Going into Winter? Tax and Digitalization in 2021

“A cold coming we had of it,
Just the worst time of the year
For a journey, and such a long journey:
The ways deep and the weather sharp,
The very dead of winter.”

In a cold December, at the end of this pandemic year, T. S. Eliot’s 1927 poem, The Journey of the Magi, seems a most appropriate summation of—or, perhaps, epitaph for—2020. But focusing in on the tax world, for a journey that started so promisingly almost four years ago, the OECD secretariat in Boulogne-Billancourt in Paris might also be forgiven for thinking that Eliot had them particularly in mind—at the end of this disrupted year, with disagreements on full view, the OECD’s digitalization project is certainly having a “cold coming of it”.

So, is it all over? Should the project be allowed to collapse and die, buried in a blizzard of political disagreements and unfavorable comments? I don’t think so. While I do believe some aspects of the project are in serious trouble, and that some significant changes are needed, I keep coming back to two basic, absolutely fundamental points. First, there is a genuine, significant and growing international tax issue about the “remote” creation of value/profit that needs to be solved. Second, in almost any circumstance, governments, citizens, and businesses will be better off with a comprehensive, principled multilateral solution to that issue than they will be if countries act unilaterally, fashioning solutions that are uncoordinated and each engineered to advantage that country (whether or not to the detriment of others).

So, having said that, let me first briefly lay out some of the major problems, and then consider how/if they might be solved at a multilateral level.

Pillar 1, Amount A

• Disagreements over scope: Should this scope be “narrow” digital, or broader Automated Digital Services (ADS)? Consumer Facing Businesses as well? All businesses above a certain profit margin?
• More specific disagreements over the inclusion or exclusion of certain sectors and sub-sectors, including substantial industries such as Pharma.
• The Arm’s-Length Standard (ALS): to what extent does it survive/operate in this proposal?
• Segmentation: how scientific and focused does this need to be? Can a business rely on its own financial reporting segmentation? What about when business has lines that are in, and others that are out, all in the same reporting segment? Is regional segmentation going to be respected?
• Countries/businesses “bearing” taxes, and allocation of taxes to other jurisdictions. There are countless landmines here, as tax revenue (i.e., the money governments spend …) is at stake. Does there have to be a business presence and substance connection with the country to which taxes are reallocated?
• How are losses dealt with? Where can they be offset? How are they carried forward? This again is a key issue not just for businesses but also for countries.

Pillar 1, Amount B

• There are fundamental disagreements over scope (just basic marketing and distribution functions, or a much more extensive—and high value—range of activities?). The split, largely, but not entirely, comes down to developed “residence” countries vs. less developed (LDC) “source” and “market” countries, with the developed countries wanting a narrower scope and a much lower fixed return, and the LDCs wanting a broader scope and a correspondingly higher fixed return.
• There are significant questions about how to limit the impact of Amount A, if a business is also subject to Amount B (i.e., in-scope activities, as well as a physical presence). And what should be done with respect to the interaction of Amount B and withholding taxes? While Amount A is clearly not meant to reflect the ALS, Amount B is meant to approximate it—but if it is a fixed percentage of profit, for example, then for a high-margin business Amount B could considerably exceed the ALS amount for those functions.

Pillar 1, Dispute Resolution

• How is the dispute resolution mechanism going to function? While the Amount A review and determination panels procedure is truly innovative, it is unclear whether tax authority resources are realistically available to make the process work even with an initial threshold of $5bn of global revenue. According to the Pillar 1 Blueprint, that’s still 620 major Multinational Enterprise (MNE) groups involved.
• Because of the objections of some of the BRICS and many LDCs, mandatory binding arbitration—which was viewed as one of the biggest potential benefits for business (and their home country governments)—has not been included in the blueprints.

Pillar 2

• For both the U.S. government and the U.S. business community, the overwhelming Pillar 2 issue is how comprehensive the exclusion from the Pillar 2 rules will be if GILTI is agreed to be a compliant Pillar 2 regime.
• If that exclusion is not comprehensive, then issues arise around the calculation of per-jurisdiction Effective Tax Rates (ETRs); the calculation of Profit Before Tax (PBT) and the need for a separate system for taking account of timing differences, etc. The result could be a very substantial compliance burden, not to mention disputes between countries.
• What is the impact on certain national incentive regimes for, e.g., innovation?
• There are issues around the priority of the Subject to Tax Rule over the Income Inclusion Rule, and the application of that rule to items (or streams) of income (even narrower than the per-country ETR).
• There is the question of how to ensure uniformity on both rates and implementation when countries will likely individually enact these measures in national legislation. This relates partly to the issue of complexity above (and the doubts already expressed by some countries about their ability to administer a system of this complexity), but also what overall governance structures might be.

