Is The OECD/G-20 Tax Agreement The Best Compromise?

In this installment of In the Pages, Robert Goulder of Tax Notes and Ruth Mason of the University of Virginia School of Law discuss the reasoning behind the OECD/G-20’s two-pillar agreement compromise and debate whether a final agreement will be unanimously approved.

Here are a few highlights from their discussion, edited for length and clarity.

Robert Goulder: Hello everyone. I’m Bob Goulder with Tax Notes. Our guest today is Ruth Mason, professor of law and taxation at the University of Virginia School of Law. She is the author of our featured article, “The 2021 Compromise.” Professor Mason, thank you for joining us.

Ruth Mason: Thanks so much for having me.

Robert Goulder: Let’s go back to the Base Erosion and Profit Shifting (BEPS) project. You describe BEPS as operating under a pragmatic credo: Agree on the things you can agree on, otherwise move on now. Why didn’t that work?

Ruth Mason: To a large extent, I think it did work. There was a lot of agreement. Wherever agreement could be reached, it was. The problem is that countries didn’t move on, or they didn’t move on in every case. Take BEPS action 1. countries couldn’t agree as to how to deal with what the OECD calls the digitalization of the economy. They essentially agreed to disagree. 

What you saw, contemporaneous with BEPS, was the adoption of unilateral actions: diverted profits taxes, equalization taxes, digital taxes. These are examples of what I would call not moving on. These unilateral actions created a kind of a productive tension. Once companies understood they were going to be subject to these unilateral measures that were complicated and potentially lead to double taxation, it made them more receptive to negotiated solutions. 

Robert Goulder: Your article points out that no country got everything it wanted, but none walked away empty-handed. Could you work through these tradeoffs?

Ruth Mason: The first thing to observe is that nobody has anything yet. We have an agreement in principle, but for any country to actually get something out of it will require further steps. 

One important thing the United States got was that pillar 1, as currently formulated, doesn’t just tax digital companies. It’s pitched in more general terms. That’s important in my view. Digital taxes are distorting, right? Any kind of sectoral tax that singles out a particular industry is going to distort investment.

I have argued in the pages of Tax Notes, with Leopoldo Parada, that these digital services taxes may cause trouble under EU law as a form of discrimination. By making the nexus in pillar 1 general, the countries have helped future-proof the rule. This is going to be, if it happens, the most important treaty reform in recent memory.

The real lesson of BEPS action 1 and pillar 1 is that we should plan for obsolescence. The economy changes in ways we don’t expect. So that’s one thing that the U.S. got. You can think of all the other countries as losing on that issue.

In general, market states are the big winners because that amount A is going to be reallocated from mostly U.S.-headquartered companies. But this idea that market states are the winners does not mean the U.S. is a loser.

Although it is giving up amount A in a residence capacity as the home state of the headquartered companies, the U.S. also has a large wealthy consumer market. Some of the income that gets allocated away from the U.S. is going to get allocated right back to the U.S. 

Robert Goulder: What else did the U.S. win on? 

Ruth Mason: I’d say the U.S. also won on the revenue threshold. It’s very high at $200 billion in global revenue. That’s much higher than the [DSTs]; those thresholds are typically €750 million.

This reduces the number of companies that will be affected, and because most of those are U.S. companies that just reduces the impact. Even if the revenue threshold goes down to $10 billion, that’s still way higher than the [DSTs]. 

Robert Goulder: The thinking has often been that source countries tend to be poor countries. But with the digital economy, do we now have larger European countries like Germany and France seeing themselves as a source country who are losing out on taxing rights?

Ruth Mason: Pillar 2 was pushed from the beginning by German professors and politicians. But it’s not really a European proposal in the sense that there are plenty of countries in Europe that oppose it.

Under the law, yes, these countries could adopt DSTs, or a harmonized corporate tax. That is legally possible, but the votes aren’t there. All the member states have to agree.

On pillar 2, you don’t need everyone to agree. You just need the big headquarter countries to agree. It makes sense to look outside Europe for that, because the biggest headquarter country is the U.S.

The big countries of Europe, Germany and France, have a natural alliance with the U.S. What they’re trying to do with pillar 2 is to cut out Ireland, and cut out Luxembourg, which is why Ireland and Luxembourg don’t to vote for these proposals when they come up within Europe. 

Robert Goulder: You point out that Nigeria and Argentina are concerned the proposed threshold rate for the global minimum tax (at least 15 percent) isn’t high enough. Can you explain what’s in pillar 2 for less developed countries?

Ruth Mason: I am going to respond to this question in a way that is overly simplistic. We’re talking about very complicated negotiation by 130 countries. It’s impossible to say what are all their desires, and to characterize them in a way that’s fair to the complexity and the nuance. An overly simplified view of the situation is that you can think about three different groups of countries.

Group one is high-tax countries, whether developed or developing, that already have significant inbound investment activities by nonresident companies, or companies that are headquartered elsewhere. These countries have found themselves engaged in tax competition with other countries and they worry that real factors of production might be moving to lower tax countries, or paper profits might be shifting while nothing about the actual activity changes.

These countries, the high-tax countries, that have the activity now — they want a floor on tax competition. A floor rate to discourage profit shifting, or to make profit shifting no longer worthwhile. For them, it’s best to do this cooperatively. That’s why France and Germany are seeking out the U.S. They have similar interests in this sense. These countries want cooperation to set the tax rate at a certain level.

Now, why do you have a cartel? Do you have a cartel of governments to reduce tax competition? Who’s your competition? Well, they are the companies in group two. These are rich, low-tax countries, like Ireland, Luxembourg, [and] Switzerland.

These are the countries that would be the natural opponents of a global minimum taxation because they’re the up-and-comers. They’re competing mostly for paper profits, and to some extent also for real activity. They want to be able to set their corporate rate as low as possible, and they want it to matter to the multinational that they have a low rate. They don’t want their low rate to be taxed away or soaked up by some other country.

Then there’s a third group of countries. These are the poor, low-tax states. These are the countries that are trying to attract new investment [and] new business activity. They may not have a lot to offer in terms of workplace, workforce, or natural resources. And they want to have a low tax rate to attract inbound activity, but they are a kind of casualty.

If Nigeria and Argentina are saying the [pillar 2] rate is too low, then they are identifying with group one. They have inbound investment and they want to tax it at a higher rate, but they feel they’re being out competed by other countries.

That’s an oversimplified response. You could put a lot more nuance on it, but we have to understand there are different kinds of countries with lots of different needs. There may be some surprises when we find out which countries are for or against pillar 2.

Robert Goulder: My favorite line from your article is that the true surprise of the July 1 OECD statement is that it exists at all. I mentioned before that I was a skeptic here; reading between the lines it sounds like you may have been skeptical too. 

Ruth Mason: I don’t think you have to be a skeptic to think that 130 countries will find it hard to agree about anything in international tax. That’s really being rational. And nothing has been signed yet. We don’t know what’s going to happen. But what we are seeing are repeated commitments to cooperation, to multilateral efforts. And that’s really important.

It’s something that countries have learned through the first BEPS 1.0 project — cooperation works. It can work even on a very large scale. It’s a sign of the times. Countries can no longer go it alone in international tax, and they know that. It’s a really exciting time for us to be studying international tax. And we can only wait and see what happens next.

Robert Goulder: Professor Mason, thank you again for joining us.