INSIGHT: Fortune 500 Speak Out on Unified Approach

On Nov. 21-22, the OECD hosted a day and a half-long public consultation meeting in Paris on its document titled Secretariat Proposal for a “Unified Approach” under Pillar One (the Consultation Document), which was released by the OECD on Oct. 9 2019.

The OECD received over 300 comment submissions on the Consultation Document. The consultation meeting was chaired by the French and U.S. government officials who serve as co-chairs of the OECD Task Force on the Digital Economy. Numerous government officials from the more than 130 jurisdictions of the Inclusive Framework attended the meeting.

Since the Consultation Document introduces several concepts for which there is no precedent in international taxation, and which may be very difficult to administer, the commenters were relatively united that the new rules must be as unambiguous as possible. They disagreed on other basic matters.

American multinational corporations (MNCs) seemed mostly resigned to the fact that some formulary elements, notably the controversial Amount A, will be part of the final proposal. They also consent to the new definition of nexus as illustrated by Netflix who commented “We support in particular increased taxing rights for market countries through the creation of a new nexus.”

Citizen advocacy groups by contrast felt the Unified Approach was complex and would raise little new tax and demanded a simple hardline formulary apportionment applied across the board.

The MNCs, themselves, were hardly united especially when their interests clashed. Notably, companies like Amazon and Unilever wanted the Unified Approach to apply to all industries and argued against “ring fencing” them.

This article organizes the over 300 comments received in terms of the most important and uncertain areas, namely (1) the scope of the Unified Approach; (2) computations of Amount A, B, and C; (3) the new definition of nexus; (4) the repeal of unilateral measures; and (5) mechanisms to resolve disputes.

Scope Issue One—Carve Out

The Consultation Document limits the scope of the Unified Approach to digital and consumer-facing industries, which of course encouraged many commenters to argue that their companies qualified to be excluded.

1. Astra-Zeneca explained that “ethical pharmaceuticals which are prescription only medicines generally prescribed by doctors” should be excluded from the scope of the Pillar One proposals” since it is not “consumer-facing.” These views were echoed by Glaxo Smith Kline and other pharmaceutical companies.

2. Semiconductor Industry Association (SIA) justified its members being out of scope because “the semiconductor industry has a limited consumer-facing element and limited direct sales to consumers. Semiconductors are components that are sold in bulk and incorporated and substantially transformed by unrelated parties into an altogether different product”

3. AB Volvo, a leading manufacturer of trucks, buses, and construction equipment, emphasized that Volvo is a commercial-facing business and that the Unified Approach “is most relevant for digital centric businesses which interact remotely with users and other consumer-facing businesses where activities can more easily be carried out from a remote location.”

4. Yum Brands!, brand owner of KFC, took a different tack to qualify for exclusion stating “We understand this project as trying to address the issue arising from exploitation of local country markets by creating revenues without any physical presence, however, the proposed solution risks sweeping-in longstanding traditional business models, such as franchise business models, which already exhibit appropriate in-market tax revenue characteristics and bear no relationship to concerns of digitalization described in the proposal.”

5. Finance: The International Banking Federation said retail banking should be excluded because the profitability of retail banks is low and because bankers do not sell financial products remotely. Insurance Europe argued for an insurance carve out, noting that insurance is highly regulated and that taxing rights are already largely with the jurisdiction of the consumer.

Scope Issue Two—Does Carve Out Only Apply to Amount A

Commenters wanted clarity as to whether the scope limitation only applied to the new taxing right, Amount A. To put it more specifically would non-digital and industrial-facing companies still be subject to Amount B and C. Typical was this question was posed by the U.S. Council of International Business (USCIB): “The scoping limitations appear to apply only to the new taxing right—Amount A. This should be clarified. Presumably, the application of “Amount B” and “Amount C” should apply equally to all taxpayers with a taxable presence in a market under the existing Article 5 permanent establishment standard.”

Scope Issue Three—Handling Both B2B and B2C

There are companies who are engaged in both consumer-facing (B2C) and business-facing (B2B) activities. At Paris, these MNCs discussed the complexity they would face in making such distinctions but offered different remedies to address the problem. InterContinental Hotels Group said they would prefer to be either within the scope of Amount A or outside it. In contrast, Lafarge was willing to have the Unified Approach apply only to its consumer-facing (B2C) segments. Yet another suggestion is that “In situations involving a business that is largely B2B but that also has some direct to consumer sales, it would be appropriate to apply a de minimis rule to treat such business as out of scope.”

Scope Issue Four—Exemptions from Amount A

A few business representatives commented that Amount A should only apply in situations where there is no group entity in the market country that is taking on risk.

