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 morning panels that addressed the Pillar 1 proposals set out in the OECD’s January 29, 2019 policy note on tax nexus and profit allocation.
Editor’s Note: A member of the BEPS Global Currents team is attending the 2019 OECD conference.
The following stakeholders spoke during the morning panel sessions on June 3rd:
- Pascal Saint-Amans, Director, 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
- Brian Jenn, Co-Chair, OECD Task Force on the Digital Economy; Deputy International Tax Counsel, U.S. Treasury
- Pam Olson, U.S. Deputy Tax Leader and Washington National Tax Services Leader, PwC
- Louise Weingrod, Vice Chair, USCIB Tax Committee; Vice President, Global Taxation, Johnson & Johnson
- Richard Collier, Senior Tax Advisor, OECD Centre for Tax Policy and Administration
- Lafayette (Chip) G. Harter, Deputy Assistant Secretary (International Tax Affairs), U.S. Treasury
- Michael Graetz, Professor of Tax Law, Columbia Law School
- Will Morris, Chairman, Business at OECD Committee on Taxation and Fiscal Affairs; Vice Chair, USCIB Tax Committee; Deputy Global Tax Policy Leader, PwC
- Liz Chien, Vice President of Global Tax and Chief Tax Counsel, Ripple Labs
A. The Road to 2020: Tax Challenges of Digitalization
Pascal Saint-Amans said that the BEPS project did not succeed in two areas: Action 1 on digital tax challenges; and certain transfer pricing issues. The goal of the BEPS project was to address broken parts of the global transfer pricing system, which ended up with creation of the DEMPE (development, enhancement, maintenance, protection, and exploitation) rules, among others. However, he added that the BEPS project did not address underlying tensions of system.
Addressing digital tax challenges was a priority of France in the BEPS project, whereas, the U.S. was opposed to developing the Action 1 item, according to Mr. Saint-Amans. The U.S. Tax Cuts and Jobs Act (TCJA) marked a change in the U.S. interest in negotiating digital tax proposals. The U.S. BEAT and GILTI rules look like unilateral rules meant to address challenges of digitalization of the economy.
Mr. Saint-Amans said that the BEPS Inclusive Framework work program released on May 31st mentions ongoing work to try to simplify the Pillar 1 proposals on nexus and profit allocation, maybe through use of some formulas and a marginal shift away from traditional transfer pricing methods. He feels countries need strong political will to come up with a solution over the coming months. The goal is to have long term stability of in the global tax system, to avoid a BEPS 3.0 in the near future. Pillar 1 will need full, meaningful consensus.
Gaël Perraud said that the Pillar 1 “user participation” approach has been more of an EU approach since the beginning of the BEPS project, not just an approach developed by the U.K. more recently. The French and German GLOBE approach set out in Pillar 2 has also been discussed for several years in the EU generally. U.S. businesses have been active participants in 2019 OECD digital discussions, including in developing productive proposals and advocating for effective dispute resolution mechanisms, according to Mr. Perraud. These suggestions are reflected in the May 31st OECD work plan. The goal is to reach Inclusive Framework consensus, which will involve merging some aspects of multiple proposals into one over the coming months, especially during the G7 and G20 meetings in July and the fall of 2019.
The U.S. had some fierce debates with France in 2018 on digital tax proposals, as co-chairs of the Task Force on the Digital Economy (TFDE), said Brian Jenn. He has been personally involved in developing digital tax proposals over the past seven years, so he has seen the evolution of the U.S. position on the issue. U.S. tax reform (i.e., the TCJA) was a key motivating factor to reaching the current OECD digital tax proposals, including through lower corporate rates, moving to more of a territorial tax system, and innovation under GILTI rules, according to Mr. Jenn.
Pillar 1 seeks to address the desire of countries to tax income derived from users in their jurisdictions, and not that companies should pay a reasonable amount of tax somewhere in the global system, Mr. Jenn added. Reaching consensus on Pillar 1 in 2020 is likely to result in a formulaic approach in taxing companies, in order to increase certainty and stability in the international tax system. Mr. Jenn feels it is important to have robust dispute resolution mechanisms as part of any digital tax consensus, to provide certainty on tax liability for taxpayers and tax authorities. Any consensus will also likely have carve outs for small businesses.
Meanwhile, Pillar 2 should focus on the “income inclusion” proposal, and make it the primary rule, according to Mr. Jenn. The “tax payments” rule may need to be a stick to encourage countries to implement the income inclusion proposal.
Louise Weingrod said that the May 31st OECD work plan reflects the complexity of digital tax issues, which should include economic impact assessments. The proliferation of unilateral measures will impact investment decisions and global growth, as mentioned in the OECD work plan. She noticed many references to “simplification” and “administrability” in the Pillar 1 section of the OECD work plan. U.S. experience with state taxes shows the complexity of having flexibility in allocation factors, so the OECD should develop one set of allocation factors for the Pillar 1 proposals. Regarding Pillar 2, Ms. Weingrod added that the TCJA shows that layering a new tax system on top of existing tax systems leads to more complexity.
Pam Olson said the May 31st OECD work plan properly reflects concerns of the business community. Paragraph 13 of the work plan shows the area where the business community should really get involved in. She feels the OECD may need to take more of an economist approach, which is reflecting on the economic impact/goals before drafting the final digital tax proposals.
