of the TFDE) several questions about the OECD consultation document, including whether the foregoing proposal seems to focus on customers, not businesses. Mr. Jenn replied that the OECD list of what constitutes a marketing intangible (e.g., trademarks and customer lists) is illustrative, and is not meant to be exhaustive. Media, music, and videos are not generally considered marketing intangibles, according to Mr. Jenn. Instead, such intangibles consist of value that customers perceive in a company. While any business, in theory, could have a marketing intangible, it makes sense to focus on businesses that have individual customer interaction, which has been part of the TFDE digital tax discussions, said Mr. Jenn.
Mr. Jenn said that there is possibility that the user participation proposal can have a larger scope than the marketing intangible proposal, but the TFDE discussions so far have not considered how to treat mobile consumers as part of former proposal. Mr. Oosterhuis provided an example of Chinese individuals making purchase outside China, and impact the impact it may have one of his EU-based clients determining the location of its customers. In his mind, the user participation proposal seeks to allocate tax to the location of an ultimate user, not the corresponding business activity.
Mr. Oosterhuis added that it would be helpful for the OECD to say that true B2B transactions are outside the scope of the pillar one digital tax proposals.
There is significant focus in the TFDE discussions on the capacity of developing countries to implement any of the digital tax proposals in pillar one on allocation of taxing rights, which would include a withholding tax element on a gross tax basis, according to Mr. Jenn. The TFDE also needs to take into account the treatment of losses and their carryforward, as part of digital tax discussions.
Ms. Perry said that the IMF is evaluating several options to address the digital tax issue, which does not necessarily cover the OECD consultation proposals. The IMF will release a paper on its evaluation in the near future, but Ms. Perry did not provide a timeline.
It seems the OECD consultation document shows the death of the arm’s-length standard, but not for B2B transactions, according to Mr. Morris. Calculating routine returns should still be determined under the traditional arm’s-length standard, with residual returns calculated under one of the OECD digital tax proposals, said Mr. Oosterhuis.
Reviewing the high-level OECD digital tax consultation document shows the complexity within each proposal, and the difficulty in drafting legislation to implement any of the options, according to Ms. Angus. Ms. Olson said that in light of the OECD consultation document, we may need to change the name of the OECD work to “base extraction and profit sharing,” to laughter from the TCPI audience.
Audience polling results showed that most (about 75%) of the TCPI conference attendees are tracking digital tax developments on a weekly basis at present. Also, more TCPI attendees (about 38%) felt that countries will continue to implement unilateral actions, compared to those (about 18%) that felt the OECD will reach consensus on the digitalized economy tax debate in the near future.
OECD Consultation: Global Anti-Base Erosion Proposals
The second pillar addressed by the OECD consultation document involves a global anti base erosion proposal, which is modelled on the U.S. global intangible low-taxed income (GILTI) and base erosion anti-abuse tax (BEAT) rules, an approach favored by France and Germany based on recent EU digital tax negotiations. This pillar would include two related rules: an income inclusion rule; and a tax on base eroding payments.
The income inclusion rule would tax income of a foreign branch or controlled entity, when it is subject to a low effective tax rate. (Para. 92 of consultation) Meanwhile, the tax on base eroding payments would protect source jurisdictions from the risk of such payments. This would be broken down into two rules: an (1) undertaxed payments rule to deny deductions for payments to related parties; and a (2) subject to tax rule to deny tax treaty benefits when the applicable income is not sufficiently taxed in the other treaty jurisdiction. (Para. 101 of consultation)
Ms. Herzfeld said that the U.S. GILTI rules are complex, in order to factor in treatment of CFC losses, and netting them against CFC income. She hopes that the OECD proposals will be simpler to apply. The other OECD proposed rule (i.e., the tax on base eroding payments) resembles the U.S. BEAT rules, but is arguably more complex to apply than the BEAT rules. The OECD will reach consensus on the digital tax issue, without need for the European Commission to drive its resolution, according to Ms. Herzfeld.
Mr. Oosterhuis said that the jurisdiction-by-jurisdiction approach of the proposed minimum tax in the OECD consultation document is not reasonable, and should instead follow the U.S. GILTI global approach to best ensure each country’s sovereignty over taxing rights. In response, Mr. Jenn said that the U.S. Treasury feels the jurisdiction-by-jurisdiction approach in the OECD consultation document is not set in stone, but Treasury has focused more of its attention on the pillar one proposals discussed in the section above (i.e., allocation of taxing rights). He added that the Treasury goal is to have the OECD minimum tax proposal be modelled off the U.S. GILTI rules.
Ms. Perry feels it is important for countries to have some form of a minimum tax on inbound investments, however structured, for developing countries to protect their tax base. The IMF feels the U.S. TCJA measures (i.e., GILTI, foreign derived intangible income (FDII), and BEAT) are innovative, but it is hard for the IMF to estimate amounts likely to be collected under them as they are new theories in the corporate tax system. She added that the U.S. BEAT is a “blunt force trauma” approach to addressing transfer pricing issues. Meanwhile, the U.S. GILTI rules can be viewed as a form of residual profit split, which makes for interesting trendsetting.
Mr. Jenn does not feel that the pillar two proposals would sufficiently address country concerns about corporate tax system issues, if countries cannot reach consensus on any of the pillar one proposals.
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