Unilever, which as a consumer-goods company, is definitely in the scope of the Unified Approach and thus regarding Amount A argues that it should still be exempted because the existing tax rules are effective in that the local Unilever entity is being fully taxed. Unilever states that “we support the application of Amount A to all countries where a corporate tax return is not currently filed.” They go on to point out that “Unilever’s in-country manufacturing, marketing and sales activity is generally housed in one or more subsidiaries incorporated and tax resident in the country of operation. There is no purpose served in making an Amount A allocation to a country where corporate tax returns are already filed and where the operating company is full risk and already reporting the taxable profits related and therefore that consideration should be given to a carve out from Amount A. This scenario has the complexity of the tax compliance but for no incremental tax impact.”

Scope Issue Five—Controversial Push for Total Coverage

Probably the most controversial argument came from consumer and digital companies, which state that the whole notion of carve outs is illogical and that new international tax rules should apply to all industries without exception.

1. P&G: “Assuming a new broadly established taxing right is established, it seems all MNEs (i.e. not just “consumer-facing” and digital) would benefit from the stabilization of the ’source/residence’ issue.“ P&G goes on to argue “We are not sure we understand the policy rationale for ‘ring fencing’ consumer-facing business models. This approach is likely to create significant ambiguity and risks.”

2. J&J: “Amount A should be applied to companies that meet high sales and high profit thresholds, and we are concerned that the consumer-facing focus in the proposal will lead to uncertainty and disputes.”

3. Unilever, the huge Anglo-Dutch consumer goods manufacturer, states that “We also suggest that if Amount A is to be thought of more in terms of a market access fee, that it should be extended to all businesses that sell into more than one country—not just consumer-facing businesses—and regardless of size of business.”

4. Amazon states that the new tax rules should be “proportionate, neutral, equitable and enforceable so that on an overall basis it is applicable to all types of businesses and the new tax rules do not ring fence the digital economy.” Amazon’s views were also echoed by Netflix and other digital companies

Computation Issue One—Simplify Measurement of Global Profit

Turning to the computation of Amount A the new taxing right based on the global profit commenters generally supported the use of financial accounting data for calculating Amount A. It also was suggested that adjustments to the financial accounting data in calculating Amount A should be kept to a minimum.

1. Data Source: KPMG opined that “relying on consolidated financial statements as the starting point would be by far the most administrable approach to determining group profit although this may result in significant departures from the way income is determined for tax principles.” Uber agreed noting that “While such an approach reduces flexibility, Uber believes, as noted in further detail below, that any such loss is outweighed by gains in simplicity and administrability.

2. Segmentation: With regard to segmentation of the global profit, KPMG indicated that the MNCs that decide to segment their global profit by business line should use the reporting segments already used for financial reporting purposes.

3. Defining Profit: Tax Executives Institute notes that profit could be defined in many ways and suggest that “One appropriate metric would be operating income/loss before (i) foreign exchange; (ii) extraordinary income/expense items (such as gain/loss on divestitures); (iii) goodwill impairment; and (iv) other similar material non-operating items.”

4. Adjustments: Commenters recommended that no adjustments should be made to the data reported by the MNC in its financial statement to reflect different accounting standards such as GAAP vs. IFRS.

5. Losses: Commenters noted that residual profits and losses should be included in the computations. Uber, which incurred losses in 2018 of $1.8 billion, stated that “Any new taxing right should provide taxpayers with the ability to determine losses and carry such losses forward to offset future taxable income (under the new taxing right).”

Computation Issue Two—Ensure Certainty on Amount A

Comments from business representatives stressed that when it comes to Amount A certainty is key—and that how Amount A is calculated and allocated to market jurisdictions must be set in stone.

There was concern that the proposed way of computing Amount A which involved determining values for routine and residual profits was too complex and would engender controversy. A number of companies therefore proposed using a clearly-defined and simple formula. P&G for example suggested that “For all MNEs that have a traditional physical presence, an “Amount A” income allocation (e.g., 10% of profit in excess of 10% global or segmented product/regional profit before tax) may also apply (assuming a certain level of sales and excess returns).”

Computation Issue Three—One-Stop Shop for Amount A

MNCs did seem to universally agree that Amount A should be administered by a central, coordinating jurisdiction or some kind of “one-stop-shop” because it would be unworkable if every country could challenge the calculation and allocation of it after the fact.

Astra-Zeneca: “The Amount A proposals are likely to result in increased complexity and an increased administrative burden. A simpler solution would be for a centralized agency or ‘one stop shop’ to take responsibility for administering reallocation and distribution of payments to reduce the risk of tax disputes and double taxation. This could be the tax authority of the parent company.

Unilever: “We consider that the parent company tax jurisdiction should take the lead role in a One Stop Shop to administer the calculation of Amount A.”

The U.S. Chamber of Commerce: “The Chamber believes that taxpayers should report and be audited with respect to Amount A only in the country where the parent company is located. This would help with administration, simplicity, would help avoid double taxation, reduce compliance costs, preserve the use of tax mechanisms for the relief of double taxation, and prevent the taxation of losses.”

