Monday, the OECD released blueprints for proposals on changing international tax rules alongside an impact assessment based on the overall design of the proposals. While the blueprints cover proposals both for changing where large multinationals owe corporate taxA tax is a mandatory payment or charge collected by local, state, and national governments from individuals or businesses to cover the costs of general government services, goods, and activities. and designing a global minimum tax, there are still many unanswered questions.
The OECD has been working over the past two years with the goal of having agreement on new international tax ruleInternational tax rules apply to income companies earn from their overseas operations and sales. Tax treaties between countries determine which country collects tax revenue, and anti-avoidance rules are put in place to limit gaps companies use to minimize their global tax burden. s by the end of 2020. However, the challenge of conducting multilateral negotiations during a pandemic alongside major differences between some countries have left the work unfinished. The timeline for reaching an agreement now reaches to mid-2021.
In the meantime, other digital tax proposals are moving forward and have the potential to result in a harmful tax and trade war.
The blueprints have been released for a public consultation that is open through December 14, 2020, with a virtual public consultation meeting in January 2021.
The discussions have settled on two pillars: Pillar 1 is focused on changing where companies pay taxes, and Pillar 2 would establish a global minimum tax.
Pillar 1 would result in some companies paying more taxes in the countries where their customers or digital users are, even if the company has no local permanent establishment in that country. Pillar 2 would give countries more tools to tax the foreign income of multinationals up to a minimum tax rate.
The economic impact assessment reveals estimated effects of the proposals. An estimated $100 billion in tax revenues would be reallocated from current taxing jurisdictions to market countries. On net, between $47 billion and $81 billion in new tax revenue would be raised by the proposals, mostly from the minimum tax rules.
Key divisions on Pillar 1 have arisen as some countries desire the new rules to only apply to digital businesses while others, particularly the United States, want a broader approach. The digital-only approach is becoming common on a unilateral basis with digital services taxes, virtual permanent establishment, and equalization levies being developed by dozens of countries. However, the U.S. is eyeing retaliatory tariffs because digital services taxes disproportionately impact U.S.-based multinational businesses.
The threat of a chaotic tax and trade war has put additional pressure on the OECD to work out a solution. The impact assessment highlights the potential economic consequences of continued implementation of digital services taxes and trade retaliations. While the OECD estimates a consensus on Pillar 1 and Pillar 2 would only have a very slight negative impact on global GDP (less than 0.1 percent of GDP in the long term), the potential damage from continued tax and trade disputes is estimated to be as much as 1 percent of GDP.
The delayed timeline for agreement at the OECD may lead to wider adoption of unilateral and alternative measures in the interim. Spain has recently legislated on a digital services tax. The African Tax Administration Forum recently released a suggested approach on digital services taxes, and the United Nations has a draft treaty provision on taxing digital services that takes a different approach than is envisioned by the OECD. The European Union is also planning to release another digital tax proposal in 2021 after efforts on an EU-wide digital services tax failed in 2018.
The OECD is aiming for a solution that results in the removal of “relevant unilateral measures” including digital services taxes and similar policies and sets a new normal in international tax, although getting to that point will require sufficient political commitment to implementing the OECD’s approach.
Despite the considerable political and technical work the OECD has done up to this point which is reflected in today’s release, there are still several important questions left open. On Pillar 1, countries still need to decide on the scope of the proposal, the allocation metrics, and a process to support tax certainty. On Pillar 2, the minimum rate and options for simplification are left unresolved among other design issues.
Even when all those issues are resolved there will likely be a multiyear implementation timeline for countries to adapt their tax rules to new international standards.
Both the unresolved issues at the OECD and the desire by many countries to enact unilateral measures mean that the end of the current chaotic scene on the international tax stage is not yet in sight.
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