On June 3, 2019, the OECD, in partnership with the U.S. Council for International Business (USCIB), began its annual international tax conference in Washington, DC. Day one focused almost exclusively on digital tax developments, on the heels of the work plan released by the OECD on May 31, 2019, which sets out various interests and planned multilateral work into 2020.
This article covers the afternoon panels that addressed the Pillar 1 and 2 proposals set out in the OECD’s January 29, 2019 policy note on tax nexus/profit allocation and remaining BEPS challenges, respectively.
Editor’s Note: A member of the BEPS Global Currents team attended the 2019 OECD conference.
The following stakeholders spoke during the afternoon panel sessions on June 3rd:
- Richard Collier, Senior Advisor, OECD Centre for Tax Policy and Administration
- Gaël Perraud, Co-Chair, OECD Task Force on the Digital Economy; Director of International Taxation and European Affairs, Ministry of Economy and Finance, France
- Harry Roodbeen, Director, International Tax and Consumer Tax, Ministry of Finance, The Netherlands
- Bill Sample, Chairman, USCIB Tax Committee; Vice Chair, Business at OECD Taxation and Fiscal Policy Committee; Tax Policy Advisor, Microsoft Corporation
- Amy Roberti, Vice Chair, Business at OECD Taxation and Fiscal Policy Committee; Director, US Federal Government Relations Leader & Global Tax Policy, The Procter & Gamble Company
- Achim Pross, Head, International Cooperation and Tax Administration Division, OECD Centre for Tax Policy and Administration
- Martin Kreienbaum, Chair, OECD Committee on Fiscal Affairs; Director General, International Taxation, Federal Ministry of Finance, Germany
- Lafayette (Chip) G. Harter, Deputy Assistant Secretary (International Tax Affairs), U.S. Treasury
- Elselien Zelle, Senior Tax Manager, Booking.com
- Barbara Angus, Global Tax Policy Leader, EY
C. Tax Challenges of Digitalization: Profit Allocation and Nexus (Pillar 1 continued)
Harry Roodbeen began the panel discussion by saying that current international tax nexus rules are based on a “bricks and stone” standard. New nexus rules are needed to reach evolved business models that do not rely on a physical presence. Accordingly, he added that there are ongoing debates among tax practitioners how to allocate corporate synergies.
Gaël Perraud said that the modified residual profit split approach (RPS) set out in the OECD’s May 31, 2019 work plan could apply to the “user participation” and “marketing intangibles proposals” in Pillar 1 of the OECD digital tax proposals. This would require identification of non-routine profits, which would then be allocated among affected countries. In contrast, the fractional apportionment approach could apply to routine and non-routine returns, using an allocation key, just as with the RPS approach, according to Mr. Perraud. The distribution-based approach in Pillar 1 would lead to tax certainty, which is demanded by tax authorities and taxpayers in the current OECD negotiations. He added that the ongoing OECD work will evaluate treatment of losses under all the foregoing approaches.
Amy Roberti said that even though her company (i.e., Proctor & Gamble or P&G) is not subject to the digital services tax (DST) measures developed by certain EU member states, they are participating in the current OECD digital tax discussions as they have a global presence with boots on the ground in many jurisdictions, so tax nexus changes would affect them. The difficulty in separating marketing from trade intangibles applies to P&G, she added. Implementing a business-line approach would still present opportunities for taxpayers and tax authorities to cherry pick allocation of corporate profits, which can vary by country from her experience.
Ms. Roberti urged an incremental approach to implementing any new digital tax rules, to better ensure tax certainty and stability. It is also important to engage the U.S. Congress to implement any digital tax, from her previous Congressional work, if the BEPS Inclusive Framework decides to adopt a formulary approach.
The mechanics of what is possible to do will have an impact on any digital tax proposals, and vice versa, according to Bill Sample. Is critical to have a modest shift from the current arm’s-length standard under any new digital tax standard. Nexus without a physical presence will create a significant burden and cost on companies, and there will still only be one corporate pie of profits for countries to allocate. He added that mandatory binding arbitration with peer review should be a requirement for allocating the corporate pie under any new digital tax standard.
Mr. Sample also said that a tax on consumption is not a good replacement for taxing based on corporate investment and jobs (i.e., functions, assets, and risk). He feels the OECD digital tax proposals are too subjective, similar to the U.S. SEC 10-K disclosure standard on segmenting operations by the chief corporate operating officers.
Simplification of any digital tax standard will be important, mainly to effectively communicate it to politicians and the public, said Mr. Roodbeen. The current OECD work is an opportunity to better align tax and accounting rules.
Mr. Perraud added that simplified digital tax rules will provide more time for tax authorities to effectively do their work, as they spend months and years engaging in corporate tax audits under the current international tax system. While implementing a business-line approach to allocating corporate profits could be challenging, he said now is a good time to explore the possibility.
Messrs. Roodbeen and Perraud said that the RPS approach is on the table in the OECD digital negotiations on how to treat allocation of corporate losses. Not taking treatment of losses into account would not be logical, including for companies that have start-up losses before becoming profitable in subsequent years.