J&J: “A new global filing requirement should be implemented to assist in dispute prevention, particularly around enterprise data”

Computation Issue Four—Integrate Amounts A, B and C

A variety of comments were received on Amount B (baseline profit) and Amount C (for more than baseline activities). Some commenters suggested there would be no need for Amount C if Amount B is designed properly. They noted that Amount C is confusing and could be duplicative. Most comments stressed that a lot more work needs to be put into defining each of the Amounts and describing the interaction among all three so that there is no overlap. Commenters were of the view that the Amounts A, B, and C must be looked at in their totality and not separately.

USCIB stated that “new taxing rights cannot be viewed in isolation as doing so will almost certainly lead to double taxation. Therefore, dispute prevention requires that overlap between Amounts A, B, and C be addressed and dispute resolution should be seamless.”

A joint submission by leading pharmaceutical companies stated that “Amounts A, B and C need to work together to avoid double taxation and ensure certainty. Guardrails are needed to ensure that Amounts A and B do not exceed an appropriate allocation of enterprise profit.”

Astra-Zeneca: “Amount C cannot be looked at in isolation as the interaction of Amount C and Amount B with Amount A will be important in determining whether an MNC faces double taxation. We are concerned that the sum of adjustments under Amount A, Amount B and Amount C may over reward the markets at the expense of innovator jurisdictions.”

J&J: “Amount B vs. Amount C requires a strong definition to clearly delineate what is part of the ‘fixed’ return of Amount B vs. the arm’s length return of Amount C. It will be important to consider specific items from a functions, risks, and assets perspective.”

Glaxo Smith Kline: “We are supportive of the intent behind Amount B—to provide greater certainty around the return associated with distribution and marketing activities for both taxpayers and tax administrations alike. However, we are concerned as to how this can be successfully implemented in practice, given activities carried out by distributors will vary amongst MNE groups even in the same industry, due to differing levels of centralization amongst other things. It would therefore be very difficult to define routine marketing and distribution activities and set an appropriate return for them in a manner which is equitable across all markets and taxpayers.”

Comments on the New Nexus

The OECD has introduced a definition of nexus that would make sales into a country made remotely or through third-party distributors subject to Amount A taxing rights.

Commenters generally accepted the new definition of nexus with the proviso that doing so would not create any other tax or legal consequences.

1. Netflix states that “We support in particular increased taxing rights for market countries through the creation of a new nexus.”

2. U.S. Council for International Business (USCIB) “supports creating a stand-alone remote nexus test, separate from Article 5. It must be clear, however, that the new nexus rule applies only for purposes of allocating Amount A to a market jurisdiction and for no other purposes whether tax or non-tax.”

3. Amazon agrees to the new nexus but states that the nexus established for direct taxation should not have any bearing on non-tax legal matters.

4. Walt Disney also supports the new nexus but so long as “it does not constitute an admission or agreement that it is subject to specific or general jurisdiction in a given country”.

5. Business Roundtable, which commented on behalf of nearly 200 chief executive officers of America’s leading companies stated, “Nexus for income taxation purposes often carries significant consequences for business beyond income taxation, including registration and payment of indirect taxes and customs duties, as well as obligations under non-tax legal or regulatory regimes in the local country. The OECD should make clear that the new nexus rule has no legal effect beyond the revised profit allocation.”

6. Glaxo Smith Kline: “Paragraph 23 makes it clear that the nexus rules will apply where an MNE sells through a distributor locally (related or unrelated) or through remote selling models. Where a third-party distributor is used it must be considered that the MNE will not have access to the same level of financial information or the business activities in that country as it would if it used its own distributor. Indeed, in some cases the MNE may not have visibility of where the products are ultimately sold if the third-party distributor operates across multiple markets.”

New Dispute Resolution Proposals

MNCs absolutely are very concerned that Pillar One will lead to double taxation and as one company told me “we are willing to pay all the taxes we need to and to whichever country wants it but we don’t want to be taxed twice on the same income.” Companies are also thoroughly dissatisfied about the MAP process to handle such issues. The MAP program is hard to get into, and even if you get into the process cases can drag on for more than five years.

Mandatory Binding Arbitration: Several business representatives said that some kind of mandatory binding arbitration must be adopted, including Booking.com; USCIB; and Astra-Zeneca which stated, “There needs to be a clear, strong and effective mandatory binding arbitration process mutually agreed and peer reviewed by tax administrations. Further guidance is required on the interaction of proposals with the current dispute resolution mechanisms such as APAs and MAP.”

