STABILIZING "PILLAR ONE": CORPORATE PROFIT REALLOCATION IN AN UNCERTAIN ENVIRONMENT.

• Author: Grinberg, Itai

INTRODUCTION 132 I. EXISTING MECHANISMS FOR MULTILATERAL COORDINATION IN INTERNATIONAL TAX MATTERS 135 A. The G20 Economic Soft Law Model 135 B. The OECD Model Treaty and the Multilateral Instrument 139 C. A Real Multilateral Treaty 141 II. THE POSSIBLE FACES OF MARKET INTANGIBLES: TWO INDICATIVE METHODOLOGIES 143 A. Capital Expenditure Method 145 B. The Operating Margins Method 148 C. Key Technical Differences Between the CE Method and the OM Method 150 III. STABILIZING THE HYPOTHETICAL PROFIT REALLOCATION METHODS 153 A. Stabilizing Profit Reallocation Using G20 Soft Law Approach 154 1. Substantive Allocation Rules at the Level of Law 154 2. Preventing "Mock Compliance" with Substantive Allocation Rules 157 B. Stabilizing Profit Reallocation Using the MLI+ Approach 158 1. Background on the Components of the MLI+ Approach 158 a. Article 9 of the OECD Model Convention 158 b. Article 5 of the OECD Model Convention 160 c. Article 7 of the OECD Model Convention 160 d. OECD Transfer Pricing Guidelines 161 e. Arbitration Under Bilateral Tax Treaties (Article 25(5)) 165 f. The Multilateral Instrument ("MLI") 166 g. The Convention on Mutual Administrative Assistance in Tax Matters 167 h. Country-by-Country Reporting 169 C. Stabilizing CE Method Using MLI+Approach 171 D. Stabilizing the OM Method Using the MLI+ Approach 175 1. Country Pairs Without Bilateral Tax Treaties 180 E. Stabilizing the CE or the OM Methods Using a Multilateral Treaty 185 1. Stabilizing the CE Method Using a Multilateral Treaty 185 2. Certain Outcomes Are Practically Impossible to Stabilize 187 3. Stabilizing the OM Method Using a Multilateral Treaty 187 F. Reflecting on the Key Dimensions: Still One Overwhelming Issue and Now Six Additional Important Considerations 188 CONCLUSION 190 INTRODUCTION

Can a new system for corporate profit allocation in the cross-border setting be agreed to and implemented by tax authorities in a manner that provides for stable and consistent international coordination and enforcement?

In May 2019 the OECD released a workprogramme that involves undertaking a comprehensive review of profit allocation and nexus rules. The OECD labeled this work as "Pillar One" of a two-part work programme. The work programme presented the skeletal outlines of various proposals to reallocate corporate cross-border income taxing rights. It also included a basic workplan to address technical issues that need to be resolved if any proposal is to be operationalized. The goal of the workplan was to provide input to a political decision on the outlines of a proposal for a consensus-based reallocation of taxing rights.

Given the political pressures for change to profit allocation rules, it is important that at every stage, the Inclusive Framework considers what legal and political instruments would be required to implement and stabilize any given proposal under Pillar One. Though the workplan alludes to this issue, its importance is not underscored. To date, the concern has not been widely discussed in public. This Article therefore presents the available stabilization mechanisms and the considerations for when they can and cannot be effective.

The Article suggests that decisions reached along six key dimensions will determine what set of tools will be required for there to be a chance of stabilizing the agreed upon Pillar One approach. It seems likely that some or all of these six key decisions will implicitly be reached settling on a "general approach" to Pillar One. As a result, immediate consideration as to the impact of those six decisions for the prospect of stabilizing the international tax architecture is advisable.