Mr. Saint-Amans closed the first morning panel by saying that while China is not likely to become an OECD member in near future, they are a member of the BEPS Inclusive Framework, so they are not a silent partner in the digital tax work. China’s ministry of finance and treasury sees themselves as the U.S. of tomorrow, regarding exploitation of valuable intellectual property (IP). The only emerging market candidates for becoming OECD members in the near future are Argentina and Brazil, he added.
B. Tax Challenges of Digitalization: Profit Allocation and Nexus (Pillar 1)
Richard Collier began the second morning panel session by saying that the commonalities of the OECD Pillar 1 proposals include a concurrent change to current profit allocation rules. He added that the ongoing multilateral work needs more realization that any consensus will create winners and losers among countries.
Chip Harter said that the G20 finance ministers are already very engaged in getting printouts of the OECD digital tax work that took place last week in Paris, before their meeting in Japan later this weekend. The next phase will involve developing a technical proposal that is most likely to lead to BEPS Inclusive Framework consensus. Developing countries have expressed desire to have a proposal that is administrable, he added.
Any Inclusive Framework agreement on Pillar 1 is likely to reflect the following, according to Mr. Harter:
- Formulaic approach that is administrable and produces consist result.
- Focus on above-normal returns and corresponding reallocations (e.g., valuable IP transactions), while taxing normal returns on actual activities performed in each jurisdiction to maintain aspects of existing tax rules.
- Much greater level of certainty of tax outcomes for taxpayers, especially in light of market jurisdictions getting more taxing rights under the Pillar 1 proposals, which includes enhanced dispute resolution mechanisms. Routine distribution functions performed in a market jurisdiction may have safe harbor margins as part of any Pillar 1 agreement, which may vary by industry, said Mr. Harter. For activities that go beyond routine distribution functions, any Pillar 1 agreement is likely to allow for more subjective evaluation by market tax authorities. He feels the foregoing may involve analysis of country-by-country (CbC) report filings to determine the safe harbor margins. He also feels this conceptual framework could reach BEPS Inclusive Framework consensus, subject to scoping exercises (e.g., by industry segments).If the ongoing OECD talks do not succeed, Mr. Harter feels it will become a signal for countries to implement unilateral measures, with a resulting chaotic situation. William Morris said that the May 31st OECD work plan reflects the complexity of the digital tax negotiations. He feels the digital tax work is larger than the previous BEPS project, and will likely cause a greater change in the international tax system than the BEPS project did. BIAC has produced a template recently that sets out principles by which it will measure any digital tax consensus, which should focus on taxing value creation. He added that the USCIB contributed to the BIAC template. Essential parts of any digital tax consensus should include the following, according to Mr. Morris: (1) any change should be modest; (2) needs to reduce possibility of tax disputes among countries; and (3) should increase the stability of the international tax system to increase cross-border investment and economic growth (i.e., it should not just be a revenue-raising project). The main thing that worries him is the current digital tax project failing to produce any consensus. The politics of the current environment does not allow for extended negotiation on addressing digitalization tax challenges, and more businesses should get involved in the negotiation process, whether through BIAC or other organizations, said Mr. Morris.Liz Chien feels that the May 31st OECD work plan exceeded expectations, and covers as many of the issues underlying digital taxation as possible. She is heartened that the opening of the work plan focuses on digital transformation. Any Inclusive Framework consensus needs to be scalable, with the ability to apply to changing business models/activities, to stay relevant. She added that the current digital tax negotiations show that it is possible for businesses to engage in the multilateral negotiation process. Michael Graetz sees the current digital tax discussions as the demonization of multinationals, which is a political exercise. Tax stakeholders should not be so modest in any digital tax changes that political leaders will continue to talk about the issue, he added. One common aspect of all the Pillar 1 proposals is that you cannot see them in action, which creates a risk of transforming the international tax system, which focuses on interests of capital importing vs. exporting countries, to allocating more revenue to capital importing countries, such as the U.S. However, he said changes are being considered in the context of income tax, not VAT, which does not focus on value added from transactions. Also, it is difficult to differentiate marketing intangibles from production activities, so this will be a political decision for countries to make. The status quo is countries moving unilaterally to address digitalization issues, without effective tax dispute resolution mechanisms, said Mr. Graetz. Stakeholders need to factor in business-to-business (B2B) transactions, such as in franchise business models (he used Subway as an example of the largest global franchise). We need a consistent mechanism of measuring intercompany profits, such as with the ongoing EU Common Consolidated Corporate Tax Base (CCCTB) discussions, but he feels it is hard to get multilateral agreement through this route. While the OECD’s 2020 timeline of reaching Inclusive Framework consensus is very ambitious, people should not bet against the OECD in getting it done, from his experience. Mr. Graetz feels that some sort of corporate minimum tax will become the norm, but meaningful engagement by stakeholders is likely to prevent challenging outcomes, such as those experienced with the U.S. GILTI rules that were layered on top of existing Subpart F rules, resulting in many Subpart F application challenges. Mr. Harter said that current arm’s-length principles provide a useful starting point, so we do not need to build a new tax system from the ground up as part of the digital tax discussions, which also increases the chances of reaching Inclusive Framework consensus. The current corporate tax rules face their greatest challenge in dealing with IP transactions, he added. He feels that the Pillar 1 proposals are more political in nature than those in Pillar 2, the latter of which will present more technical challenges for the OECD.Mr. Graetz finished the second morning panel session by saying that use of safe harbor margins is important in using a “bottom up” approach to introducing a digital tax system.