Mr. Sample sees a lot of challenges in identifying market jurisdictions, because of the evolution of distribution networks, as an example. Messrs. Roodbeen and Perraud then said that determining how third-party sellers should be treated will be the biggest challenge for the OECD to figure out.
The panel then discussed using withholding taxes as part of the digital tax proposals. Mr. Sample said that there will likely be a role for withholding taxes, but he is not sure how they may look. Studies have shown that a fractional apportionment system would be challenging for developing countries to administer, so it may be better to use withholding taxes, but not on a gross basis, he added.
Mr. Roodbeen does not see consumers doing the withholding, so sellers would likely have to perform it. Taxing on a gross income basis is not a good long-term measure, unless there is a short-term political reason for doing so, according to Mr. Perraud. He added that taxing on a gross basis is likely to create disputes among countries on application.
From P&G’s experience, there is nothing simple about using a profit split approach, as reflected in the many questions on the approach in the OECD’s February 13, 2019 digital tax consultation document, said Ms. Roberti. She favors a more formulaic approach.
While there are complexities in following a routine/non-routine function approach, it has not been complex from Mr. Sample’s experience in identifying routine returns, especially with better experience now in treatment of intellectual property (IP). He added that the harder part is figuring how to divide the residual pool into different pools. Mr. Perraud agreed that the OECD will face a bigger challenge in determining residual baskets and allocation under a routine/non-routine function approach.
D. Tax Challenges of Digitalization: Remaining BEPS Challenges (Pillar 2)
The OECD’s May 31st work plan discusses the effect of the Pillar 2 proposals on tax incentives, according to Achim Pross. Several developing country members of the BEPS Inclusive Framework seem to now recognize that tax incentives are not generally beneficial for them.
Mr. Pross added that the OECD’s “income inclusion” proposal resembles controlled foreign company (CFC) and the U.S. global intangible low-taxed income (GILTI) rules, and the May 31st work plan mentions OECD consideration of a “top up” approach, based on an effective tax rate. He added that the “switch-over rule” would apply when a tax treaty mandates switching from a credit to exemption method to resolve double taxation. Rule coordination needs to be agreed to in the OECD digital tax discussions, including compatibility with tax treaty non-discrimination provisions.
Mr. Pross also said that creating a country tax rate blacklist is not the goal of OECD’s digital tax work. However, discussion of having some carve outs from the Pillar 2 rules shows the need for the OECD to further reconsider the impact of the proposals.
Martin Kreienbaum said that while the 2015 BEPS Action 1 final report said the OECD agreed to revisit tax challenges of digitalization in the future to see how the other BEPS action items affect the topic, Germany, as G20 Presidency holder in 2017, requested the OECD to speed up the Action 1 follow-up work. The OECD still recognizes each country’s sovereignty in setting their corporate tax rates, and certain tax incentives, but future tax rules should not allow for a race to the bottom, he added.
Chip Harter said that the U.S. was an early adopter of a CFC minimum tax regime (i.e., GILTI), but was beat by Kazakhstan as the first adopter. The U.S. GILTI rules have led to some complexity in operation of the U.S. foreign tax credit (FTC) rules, whose goal is to limit double taxation. The final U.S. GILTI regs set to be released this month (i.e., June 2019) are meant to rough out some of the edges of the U.S. FTC rules, and how they apply in the GILTI regime. He added that the U.S. GILTI rules apply a global FTC, rather than a country-by-country, approach for simplicity reasons. The OECD has a challenge in determining the tax base for effective tax rate purposes under the Pillar 2 proposals.
The final U.S. GILTI regs will be released before June 22, 2019, and will be over 300 pages in length, said Mr. Harter. He recognizes that the U.S. GILTI rules still create incentives for shifting income to reach a favorable average rate, but a per-country approach would allow countries to pick up income that low-tax countries may not reach.
Barbara Angus feels that the OECD’s February 2019 consultation draft did not address the policy rationales of the Pillar 2 proposals, which the May 31st work plan partly addresses. The work plan reference to tax incentives by developing countries being redundant is a very important discussion for the BEPS Inclusive Framework to have. She added that the Pillar 2 work is departure from OECD’s previous work in merely determining how tax incentives can be harmful, which stakeholders should be more mindful of.
There is a technical corrections draft pending in the U.S. Congress that would make some needed refinements in the U.S. international tax system, to ensure a better shift to a more territorial system, so legislative work in area remains, said Ms. Angus.
Elselien Zelle said that the main purpose of Pillar 2 seems to be to ensure companies are subject to some form of a minimum tax, but the OECD should ensure it would function as a minimum tax, based on difficulties in applying the U.S. GILTI rules, which have captured some companies whose foreign tax rate is above 13.125 percent.
Because there is no need for consensus on Pillar 2, Ms. Zelle is concerned about double taxation from variation in future country implementation. She queried the OECD why countries are not considering a minimum tax rate to ensure effective global taxation, which would be simpler to implement, instead of focusing on many complex rules to ensure country sovereignty on tax rates remains.
In listening to stakeholders, Ms. Zelle sees the difficulty in coming up with a simple approach under Pillar 2. She hopes Pillar 2 result will not have thresholds, which create cliff effects, such as with the U.S. base erosion anti-abuse tax (BEAT) rules.
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