The old joke usually involves a rather befuddled Englishman and one of his much cannier Celtic neighbors. Scratching his head and pointing to a confusing road sign or incomprehensible map, the Englishman asks: “So how do I get there?” To which the reply always comes: “Oh, if I was going there, I wouldn’t start from here!”
Despite the reassuring tone from the G20 Finance Ministers in their July 18 communique about “blueprints” being produced for October, the turbulence of the past several weeks around Amount A of Pillar 1 has for some people raised precisely the question in joke: exactly how we are going to get there from here? The letters going to and fro between the U.S. and the G4 (U.K., France, Italy and Spain), whispers of a “pull-out,” murmurs of an “impasse,” calls for swift action, calls for delay, commitment to continued work, and the undeniable, ever-present, yet ever-changing effects of the Covid-19 crisis, have all muddied the picture. However, if we do still want to get “there”—and given we have no choice but to start from “here”—how do we do that?
To answer that question, we probably need to step back. First we need to figure out whether where we’re headed is the place we first thought we were going. Put slightly differently, does current Amount A deal with the issue of digitalizing business models? Second, we also need to be clear-eyed about where we truly are currently starting from, to then figure out what obstacles might lie in the way and how we might be able to get around/over/through those.
So, what was the original destination of Amount A? In essence, it was—where necessary—to redesign or add to elements of the current international tax system in order to appropriately tax new, digitalizing business models not covered (or not covered sufficiently) by current rules. These new models rely heavily on intellectual property and the ability to remotely deliver goods or services; they may rely on the collection of user data; and often there is no (or very limited) physical presence in a country in which the goods and services are used or consumed (“scale without mass”). Equally importantly, this part of the project was expressed not to be a continuation of the BEPS project, and thus a further series of anti-avoidance patches, but, rather, a new, and, hopefully, dispassionate tax design project.
To get to this destination, a map was laid out that took in scope (definitions of the digitalizing economy), nexus in the absence of physical presence, a determination of “reallocable” profit, and an equitable way of reallocating that defined amount of profit among countries based on some agreed (and principled) method of allocation. It’s possible that “Amount A” has become more than just this single destination set out above, but even now I believe that remains at its core, and strikes me, still, as a place worth trying to get to.
However, to get “there” we also need to figure out where we currently are, and what the obstacles are that now need to be overcome. Only then can we determine if the original route still works, or if we need to try a slightly different one. What follows is an assessment of the point from which we’re starting in late July 2020 (which is different from February 2020, far less 2019 or earlier). It’s likely not comprehensive, but it’s a start:
1. Digitalization and the ability to service countries without a physical presence, allied to the ever-growing comparative value of IP, are issues that the current international rules do not fully and adequately cover. (Essentially the original objective.)
2. For some countries, particularly but by no means exclusively in Europe, the activities of large U.S. tech companies have become political issues and/or symbols that (politically) need to be addressed (regardless of the current taxation of such businesses post-BEPS, and post-TCJA). This may have been true before the project started, but the perceived issue has grown in magnitude and geographic reach, particularly since the beginning of the Covid-19 crisis.
3. Outside Europe, there are concerns about the existing system for income allocation with respect to sectors well beyond large tech companies.
4. In the U.S., both the Obama and Trump Administrations, as well as legislators from both parties in both houses of Congress have opposed “ringfencing the digital economy” (not least because of concerns that this is simply a one-sided tax base transfer from the U.S. to other countries). This red line has been clearly drawn (and so often articulated) that it would be very hard for the U.S. to walk away from.
5. There are significant splits within the business community on the best path forward. Particularly in the U.S., but also in some major European countries, this complicates progress as legislators respond to their own business stakeholders.
6. Digital Services Taxes (DSTs) seem likely to further increase in number, yet to secure U.S. agreement, already enacted DSTs will need to be repealed, or at least meaningfully negated for those businesses covered by an OECD agreement.
Elements #2-6 of this list have come into clearer focus since the outset of the OECD process and complicate the route to that original destination—which was already relatively complex owing to the involvement of 137 countries with widely divergent interests. A further difficulty (stretching the travel metaphor to its limits) relates, perhaps, more to the vehicle rather than to the route. But a relatively “tactical” approach to Amount A, focusing mostly, for example, on the percentages, thresholds, and limits that governments, and to a lesser extent businesses, could live with, doesn’t seem to have proved a strong basis for reaching a long-lived agreement. So, if we are to get to the destination, underlying principles must also be discerned, articulated, and widely agreed on. If we don’t, we are unlikely to reach a stable consensus, because any country that is dissatisfied in the future will claim that the previously agreed formulas no longer fit the new facts.
