Money Grab: How The G20/OECD Inclusive Framework for Taxation Could Unnecessarily Disrupt Corporate Incentives and Misallocate Taxing Rights.

• Author: Anderson, William T.

TABLE OF CONTENTS I. INTRODUCTION 1052 II. BACKGROUND 1060 A. Difficulties of Taxing in the Digital Age and Problems with the Trajectory of International Taxation 1060 B. Benefits Technology Companies Provide in Developing Countries and the Income They Make 1065 C. OECD/G20 Inclusive Framework on Base Erosion and Profit Shifting 1068 D. Path to Implementation of the OECD Proposal, Including Likely Political Challenges 1071 III. ANALYSIS 1072 A. Could Pillar One Taxation Cause Corporate Breakups or Otherwise Disincentiuize Revenue or Profit Maximization on the Margin? 1073 B. Is Pillar One and its Revenue-Based Allocation of Taxing Rights Consistent with Theories of Taxation? 1075 C. Benefit Theory of Taxation 1076 D. Ability-to-Pay Theory of Taxation 1076 E. Certain in Amount and Process to the Taxpayer 1077 F. Convenient for the Taxpayer to Pay 1078 G. Not Overly Burdensome Relative to the Needs of the State 1078 H. Could Pillar One and the Amount A Allocation Disincentivize Companies from Offering Services in Jurisdictions Where They Are Nominally Profitable and Would Incur Unnecessary Compliance Costs? 1080 IV. SOLUTION 1081 A. Removing the Segmentation Rule for Pillar One Inclusion 1081 B. Applying a Profit-Based, Not Revenue-Based, Allocation to Pillar One Amount A 1083 V. CONCLUSION 1085 I. INTRODUCTION

In the wake of the 2008 financial crisis (the Great Recession), wealthy countries faced a dangerous combination of declining tax revenues coupled with increased spending. (1) In 2009, the International Monetary Fund (IMF) estimated that the world's ten largest economies would see their debts increase to 114 percent of gross domestic product

(GDP) by 2014. (2) In addition to increased spending related to the Great Recession, these deficits were also caused by the broader trend of declining corporate tax revenues. (3) Across the then-thirty or so richest countries in the world, tax revenues decreased by 11 percent from 2008 to 2009. (4) Specifically, governments suffered from a 28 percent decline in corporate income tax revenue, followed by a 16 percent decline in individual income tax revenue. (5)

While the Great Recession contributed to shrinking corporate tax revenue as corporate earnings fell, declining tax rates also played a role. Since 2000, the global average statutory tax rate for corporations has fallen from 28.3 percent in 2000 to 20.0 percent in 2021. (6) Out of 111 countries over this period, the tax rate fell in ninety-four, remained constant in thirteen, and increased in only four. (7) This trend represents a race to the bottom where countries lower their corporate tax rates to attract inbound investment that, theoretically, contributes positively to domestic economic growth. (8)

The math for corporations, and for countries, only works when there are meaningful differences in effective corporate tax rates across jurisdictions. When these differences exist, companies may even seek to relocate entirely rather than shift the location of their assets. In 2015, Pfizer, a US pharmaceutical company, planned to merge with Allergan, an Irish pharmaceutical company. (9) As part of the $160 billion USD merger, Pfizer would have re-domiciled to Ireland, subjected itself to Ireland's lower taxing regime, and ceased to be a US-headquartered corporation--thereby completing a tax inversion. (10) The re-domiciled

company would have saved up to $35 billion USD in US corporate taxes as a result. (11)

In response, US legislators and administrators from the Internal Revenue Service (IRS) and Department of the Treasury (Treasury) sought to make the deal less favorable from a tax perspective by reducing Pfizer's ability to capture potential tax savings. (12) The merger was eventually called off in 2016 due to reduced tax advantages. (13) This was part of a broader trend, not an isolated event. (14) As countries raced to the bottom of corporate taxation, companies followed suit by leaving countries with comparatively higher taxing regimes. (15) A year later in 2017, the United States sought to catch up in the race by reducing its top effective corporate tax rate from 35 percent to 21 percent. (16)

Amid the Great Recession at the Group of Twenty (G20) Summit in Pittsburgh, Pennsylvania, the Leaders' Declaration endorsed the OECD Global Forum on Transparency and Exchange of Information (Global Forum). (17) More specifically, the G20 endorsed the Global Forum's goal to "improve tax transparency and exchange of information so that countries can fully enforce their tax laws to protect their tax base." (18) The emphasis on protecting the countries' tax bases likely reflected the tax revenue shortfalls these countries faced due to the Great Recession. (19) Also at the summit, the G20 Leaders officially designated the OECD as "the premier forum for international economic co-operation." (20) An endorsement from the leaders of the twenty most powerful countries in the world is not to be taken lightly.

