Interview: Analyzing The OECD’s Plan For Taxing The Digital Economy

Tax Notes legal reporter Ryan Finley summarizes the OECD’s pillar 2 proposal and Monika Loving of BDO provides her take on the consultation draft.

Read the podcast transcript below. This post has been edited for length and clarity.

David Stewart: Welcome to the podcast. I’m David Stewart, editor in chief of Tax Notes Today International. This week: pillar 2. On November 8, the OECD released the second part of its two-pillar plan for the taxation of the digital economy. The pillar 2 draft explores design questions for a global minimum tax.

A little later, we’ll talk to Monika Loving, the national practice leader at BDO’s international tax services group, to get her take on the new draft.

But now, I’m joined by phone by Tax Notes legal reporter Ryan Finley to talk about what’s in this latest draft. Ryan, welcome back to the podcast.

Ryan Finley: Thanks for having me.

David Stewart: Could you give us an overview of some of the key aspects of this pillar 2 proposal?

Ryan Finley: Sure. The pillar 2 proposal attempts to implement a global minimum effective tax through four basic components: an income inclusion role, an undertaxed payments rule, a subject-to-tax rule, and a switchover rule. The income inclusion rule would apply to a foreign subsidiary or a branch if its income is taxed below some minimum rate that hasn’t yet been specified. The undertaxed payments and subject-to-tax rules would basically deny the deduction, deny treaty benefits, or impose a withholding tax in the case of payments to foreign-related parties that are taxed at a rate below this minimum rate threshold. These elements have been compared to the U.S. global intangible low-taxed income and base erosion and anti-abuse tax regimes that were enacted in 2017. There’s also the switchover rule, which would amend bilateral treaties to switch from an exemption method to a tax credit method for income tax at an insufficient effective rate.

David Stewart: What is the problem the OECD is seeking to solve with this proposal?

Ryan Finley: Well, the consultation document basically highlights two things. One is to address the issues left unresolved after the base erosion and profit shifting project by ensuring that multinationals are subject to some minimum level of tax. According to the consultation document, pillar 2 would limit multinationals’ incentive to engage in complex and artificial tax planning structures and it would curb tax competition between countries because there’d be no benefit to having a rate lower than this minimum effective rate.

David Stewart: Now, how does pillar 2 relate to pillar 1 and the original BEPS project?

Ryan Finley: Pillar 2 is designed to counter profit shifting and avoidance by multinationals like the original BEPS project in 2015, whereas pillar 1 was more about deciding on the allocation of taxing rights among countries, not really about multinationals’ avoidance practices. Basically, the document says that the original BEPS project still allowed multinationals to arrange structures that resulted in unacceptably low effective tax rates. If you look at the BEPS report, even though they tightened the economic substance standards, nothing would really prevent a multinational from moving some operations to a very low tax country and then benefiting from the lower rate.

David Stewart: What sort of design issues is the OECD grappling with in this proposal?

Ryan Finley: The first thing is defining the tax base. On the tax base issue, the consultation focuses on the challenges that arise as a result of countries’ differing definitions of taxable income, particularly as they relate to timing issues. The consultation is pretty clear that to establish some level of uniformity, the best approach would be to use financial accounting standards because the level of variance in different countries— financial accounting standards — is less than the variance in their corporate tax laws. But even starting from financial accounting standards, there are still a lot of difficult technical issues.

The second big issue is blending. The consultation says that the options are blending at a global level, blending at a jurisdictional level, or blending at an entity level, or some hybrid of the three. The simplest would be to blend at the global level because countries would not have to look at every single subsidiary and apply the rules to each and every one. They also would not have excess tax in some jurisdictions and insufficient tax in other jurisdictions and would not be able to credit the overpayments against the underpayments in other jurisdictions in that year. On the other hand, it also says that global blending may partially undermine the goal of countering tax competition. Whichever approach they use, there are significant technical issues, including how to allocate income between transparent entities and between an entity and a foreign branch.

On the carveouts and thresholds issue, the consultation sets out two basic alternatives. One would be to use quantitative criteria like revenue or some sort of allocation method to determine whether a company falls within or outside of the scope of the pillar 2 proposal. The other approach would be more of a facts and circumstances test. The consultation doesn’t really come down one way or the other, but it says that using objective quantitative criteria may be more prone to allowing abuse, but it would also be much easier to administer.

David Stewart: What specific issues is the OECD asking for comments on?

Ryan Finley: The document is basically asking for input on the pros and cons of all the different options it sets out. This includes questions on the tax base, asking stakeholders whether they agree that financial accounting should be the starting point, and for practical feedback regarding the exact mechanisms for dealing with these temporary timing tax differences. The questions on the blending issue tend to focus on whether they should use a global jurisdictional or entity level approach, and a lot of them focus on the level of uncertainty and administrative burden involved in each option. Carveout questions also include questions regarding which industrial sectors, if any, should be carved out of the regime.

David Stewart: What is the timeline for this consultation process?

Ryan Finley: It’s fairly tight. The consultation document came out November 8 and the consultation period runs through December 2. A public consultation meeting is scheduled for December 9 in Paris. In light of the 2020 deadline for the OECD to reach an all encompassing agreement on both pillar 1 and pillar 2, there may be some doubts as to whether they’re going to make that deadline.

David Stewart: Well, Ryan, thank you very much for being here.

Ryan Finley: My pleasure.

David Stewart: Joining me now by phone is Monika Loving. She’s the national practice leader at BDO’s international tax services group. Monika, welcome to the podcast. 