To consider the question, some background on the extant multilateral system of governance in international tax affairs is required. That system currently involves two interrelated but quite different mechanisms for coordinating international tax affairs among jurisdictions: a G20 Soft Law mechanism and a model treaty-based mechanism. (1) Part I of this Article first outlines these two mechanisms for achieving international coordination in corporate income tax matters. It then sets out the possibility of a true multilateral treaty, which is not a part of the current international tax landscape. Part II explores the proposals for reallocating taxing rights that are currently being discussed at the OECD. Part II first highlights that the parameters of this new concept are somewhat uncertain. I then outline two hypothetical versions of a Pillar One "solution" drawn from my interpretation of the OECD's recent public consultation document, (2) features of the public consultation itself, and the work programme. I do not intend these two hypothetical solutions to be indicative of my predictions of where the OECD process will end up. Rather, I hope they set out two extremes among the plausible range of possibilities. By so doing, the strawmen allow me to highlight key structural considerations that should be taken into account if relatively stable and consistent international coordination and enforcement is a desired goal of the present Pillar One negotiation. Part III asks whether it is possible and what it would take to stabilize either of the two strawman versions of Pillar One set out in Part II. One relevant question in this regard is whether the extant mechanisms for achieving international coordination in corporate income tax matters (as described in Part I) would suffice, or whether a true multilateral treaty would be required.

Part III suggests that the simplest extant proposal to alter profit allocation rules just might be implemented using a combination of tools previously used multilaterally by the OECD in the international tax area. In contrast, other proposals require a truly multilateral treaty on substantive taxing rights. Such a treaty has not previously been agreed upon by the nations of the world, despite having been discussed on and off for 100 years.

Note that this Article never evaluates whether either of the strawmen, or any existing proposal for reallocating taxing rights, is normatively desirable. In a prior paper, I expressed substantial doubts about the conceptual basis and the administrative feasibility of two proposals that have received a great deal of public discussion (3) the "user participation" concept and certain versions of the "market intangibles" concept. This Article does not revisit those issues; my silence on normative matters is not meant to indicate approval (or disapproval) of any proposal discussed herein.

Rather, this Article is motivated by, and focused on, the question of international tax order. My interest in international tax order is fundamentally conservative; I view order in this area as a value in and of itself, regardless of what the substantive outcome of multilateral discussions on profit allocation might be. The two strawmen proposals I set out are accordingly meant simply to highlight important stabilization considerations that arise in the Pillar One debate, which continues to develop even as this Article is going to press. (4)

1. EXISTING MECHANISMS FOR MULTILATERAL COORDINATION IN INTERNATIONAL TAX MATTERS

   1. The G20 Economic Soft Law Model

      Up until the current attempt to reallocate taxing rights and agree to a global minimum tax regime, most commentators would agree that the BEPS project was the most extensive effort to reset multilateral international corporate income tax norms since those norms were established under the auspices of the League of Nations in the 1920s.

      A key procedural feature of the BEPS project was that it arose through G20 convocation. The G20 framework for international economic regulation is a "top-down" architecture, in which G20 convocation and agenda setting provides the impetus for law- and regulation-making. G20-led international economic regulation usually involves a request at the G20 level for international coordination around standards to be created by a specific "standard-setter" that the G20 convenes. When it takes this step, the G20 also often asks for the establishment of monitoring bodies, enforcement vehicles, and technical assistance providers ("enablers") to support compliance with the new international economic regulatory standards. (5)

      Once standards are set, a monitoring body may determine whether national regulators are complying with a standard, potentially imposing discipline. Enforcement mechanisms are often established (or threatened) by the G20 and tied to the monitoring bodies' judgments. Finally, jurisdictions that lack the human capital needed to meet the standards may be offered technical assistance. (6)

      This G20-based institutional and procedural system for multilateral action, which was adopted for the BEPS project, has existed for a longer period of time in other areas of international economic law. For example, the G20, working through the Financial Stability Board as a "standard-setter," helped create monitoring bodies, enforcement mechanisms, and enablers that together represent a soft-law framework for what is now sometimes referred to as "international financial law." (7) The procedural similarities in G20 Soft Law made across various subdisciplines of international economic law allows for some trans-substantive lessons to be drawn from historical experiences across subfields.

      One such lesson from the history of G7 and G20 engagement with initiatives in various areas of international economic affairs, is that once those bodies engage an issue area within international economic law, they tend not to disengage. (8) In BEPS, the G20 certainly engaged with international tax. Moreover, in recent months the OECD Centre for Tax Policy and Administration Director Pascal Saint-Amans, as well as EU Commissioner Pierre Moscovici, have suggested that in a G20 environment that is otherwise deeply contentious, tax appears to be emerging as the anomalous success story where countries continue to cooperate. As...