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

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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.

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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.

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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.

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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.

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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.

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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

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We have submitted comments to the OECD on the consultation draft proposals to provide tax certainty for Amount A of Pillar One.

10 June 2022

Summary

The best way of achieving tax certainty is to formulate rules that are simple, clear and objective. The design of Amount A is a major step forward, since it will allocate a portion of the global consolidated profits of multinational enterprises (MNEs) by a formulaic method, in contrast with the current rules. However, Pillar One is designed as an exceptional system that would apply to only a small part of the profits of only around one hundred of the largest and most profitable MNEs, retaining the current defective transfer pricing rules for all other purposes.

For Amount A itself, the small number of MNEs likely to be in scope should make it easier to roll out the system through administrative arrangements coordinated among the tax authorities concerned. Its design makes it easier to provide certainty through administrative arrangements that could and should involve only tax officials. We support the composition suggested in this draft for Review Panels, as well as the Government-Only option for Determination Panels, which provides an appropriate balance of officials from states that would benefit and those that would lose from an Amount A allocation. It is inappropriate, unnecessary, and we believe detrimental to include non-governmental experts, who would inevitably and overwhelmingly be current or retired business advisers who could not be truly independent.

Uncertainty will nevertheless be created in the short run because of the novelty of the system. It should now be recognised that the timescale for Pillar One has been far too ambitious, and to recalibrate the process. The proposals have been developed at great speed and largely under strict secrecy, and they require more effective participation of tax officials particularly from poorer countries, and much greater public scrutiny. A more careful process should aim to design the building blocks for a new approach to taxation of MNEs that could eventually be applied much more widely.

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We have submitted comments to the public consultation on the Implementation Framework for the Global Minimum Tax.

Summary

The agreement on measures to end international tax competition is a historic feat of international cooperation. However, its main component, the global anti-base erosion tax (the GloBE) has serious flaws. Implementation must respect states’ tax sovereignty, and each country must decide after a full democratic debate whether to adopt the GloBE, and if so how to incorporate its rules into national law. In our view most low-income countries will not implement the GloBE itself, partly due to its complexity, but above all because of the bias in its rules in favour of the home countries of multinational enterprises (MNEs). This gives lowest priority to taxation of profits at source, where they arise, by MNE host countries, disadvantaging low-income countries which generally are only hosts to MNEs.

Nevertheless, adoption of the GloBE could benefit all countries, provided that it is not implemented in a way that reinforces this unfair bias. Ensuring that all profits will be taxed at least at the minimum rate should enable and encourage all countries to end unsuitable tax incentives to MNEs and adopt appropriate measures to strengthen source taxation. These measures should not be limited to those provided in the GloBE itself. For those participating in the scheme, they need only be compatible with the GloBE outcomes, while those not participating should be allowed and encouraged to adopt any measures they consider suitable, particularly to prevent the shifting of profits out of countries that are hosts to MNEs. The aims of the GloBE should be clearly stated as enabling MNEs to be taxed where they have real economic activities, and ending the secular decline of corporate taxation that damages all countries in the long run.

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