Digital taxation: US shift on OECD proposals raises hopes for consensus
In January, the Organisation for Economic Cooperation and Development (OECD) opened a public consultation on its proposals to address the tax challenges of digitalisation, blueprints for which were published in October 2020.
The OECD has been seeking to tackle the issues raised by the growth of multinational corporations, particularly digital companies, and their tax planning strategies for some time.
In February, outgoing OECD Secretary-General José Ángel Gurría Treviño told the G20 that the need for a multilateral solution to the tax challenges arising from digitalisation was critical, particularly in the wake of Covid-19, and the absence of such a solution could reduce global gross domestic product by more than one per cent.
Following the agreement of a multilateral instrument (MLI) designed to tackle multinational tax planning strategies known as base erosion and profit shifting (BEPS) in 2015, work was carried out which eventually resulted in the publication of two proposals, Pillar One and Pillar Two.
There’s a strong interest for Europe to reach an agreement because, despite the rhetoric, everybody recognises that if the OECD fails then we open a Pandora’s box
Member, IBA Anti-Corruption Committee Advisory Board
Pillar One focuses on residual profits for digital and consumer-facing businesses, with the aim of taxing companies in the jurisdiction where revenue is sourced. Pillar Two is aimed at ensuring large multinational companies pay a minimum level of tax globally.
Following the public consultation on the blueprints, the aim is to agree final proposals by the July 2021 meeting of the G20 finance ministers.
Nicola Bonucci is the former Director for Legal Affairs for the OECD and is currently a Member of the IBA Anti-Corruption Committee Advisory Board and a litigation partner at Paul Hastings in Paris. He says there are fewer issues unresolved on Pillar Two than Pillar One at present. The two pillars – while covering different areas – are interlinked, and ultimately agreement will need to be reached on both.
A sticking point, particularly on Pillar One, was the United States’ reservations about aspects of the proposals under former President Donald Trump. In 2019 then-US Treasury Secretary Steven Mnuchin wrote to the OECD to moot the idea of making Pillar One optional, with a ‘safe harbour’ regime allowing companies to opt out of the unified approach put forward.
However, soon after Joe Biden became US President in late January, his Treasury Secretary Janet Yellin confirmed the US had dropped the safe harbour proposal.
‘There are really good reasons for the US to want to participate. Right now the proposals are a train headed towards a system that doesn’t function particularly well within the existing US tax system,’ says Kat Saunders Gregor, Young Lawyers Programme Officer for the IBA Taxes Committee and a partner at Ropes & Gray.
‘Pillar One is just a harder sell politically. It’s a radical change in the way the trade sourcing rules are applied,’ says Paul Carman, the Practice Group Leader of Chapman and Cutler’s Tax Department, based in Chicago. ‘The picture’s much brighter for Pillar Two than it is for Pillar One.’
Carman says the US broadly agrees to the concept of a global minimum tax rate, and on the face of it, Pillar Two would not move tax away from the US jurisdiction. Pillar One, in contrast, would.
Saunders Gregor highlights that for other countries, getting US agreement is not critical. Pillar One as it stands is more likely to have a negative impact on the US and US-headquartered companies, with other jurisdictions already beginning to move to taxing revenue at source. That could prompt some to shift headquarters out of the US if they fear double taxation.
‘As more and more countries adopt the digital services tax or a Pillar One equivalent, US multinationals will be subject to increased double taxation’, agrees Carman.
But Bonucci says there’s as much an incentive for other countries to participate in talks and reach a consensus agreement as there is for the US to do so.
‘There’s a strong interest for Europe to reach an agreement because, despite the rhetoric, everybody recognises that if the OECD fails then we open a Pandora’s box’, he says. ‘We get to, in the best scenario, a European community initiative; in the worse scenario, a set of unilateral initiatives which won’t help anybody.’
If there is a proposal to put to the G20 in July, the next step will be implementation. This could be another sticking point from the US perspective. Multilateral treaties have been a point of contention in the US Senate, with the Republican senator for Kentucky, Rand Paul, repeatedly blocking the ratification of tax treaties over information sharing.
Saunders Gregor says the ideal position would be proposals that could be implemented through Treasury guidelines, rather than legislation or a treaty.
‘The issue is that the US doesn’t really operate in an exemption system. We would have to change domestic law to implement that. We would also have to think about how various treaties might not work as well as necessary to implement an exemption system,’ she points out.
Bonucci says a treaty or convention is the most likely outcome for Pillar Two, at least.
‘It will certainly be a combination of tools and instruments, the OECD is agile in this regard,’ he says, adding that there could be parts of the proposals that are easy to implement at a national level.
The prospects for an agreement look much brighter now than they did a year ago, although Carman remains doubtful that there will be much movement on Pillar One from the US perspective.
Bonucci is more positive, saying the positive reception by the 125 members of the inclusive framework on BEPS is a sign that countries are willing to work towards a common goal. It might not be the ideal solution for all, but any solution is better than none.
‘From where we are today to get to an agreement where there are clear rules on Pillar One and Pillar Two, if you’d asked me even ten years ago is this possible, I’d have said no, not in my lifetime’, he explains.
‘One has to be realistic. When you’re in a multilateral setting you’re in a multilateral setting and you need to accept the consensus is the best result’, adds Bonucci.