The OECD is an international organization that for sixty years has worked to "build better policies for better lives." (21) As a multimember body with thirty-six member countries and five partners representing 80 percent of world trade and investment, the OECD has developed 450 international standards covering areas such as finance and investment, governance, and the environment. (22) Of the 450 international standards, 250 are currently in force as legal instruments. (23) International tax reform, through the OECD/G20 Inclusive Framework on Base Erosion and Profit Shifting (Inclusive Framework), is one of the organization's current initiatives and the topic of this Note.

The OECD's role in international tax policy is not a new development. Following the G20's support, the Global Forum has worked with its member countries to end banking secrecy and tax evasion through two primary international standards, which began receiving comments in 2009. (24) The first standard is an Exchange of Information on Request framework that "provides for exchange on request of foreseeably relevant information for carrying out the provisions of a tax convention or for the administration or enforcement of the domestic tax laws of a requesting party." (25) The second standard is an Automatic Exchange of Information process where "a pre-defined set of information on financial accounts held by non-residents is automatically exchanged each year." (26) In tandem, these standards operate to promote the flow of critical information to support domestic tax investigations and enforcement.

While the Global Forum is focused on preventing illegal tax evasion from reducing countries' tax bases, countries' tax bases are also being reduced by base erosion and profit shifting from multinational enterprises (MNEs). (27) MNEs shift profits artificially, rather than organically, by engaging in aggressive tax planning. (28) Aggressive tax planning involves shifting profits to low-tax jurisdictions through a combination of tax entity structures and transfer pricing of intercompany transactions between separate legal entities within the same parent MNE. (29) The evidence of these profit-shifting efforts can be seen by a misalignment in the company's expenses, revenues, and earnings across countries. (30) For example, in 2011, 30 percent of Apple's pre-tax income was attributable to the United States despite 39 percent of Apple's sales coming from the United States. (31) This 2011 misalignment of sales revenue and income is evidence of tax planning, which is legal, given Apple's status as a US-domiciled corporation and the United States' then-corporate tax rate of 35 percent. (32) In a 2012 Senate hearing with Tim Cook, the Apple CEO, Senator Carl Levin's panel asserted "[Apple] transfer[ed] valuable intellectual property assets offshore and shift[ed] the resulting profits to a tax haven jurisdiction." (33)

In 2012, the G20 Leaders' Declaration continued the tone of the 2009 Pittsburgh Leaders' Declaration but more directly emphasized the need for a more coherent international tax framework. (34) Specifically, the G20 leaders reiterated "the need to prevent base erosion and profit shifting" and their plans to "follow with attention the ongoing work of the OECD in this area." (35) Following the G20's request, the OECD released their Action Plan on Base Erosion and Profit Shifting (BEPS), which addressed the three main problems associated with taxing MNEs in the digital age: (1) declining MNE effective tax rates leading to tax revenue shortfalls in government budgets; (2) higher tax burdens for other taxpayers across the world to make up for the shortfalls; and (3) increased aggressive tax planning harming the competitive abilities of less aggressive companies (both purely domestic enterprises that cannot take advantage of disparate taxing regimes across jurisdictions and less aggressive MNEs that choose not to take advantage of such disparate regimes). (36) The G20 leaders endorsed the action plan in 2013 and at the 2015 G20 Leaders' Summit in Antalya "[called] on the OECD to develop an inclusive framework by early 2016 with the involvement of interested non-G20 countries and jurisdictions which commit to implement the BEPS project, including developing economies, on an equal footing." (37)

After years of deliberation and planning, the OECD released the Inclusive Framework in July 2021 with 130 countries endorsing the proposal. (38) The goal of the proposal is "to ensure that large MNEs pay tax where they operate and earn profits, while adding much-needed certainty and stability to the international tax system." (39) The proposal has two pillars: the first is designed to focus taxation on the location of business activities and profits (Pillar One), and the second is designed to establish a global minimum tax (Pillar Two). (40) Pillar One, and Amount A in particular, "provide[s] a new taxing right to market jurisdictions, by re-allocating a portion of an...