Of course, depending on the severity of some of the potential obstacles noted above, plotting a route may not be easy—and I am not going to try here. However, it’s worth being clear that much of the work the OECD appears to have done on this (although, absent seeing their detailed thinking, one can’t be definitive) will still provide roads and avenues down which we can travel, albeit perhaps with diversions and in a slightly different order to that envisaged a few months ago. So here are some suggestions for planning the route (building wherever possible on that existing OECD work):
- It seems the “digital economy” (“tech” for these purposes) cannot be “ringfenced” if there is to be an comprehensive agreement, and the proposed extension to “consumer-facing” businesses has been beset with definitional issues, and accusations of unfairness. So, rather than defining sectors, is there instead a way of defining classes of activity and/or income streams that flow from the “digitalizing activities”? Should we focus (and this is non-exhaustive set of examples) on:
- Nature/types/features of products and services?
- Delivery channels?
- “Virtual” in-country activity?
- Quantitatively measurable features of business activity that relate to the generation of income?
- Pillar 1 is about reallocating income between countries—and thus not cost free for countries. Taking account of that, consensus will be difficult to achieve if the project appears to ask only the U.S. (at least among large countries) to allocate its tax base/revenue to the rest of the world. So, there needs to be a carefully articulated theory or set of principles that both covers the whole “digitalizing economy” rather than a limited selection of named (and possibly static) sectors, and which (eventually, at least) picks up any applicable income above a de minimis amount from all countries.
- In relation to that last point—and while acknowledging the technical and practical valuation difficulties—one possible place to start would be to more clearly articulate what creates value in digitalizing business models, and to carefully differentiate between those factors in different business models.
- Assuming that “scale without mass” is essentially a negative definition (i.e., that you no longer need a proportionately increased physical presence in order to increase sales/profit in a market), how do you identify/isolate the new value-creating features that digitalizing business models utilize—and then how do you measure or quantify those beyond a simple appeal to sales revenue? Certain investment metrics, for example, as well as other quantitative metrics have been suggested.
- Is “active user participation” useful as a value-adding concept?
- How can we measure the relative value-creating contribution of IP vs. other activities?
- Is there a way to start smaller/incrementally?
- Higher revenue thresholds (both for the group, and by country)?
- Higher profitability thresholds?
- Other measures, such as lower permanent establishment thresholds in certain cases?
- Is there the possibility of a pilot scheme (see below)?
- Can principles be imported from current transfer pricing rules? Countries obviously want to avoid full facts and circumstances inquiries, but are there public global benchmarks, or other objective publicly-available metrics that could be used to mirror the third-party/real world insight of TP?
- For example, could more mechanical multiyear advance pricing agreements (with some benchmark elements) be reimagined for some of the Pillar 1 issues while still remaining faithful to the arm’s length standard?
- DSTs have several undesirable global tax policy flaws: they are revenue based and take no account of margin; they are outside tax treaties and, thus, MAP (and in some cases non-discrimination provisions); they can be cascading taxes; and they are not creditable, and can therefore burden businesses with possibly excess taxes, which could, obviously, be passed on to consumers.
- So, could DSTs be turned into (partial?) net basis taxes that would be covered by tax treaties with dispute resolution, and carry some tax credit like the Italian IRAP?
- Could certain deductions be allowed against the DST? Or incorporate protections for low margin businesses?
- And what would be the clearly articulated benefit of this for countries that have to give a tax credit?
- Cognizant of the fact that the December 2019 suggestion on “electability” (subsequently “safe harbors”) was not well-received outside the U.S., nevertheless, is there still the possibility of some type of election—possibly as a pilot program—into a net income tax regime for very large businesses that would balance the additional income tax cost with enhanced dispute resolution, increased certainty and bring consistent application (and which would also function as an election out of DSTs for relevant companies)?
None of these on their own is a silver bullet, but between them, perhaps, they hold the possibility of: dealing with digitalizing business models; answering the political imperatives of many non-U.S. countries; not ringfencing the U.S. tech sector, or asking only the U.S. to give tax base away; bringing together the business community in several countries; and, eliminating or significantly reducing the application of DSTs. And underlying all of these is the possibility of articulating clear principles that will make any agreement more sustainable for the long term.
To return to our original question, the exact route we had thought had been mapped out may not now get us from “here” to “there.” But the original objective of the project remains valid, and the desirability of a principled solution that can endure and adapt over time only grows as the issues become ever more pressing, especially because of the Covid-19 crisis. To arrive at this destination will be good for governments, taxpayers, and other stakeholders, and is essential to providing a base for reviving economic growth, as well as equitably meeting governments’ revenue needs. So, to get to that destination it is worth looking hard at the map, determining where we actually are, and being realistic about the obstacles around which we’ll have to navigate to get to where we want to go. But achieving a principled, broad-based and sustainable multilateral solution to one of the most challenging tax issues of our time is very definitely worth a few small course corrections.
This column does not necessarily reflect the opinion of The Bureau of National Affairs, Inc. or its owners.
Will Morris is PwC’s Deputy Global Tax Policy Leader. However the views expressed in this article are personal and do not necessarily represent the views of PwC.