This short Briefing analyses and compares the two proposals for modifying tax treaties by inclusion of a Subject to Tax Rule (STTR), one developed by the United Nations Committee of Tax Experts (UNTC), and the other through the OECD/G20 Inclusive Framework on BEPS, as part of the Two Pillar proposals.

We provide an overview, comparison and evaluation of the two proposals, to contribute to better public understanding of this important but technically complex matter.

The Briefing is based on a longer article, available here

Here we provide a Briefing, which analyses the outcomes of the latest phase of the G20/OECD project on base erosion and profit shifting (BEPS), and outlines options and alternatives, especially for developing countries.

We show the limitations of the BEPS project measures, and their unsuitability for developing countries. Such countries should take action to adopt measures in response, especially to the global minimum tax (the GloBE), implementation of which is under way. The GloBE itself is unfair and ineffective for most developing countries, but its implementation could put a brake on the race to cut corporate tax rates. It provides an opportunity for developing countries to (i) review and phase out inappropriate tax incentives, and (ii) introduce stronger measures to protect the source tax base, which can be designed to be compatible with the GloBE.

We have submitted our comments to the public consultation on the discussion draft on a simplified method of allocating rights to tax MNE profits referred to as Amount B.

We strongly support the need for simplicity and certainty in allocating the rights to tax MNE profits, but this can only be achieved through formulaic methods. We analyse the proposal and explain why in our view, the approach now suggested would be both ineffective and inappropriate. An MNE’s profits from sales result from a range of activities which can only fictitiously be attributed to different entities. In practice wholesale distributors will have valuable information and data on local markets and customers. Limiting Amount B to supposedly ‘baseline’ stripped-risk functions will result in a systemic under-allocation of profit to sales jurisdictions.

Simplification should be done in line with the general approach in Pillar 1, of a formulaic allocation from the total global profits of the MNE, and the present proposal should be revised to present a formulaic method based on group-wide profitability.

We have submitted our comments to the public consultation by the European Commission on the proposal it will develop on Business in Europe - Framework for Income Taxation (BEFIT).

We strongly support the Commission’s longstanding view that the fairest and most efficient approach to taxation of business profits within the EU’s single market is by adopting a common corporate tax base together with formulary apportionment. Indeed, in our view this approach should be adopted worldwide. The time is now ripe, since detailed rules to implement this approach have now been formulated as part of the OECD/G20 BEPS project, on consolidated accounts, and the definitions of assets, employees and sales by destination.

We have submitted our comments to the public consultation on the draft provisions on withdrawal of Digital Services Taxes and ‘relevant similar measures’.

Each country should carefully evaluate its potential gains from Amount A against the losses from measures proscribed under the MLC, following a full public debate. From the available evidence, our expectation is that many countries will find their projected allocation of Amount A from the MNEs in its scope to be insufficient. The narrower the scope of the proscription of alternative measures, the more likely it would be that countries would join the MLC, although its complexity will also be a deterrent, especially for low capacity countries.

We are here publishing the comments we submitted to the Public Consultation on the Progress Report on Amount A of Pillar One release by the OECD in July on behalf of the Inclusive Framework on BEPS.

Pillar One marks a historic paradigm shift in international taxation, rightly described as ‘revolutionary’ by the OECD Secretary-General. For the first time it will allocate rights to tax multinational enterprises (MNEs) on a portion of their global profits among the countries from which they derive revenues, regardless of physical presence. Furthermore, the technical work that has now been done provides the methodologies to define for tax purposes the consolidated profits of MNE corporate groups, rules to determine the source of revenues from sales (including for services), and definitions and quantification of physical assets, employee numbers and employee remuneration.

We now therefore have the building blocks to ensure that MNEs can be taxed in accordance with the business reality that they are unitary enterprises, by apportioning their global profits for taxation by countries in which they have real economic activities, as mandated by the G20 in 2013.

Regrettably, however, the current proposals for implementation are designed to apportion only a part of the so-called ‘residual’ profit of less than one hundred of the largest and most profitable MNEs. This leaves in place the current defective rules for attributing the remaining profit of these in-scope MNEs, as well as for all others. Hence, instead of replacing the present flawed and complex rules with this new and simpler approach, it simply adds a new layer of complexity.

This discussion draft provides ninety pages of highly abstruse rules intended to be applied directly in the domestic law of participating countries, and to form the basis of a multilateral convention that must be approved by national legislatures to enable ratification by all relevant countries where these MNEs operate. This would be unprecedented, and in our view is highly unlikely to occur. However, the detailed rules could and should begin to be introduced to facilitate a more coordinated taxation of MNEs and a transition by some or all countries to a more comprehensive adoption of the new paradigm.

We have submitted comments to the OECD on the draft proposals for tax certainty on issues “related to Amount A in Pillar One.

Summary

The best way to achieve certainty for allocating the rights to tax the profits of multinational enterprises (MNEs) is to formulate rules that are clear and simple, and in line with the business reality that they operate as unitary global enterprises. This is achieved in the design of Amount A in Pillar One, for which certainty can be ensured through an essentially administrative coordination process. This will deal with all the issues of definition and allocation of Amount A, including avoiding any double taxation.

Regrettably, however, Amount A has been designed as an exception, applicable only to a small part of the profits of around one hundred of the largest and most profitable MNEs, so that the existing rules on transfer pricing would continue to apply in all other cases. These rules are highly complex and rely on subjective judgments, and inevitably generate conflicts. These concern often highly contentious issues, particularly when they involve claims by host countries to tax more than the ‘routine’ profits from the local activities of foreign-based MNEs. Yet it is these very disputes to which this proposed procedure would apply for MNEs in scope of Pillar One.

The proposal would require any unresolved conflict to be referred to mandatory supra-national arbitration through a Panel, the majority of members of which would be business tax advisers. This is a fundamental abdication of state sovereignty, entrusting decisions involving often large amounts of government revenue to unaccountable private practitioners, who would operate in total secrecy, and provide no explanation or rationale for any decisions made. These proposals are totally inappropriate and unnecessary, and their inclusion would make it even more unlikely that many states will adopt Pillar One. In our view, since international tax disputes are between states, and concern important issues affecting government revenue, they should be settled only between governmental representatives.

10 June 2022