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INSIGHT: The OECD’s Tax and Digitalization Project—No End in Sight

May 4, 2020, 9:45 PM

On May 4, 2020, the Organization for Economic Cooperation and Development (OECD) provided a brief update on its work on the tax challenges of digitalization, which aims to reallocate corporate profits in favor of market countries (Pillar 1) while also creating a global minimum tax regime (Pillar 2). The main takeaways:

  • The time at which the 137-member Inclusive Framework on base erosion and profit shifting (BEPS) will be asked to approve a proposed package of reforms has been moved from July 1st to sometime in the first half of October this year.
  • The proposed package is likely to be partial in nature, addressing only some of the many open issues under Pillars 1 and 2 as the first step in a “staged process” that will continue into 2021 and perhaps beyond.
  • The OECD will not be able to provide any further information to the public regarding the likely economic impact of the proposed changes until the end of this summer.

Let’s look at each of these in a bit more detail.

The OECD Center for Tax Policy and Administration, acting as the secretariat for the Inclusive Framework, has been organizing virtual meetings and preparing policy papers for the Steering Group of the Inclusive Framework (which met April 27-28) and for several working parties that are discussing technical issues arising from the Pillar 1 and Pillar 2 proposals. The plan had been for the entire Inclusive Framework to convene on July 1-2, either in Berlin or via teleconference, to approve agreed solutions to Pillar 1 and Pillar 2 issues that have been the subject of negotiations for several months now.

It appears, however, that the negotiations are not proceeding at the pace that the OECD expected in late January 2020 when it announced that the Inclusive Framework had blessed the “proposed unified approach” to global reallocation of profits under Pillar 1 and had also given the green light to further work on the design of the global minimum tax under Pillar 2. Undoubtedly Covid-19 has had something to do with this.

Nevertheless, the OECD and the Inclusive Framework remain committed to delivering to the G20 leaders, at their meeting in November 2020, an agreed proposal regarding the tax challenges of digitalization. By delaying the decision until early October, the OECD is buying time to cobble together a package of proposed measures that all of the significant participants in the 137-member Inclusive Framework can agree on.

As noted earlier, this package will most likely deal with only some of the issues that need to be resolved, leaving other issues to be agreed on at a later stage. Given the large number of open issues in relation to both pillars, there are many different possible scenarios for the October package. Might the Inclusive Framework agree on a minimum tax (Pillar 2) proposal only, leaving all of Pillar 1 to be dealt with at a later stage? Or, alternatively, might they agree on just enough of the elements of Pillar 1 regarding reallocation of profits to market countries to persuade relevant members to hold off on the implementation of unilateral digital services taxes? Time will tell.

Pascal Saint-Amans, the director of the OECD’s Centre for Tax Policy and Administration, noted during the May 4 webcast that there is tension between, on one hand, a group of countries that wishes to limit the new allocation rules under Pillar 1 to highly digitalized businesses, and, on the other hand, the U.S. and China, both of which are opposed to ring-fencing of this kind. The U.S. has always been skittish about the project as a whole, because it perceives any attempt to impose higher taxes on the digital sector as discriminating against successful U.S multinationals such as Google, Amazon, and Facebook. Moreover, higher income taxes in market jurisdictions would erode the U.S. tax base due to the foreign tax credit. Hence, the U.S. has taken the view that, in order to avoid a proliferation of unilateral digital services taxes around the world, it could live with new rules involving a “modest” reallocation of multinationals’ profits to market countries, provided that the new rules apply broadly to multinational businesses rather than mainly to U.S.-headquartered businesses only.

Regarding the third takeaway noted above, it is not surprising that the OECD is now admitting that the promised economic analysis and impact assessment of the Pillar 1 and 2 proposals will not be available for several more months. Although the OECD has a team of highly qualified economists, it was never realistic to expect that they could easily analyze the economic effects of incomplete tax proposals meant to take effect in 137 different jurisdictions. Global tax policymaking is uncharted territory for the economists as well as all of the other participants in the process.

One positive note for multinational businesses: the likelihood of an extension of the project into 2021 means that there will be more time to engage with policymakers in an effort to ensure that the proposals are grounded in reality. The digitalization project appears likely to continue for quite some time.

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