Monika Loving: Thank you very much for having me.

David Stewart: What is your overall take on this pillar 2 consultation draft?

Monika Loving: I think about the goal for pillar 2 as a starting point. It’s a big task. This would be a significant change in our global tax landscape. I can’t help as a U.S. tax professional to reflect upon pillar 2 sharing many of the concepts that we’ve worked through over the past two years as a part of the 2017 U.S. tax reform law, the Tax Cuts and Jobs Act. It introduces an income inclusion rule, which operates in a generally similar manner to the U.S. GILTI rules. There’s the undertaxed payments rule, which has similarities to the U.S. BEAT. Pillar 2 also lays out a number of tactical points that must be agreed in implementing the global minimum tax. Most fundamentally, what’s the starting point of the calculation? How would it be derived when each country has a different application of its domestic tax roles and financial income is also calculated under various different accounting principles? 

David Stewart: Do you think that this draft gets at the questions that need to be answered to implement a minimum tax?

Monika Loving: It’s a big question to start with. I’ll start with one of the questions that wasn’t answered with the draft : What’s an appropriate rate of the global minimum tax? Most importantly, the consultation draft did not include a discussion on a suggested applicable rate for the minimum tax. The OECD has deferred comments until more of the design elements are agreed to, but the consultation draft does discuss a number of key definitional points which are very important. These are at the technical design stage. There are suggestions of potentially numerous carveouts for de minimis items as well as threshold level questions for potential application of the rules. Reflecting on the experience with U.S. tax reform, one of the most challenging aspects of addressing implications of the GILTI provisions has been the potentially profound impact in the case of a significant corporate life event, such as an acquisition or disposition. This is an area where I see further discussion could be needed because a global minimum tax would drive effective tax rate for large multinationals and understanding potential impacts in that scenario with a large scale transaction.

David Stewart: Now assuming they are able to reach an agreement, does this minimum tax create a potential for more complexity as each jurisdiction attempts to implement it?

Monika Loving: The short answer is yes. The complexity of global tax reporting will increase substantially. Even with an agreed upon framework for determining that financial income as a starting point and the tax base as a starting point, multinational groups will have a very complex process to undertake on an annual basis to operationalize this. Calculating a global minimum tax on either a jurisdictional basis or an entity-by-entity basis would be a very significant compliance effort. Parent country and home country jurisdictions would need to agree to a mechanism for reporting, for tracking, and for payments of potential top-up payments that would occur as a result of the minimum tax.

David Stewart: Based on what we’ve seen in the pillar 1 and pillar 2 drafts, do you think that we’re anywhere close to an agreement at the OECD level?

Monika Loving:The scale of this project is very significant. We have a global tax redesign project that involves more than 130 countries as stakeholders. The OECD is really working through a very massive task and has many milestones it’s already delivered on, but you continue to have additional milestones that it needs to hit. The policy note that it issued on the digital economy — that was in January of 2019, so we’re 11 months out. The progress that has been made over those 11 months is very significant, but there are still very fundamental design issues to be agreed on. Consensus is critical to the success of the overall work. Without the consensus, there is concern on unilateral measures. I think that we may see the timeline continue to progress and perhaps extend beyond the initial timeline that’s been stated. 

David Stewart: Now, from where you stand, having seen the pillar 1 and pillar 2 drafts, is there anything missing from this project that you want to see?

Monika Loving: I would like to see further work around operationalizing these areas. In terms of the potential compliance burden for companies with a global minimum tax, this will be a very significant impact on how businesses operate their tax departments. It will be important that we have a practical way to implement these rules from a reporting perspective. I’d like to see in any further consultations and further comments from a practical element how businesses will be directed to meet the compliance requirements.

David Stewart: Now you mentioned that some of this might slip beyond the currently outlined timeline. Do you think that there’s any possibility that they can finish this work in 2020?

Monika Loving: I think they will push as hard as possible. There is significant pressure to meet the 2020 deadline as countries continue to provide their input into this consensus process. There are jurisdictions that continue to move forward from a domestic law perspective around unilateral measures. I think that the OECD will press as hard as they can to bring together the inclusive framework to meet the deadlines.

David Stewart: Now amid all of this uncertainty, what would you advise businesses to do? Are there any concrete steps they should be taking at this moment?

Monika Loving: At this point, I think businesses should be in a monitoring mode. Continued monitoring of this debate is really critical for a multinational business. We’re talking about the architecture of our international tax rules potentially changing. We’re shaping the international tax rules for a very broad base of business, including many that are outside of a typical technology company or digital business. Also, the OECD is inviting comments. There has been a very robust public consultation process around pillar 1. The pillar 2 consultation process is now open. I think it is important that the business community provide input on as many aspects of this design as possible. And companies can begin to analyze how these provisions may impact their global effective tax rates. These provisions are still in the design stage, so it would certainly be at a high level, but understanding the impacts of these provisions, like how they might shape what the effective tax rate of the organization looks like as the OECD is laying out this framework, is important. We know that there could be something like the income inclusion rule, a potential tax on base eroding payments. These could all be considered by the companies in the context of their current structures. High-level modeling of this impact on the total tax liability of the business and informing the key stakeholders, the potential impacts, the long-term effective tax rates, is an important next step.

David Stewart: All right. It sounds like there’s going to be a lot to watch out for in the next couple of months. Monika, thank you for being here.

Monika Loving: I appreciate you having me. Thank you very much.