Standardized Advance Pricing Agreements: J&J believed that “The concept of an APA is very valuable: avoiding disputes by agreeing [to] transfer pricing in advance. The criticisms for APAs usually center on the lengthy timeframe to complete. This could be improved by standardizing certain types of APAs to allow for simplicity”

The Necessity of Repealing Unilateral Taxes/Measures

To deal with the issues that the Unified Approach is design to resolve some countries have unilaterally introduced measures on their own. Commenters insist that these unilateral measure should be repealed once a consensus is achieved on the Unified Approach.

1. Tax Executives Institute (TEI): “The proliferation of unilateral taxes targeted at highly digitalized businesses or certain business models is a major impetus for the OECD moving forward “Pillar One.” These unilateral measures include diverted profits taxes, a digital advertising or services tax, a withholding tax on services, equalization levies, multinational anti-avoidance laws, and other analogs. TEI believes any agreement on Pillar One must require these taxes be repealed as a condition of such an agreement.”

2. U.S. Chamber of Commerce: “The Chamber believes that any proposal from OECD should require: Withdrawal of unilateral measures (DSTs, DPTs, ORT, MAALs, equalization levies, etc.).”

Views from Citizen Advocacy Groups

Finally, it is interesting for companies to hear from the other side of the aisle; namely the many citizen groups advocating that major companies pay a fair share of tax:

The Independent Commission for the Reform of International Corporate Taxation (ICRICT) fulminates that “the OECD proposal leaves the transfer pricing system largely in place, while adding complexity with a three-stage bolt-on solution for a small percentage of global profits” and that “the scope of the reform focused only on ‘large consumer-facing businesses’ is too limited and likely to be further watered down by carve-outs for specific industries or business models”

The European Network on Debt and Development (Eurodad) asserts “that formulary apportionment should replace the entire existing transfer pricing system, not be used as an additional complex layer which will cause more confusion and disputes.”

Also advocating for formulary apportionment were the Coalition for a Prosperous America, the BEPS Monitoring Group, TUAC, and Oxfam.

The citizen advocacy groups also are against binding arbitration to resolve disputes. Oxfam, called mandatory binding arbitration a “policy trap’ that creates a great risk of countries becoming subject to an undemocratic parallel system. The BEPS Monitoring Group said that business reps are in “a dream world” if they believe that all countries will agree to mandatory binding dispute resolution at the OECD and a one-stop-shop in exchange for a small allocation of additional tax provided to them under the unified approach. Developing countries are worried that will they be forced into a type of dispute resolution that will infringe on their sovereignty.

Next Steps

The OECD signaled it was open to some of the issues raised, including taking a look at the “one-stop shop approach” and defining what “consumer-facing businesses” would be taxed under the plan as well as exploring new dispute resolution mechanisms.

The Inclusive Framework—the more than 130 jurisdictions that will ultimately agree to or veto the plan—will meet in January to discuss what they will take from the latest proposal, said Pascal Saint-Amans, director of the OECD’s Center for Tax Policy and Administration. The framework “may reshape, more or less dramatically, what the Secretariat puts on the table,” he added. They will meet again in June or July, he said and a consensus will be reached in 2020

The business community feels that this timeline is too rushed and warns that “In the view of the Business Roundtable, a careful examination of the issues raised in the Pillar One consultation document, followed by work to agree on technical details and implementation, may require exceeding the year-end 2020 timeline for a final report. We urge policymakers to set as priorities sound tax policy and long-term economic stability, rather than nominal deadlines.”

Perspectives and Conclusion

There are many unknowns ahead but it is the author’s view that scoping is right now the most important question mark. The Unified Approach introduces the concept of having a separate set of tax and transfer pricing rules for consumer-facing versus other industries. There is no precedent in international taxation for such a type of distinction. The OECD logic in isolating consumer-facing industries is that they own market intangibles but even non consumer-facing products such ethical pharmaceuticals sold to doctors are considered to have huge market intangibles.

Netflix warns that “linking the mechanics to a vague and multi-faceted term such as that of ‘large consumer-facing businesses’ would render the entire system difficult to manage and become detrimental. The OECD could resolve the confusion by publishing a “Black List” of industries at a detailed 3-digit SIC code who are within the scope.

However, creating a Black List would not solve the basic problem of trying to have a separate set of rules for some industries. In implementing Pillar One, unilateral measures include diverted profits taxes would need to be repealed and domestic rules in each country revised. However, current tax and transfer pricing rules and measures such as the diverted profits taxes cover all industries which creates a dilemma that defies easy solution.

MNCs should closely monitor this scope issue along with the other areas of controversy summarized in this article and see how they are addressed at the January meeting of the OECD.

This column does not necessarily reflect the opinion of The Bureau of National Affairs, Inc. or its owners.

Author Information

Glenn DeSouza is a national transfer pricing leader at Dentons China based in the firm’s Shanghai office. Glenn may be reached at Glenn.Desouza@dentons.cn.