As the Biden administration begins to engage with other countries in the OECD tax discussions, some viable proposals are starting to take form. PillarOne finally has a possible path forward. And Pillar Two has become even more understandable, now that the administration’s domestic tax proposals overlap with the OECD negotiations. However, Pillar One steps outside transfer pricing rules. Even though this is a necessity, it’s causing consternation and concern.
Pillar One remains a necessary proposal for the entire OECD tax negotiations. At its core, Pillar One’s key section is the market-based allocation of a certain percentage of corporate profits outside the scope of transfer pricing by certain companies. At the end of last year, the scope, threshold, carve-outs, and percentage allocations concerning Pillar One’s market allocation resulted in a convoluted mess. Many experts wondered if the expected revenue return for the complexity had demolished the intent of the proposal.
Domestic U.S. companies champion the market-based allocation of corporate profits because it is often considered the core of a “sales factor apportionment” tax system. In principle, the profit distribution of Pillar One doesn’t rely on transfer pricing. Domestic companies remain concerned that the current reliance on transfer pricing creates tax differentials between those companies that can profit-shift offshore and those that cannot. Sales factor apportionment remains the most attractive domestic company solution because of its simplicity and transparency in allocating taxable profits to the U.S. because relevant sales are to American consumers.
The U.S. proposal regarding “comprehensive scoping” for PillarOne is an excellent first step. Comprehensive scoping simplifies the threshold and scope with a sales factor-style solution. To be clear, no one has officially suggested implementing a plan called “sales factor apportionment.” But the Financial Times initially leaked the U.S. Treasury’s offer to the OECD negotiators from other countries to clean up an international tax proposal called Pillar One.
Previously, Europe and emerging markets tailored Pillar One for digital companies and “consumer-facing” corporations. Numerous tax carve-outs and weak scoping created a nearly toothless mechanism for every company, except U.S. digital companies.
The Treasury Department’s comprehensive scoping suggests simplicity by targeting corporations with a very high threshold of revenue and a certain level of profitability. The proposal is aimed at the top 100 corporations in the world regardless of industry. Other countries are still parsing through this offer, and this reduction makes the proposal easier to administer for smaller countries.
The Pillar One proposal is not without concern. Despite being one of the most prominent digital companies, Amazon’s tax structure could be unaffected by potential profitability thresholds as its profitability is too low. Some countries are suggesting new complexity to find a way to include Amazon’s profits. But a more straightforward method would reduce the profitability threshold to include Amazon and any other corporations in the same fiscal circumstances. But such a change might be politically inconvenient for another country trying to protect its corporations.
Regardless of international politics, Congress will need to address Pillar One changes. And in case of a treaty, the Senate will need to ratify the deal. Current proposals on the domestic front regarding global intangible low-tax income (GILTI) and other Tax Cuts and Jobs Act international provisions create an intelligent path forward.
The White House has included several tax proposals to pay for the American Jobs Plan. The international tax provision reforms in it have a striking similarity to Pillar Two. Specifically, the American Jobs Plan’s spending on infrastructure depends on “Made in America” taxes.
The “Made in America” tax plan has seven major proposals, half of which deal with international corporate taxes or profit shifting. Unfortunately, none of the current proposals directly deal with Pillar One or sales factor apportionment. Comprehensive scoping is currently only being discussed at the international level.
Domestically, the critical international corporate tax proposals in the “Made in America” tax plan revolve around altering the (TCJA). The overlap is quite clear since GILTI rules inspired Pillar Two’s global minimum tax proposals.
The Made in America tax plan includes a corporate tax increase to 28%, which reframes the proposed GILTI changes. GILTI tax is currently a 50% deduction (10.5% GILTI tax rate). But by increasing the corporate tax rate, the proposed GILTI deduction will be reduced to 25% (21% GILTI tax rate). Furthermore, the White House intends to remove the carve-out for routine profits currently holding at 10% on overseas depreciable tangible property.
Another change is replacing the base erosion and anti-abuse tax (BEAT). The BEAT failed to live up to early expectations. The BEAT can tax the deductions of costs often associated with profit-shifting, such as royalties. But due to poor performance and loophole concerns, the administration wants to replace BEAT with “Stopping Harmful Inversions and Ending Low-tax Developments” (SHIELD). SHIELD will require that a corporation’s payments made to its subsidiaries meet a minimum tax. If the subsidiary doesn’t meet the minimum, SHIELD denies the corporate deductions for these payments.
Finally, the administration is talking about ending the Tax Cuts and Jobs Act’s foreign-derived intangible income (FDII) altogether. FDII is a carrot reward for intellectual property located in the U.S. but sold overseas. The Biden administration believes boosting R&D incentives can more effectively replace this deduction.
These domestic provision changes are related to squaring the U.S. with the international OECD negotiations related to Pillar Two. They are not exact, but they may grandfather the TCJA system into an international agreement. Pillar One will need a similar domestic treatment to be implemented in the U.S.
The Biden administration’s domestic proposals depend on a robust Pillar Two system (GILTI/SHIELD). But domestic companies believe the complexity and function of transfer pricing creates a short shelf-life for tax policy. The tax morale of these domestic companies depends on the idea that their greatest competitors will not be able to game the tax system in the long term.
Congress should consider the unilateral implementation of the core principles of sales factor apportionment, Pillar One, and comprehensive scoping regardless of multilateral solutions.
This column does not necessarily reflect the opinion of The Bureau of National Affairs, Inc. or its owners.
David Morse is Tax Policy Director of the Coalition for a Prosperous America Education Fund.
Bloomberg Tax Insights articles are written by experienced practitioners, academics, and policy experts discussing developments and current issues in taxation. To contribute, please contact us at TaxInsights@bloombergindustry.com.