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INSIGHT: OECD’s Preliminary Economic Analysis Highlights Need for Pillar Two Information and Engagement

Feb. 19, 2020, 8:00 AM

On Feb. 13, 2020, the Organization for Economic Cooperation and Development (OECD) presented preliminary findings from economic analysis of the expected effects of implementing the Pillar One and Pillar Two proposals being considered by the Inclusive Framework on Base Erosion and Profit Shifting in relation to the tax challenges of digitalization. The presentation indicated that, given certain assumptions, the new rules could raise $100 billion of additional corporate income tax revenue each year from multinational enterprises (MNEs) globally.

Surprisingly—given that Pillar One has received the lion’s share of the attention of policy makers and stakeholders to date—the economic analysis showed that the new tax revenue would come mainly from Pillar Two’s global minimum tax rules, not Pillar One’s reallocation of taxing rights in favor of market jurisdictions. The economists did not indicate how much double taxation the Pillar Two rules would produce, but this is a question that the business community should be asking.

The global anti-base erosion (GloBE) proposal of Pillar Two would tax profits of MNEs at a minimum rate (or higher rate, if a country chose) under either an income-inclusion rule (applicable to the parent company of the group in its home country) or an undertaxed-payments rule (applicable to a group company making a base-eroding payment to a nonresident with an effective tax rate below the global minimum rate). The undertaxed-payments rule would involve either non-deductibility of the expense, or imposition of withholding tax on the outbound payment.

The OECD has acknowledged the need for coordination rules to minimize the risk of double taxation of amounts caught by both rules. So far, though, the Inclusive Framework has not put forward proposed coordination rules. Countries with a significant number of MNE headquarters presumably would like the income-inclusion rule to trump the undertaxed-payments rule. In contrast, the many developing countries in the Inclusive Framework are likely to argue that they should get the first bite of the apple by applying the undertaxed-payments rule in their countries.

Alarmingly, the director of the OECD Center for Tax Policy and Administration, Pascal Saint-Amans, has said from time to time that it may not be necessary for the Inclusive Framework to reach consensus on Pillar Two. Given that part of the OECD’s mission is to reduce barriers to cross-border trade and investment—and double taxation is one such barrier—it is very odd to see the OECD promoting a global corporate income tax proposal that presents a clear risk of widespread double taxation, and would increase corporate income taxation globally. Readers may be aware that the OECD has in the past advised member countries that corporate income taxation is the type of taxation that is least conducive (or most harmful) to economic growth.

The GloBE proposal originated with the German Finance Ministry and has the support of the French government as well. The Germans and the French will not support a Pillar One solution unless Pillar Two is attached as part of the package. The U.S. has already enacted an income-inclusion rule (the GILTI regime) and a special tax on outbound base-eroding payments (the BEAT), with some built-in double taxation, so the U.S. cannot say much against Pillar Two. The OECD is beavering away at the design details of Pillar Two in its Working Party 11, apparently on the assumption that Pillar Two will of necessity become a reality by riding on the coattails of Pillar One. The Inclusive Framework stated on Jan. 31, 2020, that it is committed to reaching consensus on Pillar One in order to avoid the chaos of uncoordinated unilateral tax measures aimed at nonresident businesses.

Clearly, MNEs need to engage with the OECD and the Inclusive Framework on Pillar Two. A public consultation on Pillar Two was hastily undertaken in late 2019, focusing on only three particular design issues and stating that further public consultation in 2020 should be expected. The Inclusive Framework’s Jan. 31 progress report on Pillar Two said nothing, however, about any further public consultation. The OECD Secretary-General’s report to the G20 finance ministers, issued on Feb. 14, 2020, said that a discussion draft on Pillar Two would be issued for public comments by April 2020, but the report was “corrected” on Feb. 18 to delete any reference to a discussion draft. Regardless, MNEs should not wait to make their voices heard. Time is short.

Regarding Pillar One, many issues were raised by the Jan. 31 revised program of work. Perhaps the most interesting is the specification of a category of business called “automated digital services.” Readers may recall that the OECD/Inclusive Framework has often asserted that it is impossible to ringfence the digital economy. Now, however, they are explicitly ringfencing automated digital services.

The creation of this category, in opposition to the consumer-facing category, facilitates the use of a special nexus rule that doesn’t require anything more than a certain level of sales revenue to customers in a market country, and also enables the possibility of a special profit reallocation formula for businesses that are highly digitalized. Undoubtedly, some countries in the Inclusive Framework want to make sure that in-scope companies in the automated digital services category are hit by the Amount A rules in a way that’s comparable to the effect of digital services taxes. At the same time, the consumer-facing category has probably been retained to pacify countries (presumably including the U.S.) that have opposed ringfencing for one reason or another. Whether those countries will agree to special rules for automated digital services remains to be seen. The U.S. would probably object to any Pillar One rules that are designed to function like a targeted digital services tax.

Regarding the proposed safe-harbor approach to Pillar One, which is on the table on a deferred basis, the author heard German government representatives at two recent tax conferences say that Germany does not support the proposal because it “sounds like” it would give companies the option of not paying tax. It seems that the Germans don’t understand that the Pillar One rules, as a safe harbor, would provide protection from unilateral tax measures that would otherwise apply. The U.S. Treasury needs to explain its proposal more clearly to the rest of the Inclusive Framework.

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

Author Information

Jeff VanderWolk is a partner at Squire Patton Boggs (US) LLP in Washington