The OECD’s new proposal to reallocate multinationals’ profits among countries has left companies with many questions. A central one: Will the rules apply to them?
The plan, released Oct. 9, hasn’t yet gained agreement among countries, and many key details remain to be decided.
Companies in the meantime are wondering how the Organization for Economic Cooperation and Development will determine what part of their revenue would be subject to the rules, how old rules interact with new ones, and how disputes would be resolved.
Under the plan, some of a multinational’s profits would be divided among countries, with the goal of giving more tax revenue to the countries where a company’s users or consumers are located. It seeks to reallocate the above-normal profits of large multinationals that interact with consumers, including digital companies like social media platforms or search engines.
“The proposal itself is a dramatic departure from the existing rules which have governed international tax for most of the last century,” said Brian Jenn, a partner at McDermott Will & Emery LLP in Chicago and former deputy international tax counsel at the U.S. Treasury, where he served as co-chair of the OECD’s Task Force on the Digital Economy.
The proposal aims to tackle concerns that global tax rules don’t capture the value consumers create for multinationals, particularly digital companies, resulting in little or no tax being paid in some countries. Some countries with big consumer bases, like India, could see more tax revenue under the OECD’s plan while others would see less. Companies could also end up with a bigger tax bill if their profits are reallocated to higher-tax jurisdictions.
“It’s really just a framework for developing a consensus approach that leaves a lot of hard questions unanswered,” said Jesse Eggert, a principal at KPMG LLP in Washington and a former senior adviser with the OECD’s Center for Tax Policy and Administration.
The OECD is trying to spur discussion among countries as it works to finalize the plans by the end of 2020—so the proposal is vague on details. Companies are closely watching to see how a few key questions are resolved.
What Is a ‘Consumer Facing Business’?
The OECD proposal targets companies that engage with consumers. Companies that sell directly to consumers would most likely fit that definition, but some companies that do business with other businesses could too. For example, social media platforms and search engines interact with users, even though their customers are the other businesses that buy advertising on their platforms.
The project comes in response to many countries’ concerns that digital companies aren’t paying enough tax in the countries where their users are located. But while countries including the U.K. proposed approaches that would capture user value, the U.S. has staunchly opposed any solution that would ring-fence the digital economy.
“It is big news for a lot of companies that the OECD is looking for a way to scope out businesses that primarily have other businesses as their customers,” Jenn said. “For a lot of companies, the news about scope will be welcome.”
How the OECD ultimately defines “consumer facing businesses” will determine which companies are subject to the new rules. The definition could also have implications for how the rules apply to different business units within an entity, which could have both business-facing and consumer-facing business lines, said Will Morris, deputy global tax policy leader at PwC.
“It’s a brand new concept. And it will take some time to work out what it means,” Morris said.
“It raises big definitional issues inside a corporation itself,” he added. “I think it’s going to take quite a lot of time to sort those boundary issues out.”
What Revenue Applies?
The OECD proposes reallocating just a portion of a company’s above-normal profits, but it has yet to decide what formula it would use or what level of profit is above normal.
The calculation could get more complicated for companies if one revenue stream within a multinational group is subject to the rules, but another isn’t. The OECD hasn’t yet determined how it will deal with those situations.
“You could have a single company have one foot in the new system and one in the old system,” Jenn said. “That’s going to be a source of complexity,” and could require companies to track and report information on different business lines—a potential compliance issue if it’s information they’re not already tracking.
“Businesses I talk to want something that doesn’t require they collect new information, so a consolidated set of financial reports that are preferably already audited would be ideal,” said Ross Robertson, an international tax partner at BDO in London.
The question of which companies, and which of their revenues, are subject to the new rules will be key to businesses, said Jennifer McCloskey, vice president of policy at the Information Technology Industry Council.
“All of that stuff will be hotly contested,” she said. “That’s going to determine who’s in scope, and to what extent.”
How Will Old and New Rules Interact?
The new plan wouldn’t replace the existing transfer pricing rules, the system that determines how companies value intercompany transfers, which in turn determines how much taxable profit a company has in a jurisdiction.
The OECD plan outlines different categories into which a company’s income could fall. The new rules, which go beyond the arm’s length standard, only apply to some income of some companies. Companies that use distributors in a local market could be treated under different rules, including assigning a fixed return to those functions. And some companies and income will continue to follow existing transfer pricing rules. The arm’s length standard, a fundamental principle of transfer pricing, dictates that related parties conduct transactions as if they were unrelated.
Questions remain about the treatment of distributors and the appropriate profit margin to assign them, Morris said, as well as how all the categories overlap and whether income could be double-counted.
The new rules result in two parallel systems—one arm’s length, and one under the new rules—and that runs the risk of double tax, Eggert said.
“There’s going to need to be substantial work to make sure those two mesh smoothly and double tax is removed,” he said.
How to Ensure Disputes Are Resolved?
Companies and countries worrying that new rules will cause multiple tax authorities to lay claim to the same revenue are hoping the OECD builds strong enough dispute resolution mechanisms into the proposal to prevent double taxation.
“Dispute resolution is going to be a key part of getting business support for this project,” Morris said.
Companies may be hoping for mandatory binding arbitration, in which countries must accept the outcome of arbitration proceedings when they are in double tax disputes with another tax authority—often an incentive for countries to settle earlier in the process.
“Binding arbitration not a magic wand that makes everything else go away, but it makes the other rules work better,” Morris said.
Dispute resolution will also be key to gaining international consensus. A promise of greater tax certainty is the bargain-sweetener on offer for countries giving up some tax revenue under the profit reallocation plan. But countries including India have been opposed to binding arbitration in the past on concerns that it compromises their sovereignty.
The Oct. 9 plan said disputes between market jurisdictions and taxpayers should be subject to binding and effective dispute prevention and resolution mechanisms. But it didn’t include details on how those mechanisms would work.
“An effective way to prevent and resolve disputes seems essential to making this proposal work,” Eggert said. “But that’s why it’s a bit disappointing that they don’t talk about binding arbitration and instead just talk about mandatory and effective dispute prevention and resolution.”
—With assistance from Hamza Ali.