Last week the Organisation for Economic Co-operation and Development (OECD) hosted a public consultation on several proposals to rearrange 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. The policies up for discussion include three separate approaches to reallocate 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. ing rights among countries and two proposals to institute a minimum level of taxation for multinational corporations. In the context of the Base Erosion and Profit ShiftingProfit shifting is when multinational companies reduce their tax burden by moving the location of their profits from high-tax countries to low-tax jurisdictions and tax havens. (BEPS) Project Action 1, the OECD has categorized the separate proposals as Pillar 1 (rearranging of taxing rights) and Pillar 2 (minimum tax approach) policies.
The Pillar 1 proposals include a rearranging of taxing rights based on:
- Profits derived from user contributions in a market country
- Profits attributable to marketing intangibles investments
- Allocation of taxing rights using a formula including sales, assets, employees, and potentially users
The Pillar 2 proposals include stronger base erosion protections including:
- A global minimum tax approach like the U.S. Global Intangible Low Tax Income (GILTI)
- A tax on base eroding payments like the U.S. Base Erosion Anti-Abuse Tax (BEAT)
The public consultation provided a forum for stakeholders to provide their views on these proposals. Respondents included tax professionals, business leaders, and civil society organizations. The Tax Foundation participated in the consultation and had previously submitted a written response to the OECD consultation.
Several key themes arose during the discussion including concerns over the potential complexity of implementing the proposals, a desire for evaluation of recent changes to international tax rules prior to adoption of new approaches, a warning to avoid creating double taxationDouble taxation is when taxes are paid twice on the same dollar of income, regardless of whether that’s corporate or individual income. scenarios, and a willingness to work toward a pragmatic solution.
The potential complexity could arise from several standpoints. The reallocation of taxing rights would create new tax liabilities for businesses in jurisdictions where they currently do not pay tax for one reason or another. When those liabilities arise, businesses may face challenges in filing tax returns or understanding why a withholdingWithholding is the income an employer takes out of an employee’s paycheck and remits to the federal, state, and/or local government. It is calculated based on the amount of income earned, the taxpayer’s filing status, the number of allowances claimed, and any additional amount of the employee requests. tax applies in a particular jurisdiction.
Respondents noted that complexity could also come from new rules being layered on top of current international tax rules without reconciling differences between the two. Conflicts over the application of current transfer pricing rules (which guide the taxation of cross-border transactions within companies) could be exacerbated if the uncertainties of transfer pricing valuations are relied upon in calculating which country taxes what share of a business’s profits.
Current international tax rules and their intersection with double tax treaties are by no means simple. Any proposal to change international tax rights should take this complexity into account.
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One respondent specifically identified ways that current rules create challenges for customs authorities and that shifting to a new set of rules could create challenges not only in tax administration, but also for customs and trade authorities.
There was also discussion of how the OECD might create safe harbors either for countries or for businesses to allow them alternatives for simpler compliance or administration of the new rules. Those simplifications could, potentially, provide businesses with more tax certainty than they currently have.
Several respondents also pointed out that the U.S. GILTI and BEAT policies have created significant compliance and tax burdens and may not be the best models for the OECD to follow. Concerns were raised that these policies may not fit well with current tax rules and could create very complex tax outcomes for some industries.
Evaluation Before Implementation
Several respondents noted that countries have only recently been implementing proposals resulting from the BEPS project. These include tougher transfer pricing regulations, patent boxA patent box—also referred to as intellectual property (IP) regime—taxes business income earned from IP at a rate below the statutory corporate income tax rate, aiming to encourage local research and development. Many patent boxes around the world have undergone substantial reforms due to profit shifting concerns. nexus rules, controlled foreign corporation rules, and country-by-country reporting. Respondents at the consultation noted that the effectiveness of these recently adopted policies should be evaluated prior to the OECD work on new policies to minimize base erosion.
This is an important issue for the OECD to consider. The current push for rearranging international tax rules has loosely defined objectives, and it is possible that the current policies on the books meet those objectives. However, it is still too early to measure the effectiveness of these policies on profit shifting.
Respondents including the Tax Foundation noted the importance of not only understanding the state of policy as it stands right now, but also the importance for the OECD to be measuring how various Pillar 1 and Pillar 2 policies could impact revenues and business activity.
Don’t Tax Us Twice
Another key theme from the consultation was the potential for double taxation of the same income under various scenarios. Multiple respondents focused on how Pillar 2 options could create likely scenarios for several layers of tax on the same income.
One respondent walked the audience through a scenario where a company with offices in four countries could face five different layers of tax due to the interaction of various BEPS and Pillar 2 policies. Multiple layers of tax on the same income create both administrative and economic burdens as the tax paid may not align with profits generated in one jurisdiction over another.
The OECD was encouraged to study the potential for double taxation and to allow for dispute prevention between taxing jurisdictions so that companies could avoid having income taxed by more than one tax authority at a time.
Some respondents provided comments admitting that they were willing to be pragmatic in working toward a solution. However, as one respondent noted, a pragmatic solution without principle might result in an unstable agreement. The OECD should therefore focus on adopting new proposals that align with shared principles and an agreed-upon rationale.
The pragmatism was also evidenced in the suggestion of a formulaic approach to rearranging taxing rights. A formula approach based on some measurable metric like sales in a jurisdiction could simplify both tax compliance and tax administration. Unfortunately, at this stage there is not enough detail in either the OECD approaches or the suggested formulas to determine the effects of any of the approaches.
The public consultation resulted in general agreement that something needs to change in the international tax rules, but also that there could be significant challenges to implementing that change. As Tax Foundation reminded the audience during the consultation, it is important to recognize that businesses are central to tax collection systems and the importance of having a discussion that is informed by the facts.
The OECD will continue to review the comments that have been received and is expected to publish a work plan in early summer. The OECD has a goal of reaching an agreement on a new policy in 2020. Tax Foundation will continue to monitor the OECD’s work on these proposals and will follow up with further analysis.
Daniel Bunn discusses the need to look at how each policy impacts the cost of capital and incentives to invest as well as overall tax complexity. Click the image above to watch.
Scott Hodge emphasizes that corporate income taxA corporate income tax (CIT) is levied by federal and state governments on business profits. Many companies are not subject to the CIT because they are taxed as pass-through businesses, with income reportable under the individual income tax. es impact workers and consumers as well as businesses. Click the image above to watch.