When you look at these significant problems, you must also remember that 137 countries (many with very different interests) are involved, understand that the next 6 months will still be interrupted by Covid, remember that an incoming U.S. Administration will likely not be fully in place before March or April, and recall that the EU is committed to coming forward with proposals on a digital tax by June. Truly, it seems that the project is having “a cold coming … of it.”

So, should I predict the demise of the project – both Pillars 1 and 2, as they do seem to be politically linked? Well, it is a real possibility. However, if that happens what will have really died is not “any action,” but the possibility of “multilateral action.” There will be no reversion to the status quo ante. Instead, the future will be full of DSTs, unilateral attempts to impose destination-based taxes, and further tax base protection measures based on deduction denial/BEAT models. That would be a very bad outcome. That bad outcome, of itself, may not be a reason to sign up to the current, rather troubled, version of the project—but it is surely a reason to seriously work on reimagining the project. How? Well, let’s go back through some of the problem areas and see what might be possible.

Amount A. The biggest problem with Amount A is the lack of a clearly articulated reason for reallocating income to market countries, and without that principle Amount A has become subject to significant horse trading. On subsidiary, specific issues I think that the current scope is an almost insoluble one at this point. The nexus rules, however, will have to change one way or another. Segmentation just seems destined to become ever more complex. And the dispute prevention and resolution procedures could be overwhelmed.

So, what might be done? Well, first, perhaps, there needs to be an acknowledgment that this is fundamentally an argument about “winners” and “losers” under the current system that can only ultimately be resolved by a full, open and honest discussion about the current balance of source taxation (and now also market/destination taxation) vs. residence taxation. This subject does need to be seriously opened up if stability is ever to be restored—but will also take longer to resolve than the next six months.

To get this project back on its feet in the short term, however, some type of narrowing of scope is required. To start that narrowing, a more modest articulation of the issue might help: the need to find a principled method for taxing the remote creation of value/profit not covered by current rules under physical presence tests. Further narrowing could take place by changing the thresholds, perhaps by way of phasing the rules in. To solve the political issue of DSTs, perhaps Amount A offsetting any DST could be reconsidered. Alternatively, something around introducing a net element into DSTs might work (both to apply it more equitably to net income, as well as making it creditable).

The time crunch issue will require the new US Administration to prioritize this (among a host of such issues …), and reach out swiftly to the Congress—and the G20 is likely to make the importance of this known to the new administration very quickly. But, while it would be very difficult for the U.S. to go back on not “ringfencing the digital economy,” refocusing any reallocation provision on a principled, proportionate, and manageable application to businesses that create value remotely (not just “tech”) is not impossible.

Amount B. Given the entrenched position of both sides, more time is needed to reach a meaningful agreement. That time could be bought by the idea raised by the OECD themselves of a pilot program.

Dispute resolution. A narrowing of Amount A would have the added advantage of reducing pressure on the dispute panels, and give them time to get up-and-running so as to find a rhythm.

Pillar 2. There is no doubt in my mind that if the OECD does not reach a Pillar 2 agreement, then the EU will pick up something pretty similar and seek to embody it in a directive. As a result, whether or not there is an OECD agreement, in order to avoid a potential compliance and administrative crunch for both taxpayers and tax authorities down the road, it will be important over the next six months to work on ways to simplify this provision. I think the desire is there for that among governments, but it will require some give-and-take around whitelists, or safe harbors based on easily ascertainable numbers rather than complex new calculations. Additionally, issues around PBT and tax base calculation and interaction with accounting rules will need to be considerably refined, but, again, I think the will exists there.

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It is, obviously, very difficult right now to predict how the project will go next year. But failure is a real possibility—and that failure will bring serious consequences. Complex—and not always internally consistent—though the ideas in the Blueprints may seem, they cannot now be un-imagined. And a good, or at least workable (and improvable) multilateral agreement, is much preferable to the free-for-all of DSTs, tariffs, revenue grabs, and mounting disputes that would otherwise follow. It’s still worth working for, because if you think it looks like winter in the international tax world right now, just wait …

This column doesn’t necessarily reflect the opinion of The Bureau of National Affairs Inc. or its owners.

Author Information

Will Morris is PwC’s Deputy Global Tax Policy Leader and Chair of the Taxation and Fiscal Committee of Business at OECD (BIAC). However, the views expressed in this article are personal, and do not necessarily represent the views of either PwC or Business at OECD.