On November 11, TEI submitted comments to the OECD Secretariat regarding its proposed "unified approach" to "Pillar One" of the tax challenges of the digitalization of the economy. TEI's comments focused on the need for (i) the withdrawal of unilateral measures after a multilateral agreement; (ii) a multilateral dispute resolution mechanism; and (iii) reliance on taxpayer consolidated financial statements for purposes of the approach, among other subjects. TEI's comments were prepared under the aegis of the Institute's European Direct Tax Committee, whose co-chairs are Kris Bodson of Johnson & Johnson and Giles Parsons. Benjamin R. Shreck, TEI tax counsel, assisted in preparation of the Institute's comments.
The OECD launched its base erosion and profit shifting (BEPS) project in 2013. Action 1 of the BEPS project was entitled Addressing the Tax Challenges of the Digital Economy and the OECD published a final report under that action on 5 October 2015 (the Final Report). (1) The Final Report concluded in part "because the digital economy is increasingly becoming the economy itself, it would be difficult, if not impossible, to ring-fence the digital economy from the rest of the economy for tax purposes." (2) The Final Report noted that the OECD would continue to monitor developments in this area, along with implementation of the other BEPS actions, with a view toward producing a follow-up report on the digital economy in 2020. (3)
Subsequent developments and substantial political pressure, however, have overtaken the "wait and see" approach anticipated by the Final Report. Thus, following the Final Report the OECD has published: (i) an interim report entitled Tax Challenges Arising from Digitalisation in March 2018; (ii) a policy note, entitled Addressing the Tax Challenges of the Digitalisation of the Economy on 23 January 2019; (iii) a public consultation document, also entitled Addressing the Tax Challenges of the Digitalisation of the Economy, on 13 February 2019; (iv) a document entitled Programme of Work to Develop a Consensus Solution to the Tax Challenges Arising from the Digitalisation of the Economy, in May 2019; and, most recently (v) a public consultation document entitled Secretariat Proposal for a "Unified Approach" under Pillar One on 9 October 2019 (the Consultation Document). The OECD also held a public consultation in Paris in March 2019.
The Consultation Document invites interested parties to provide comments on the Secretariat's "Unified Approach" no later than noon Paris time on 12 November 2019. I am pleased to respond to the OECD's request for comments on behalf of Tax Executives Institute, Inc. (TEI).
TEI was founded in 1944 to serve the needs of business tax professionals. Today, the organization has 57 chapters in Europe, North and South America, and Asia. As the preeminent association of in-house tax professionals worldwide, TEI has a significant interest in promoting sound tax policy, as well as the fair and efficient administration of the tax laws, at all levels of government. Our nearly 7,000 individual members represent over 2,800 of the leading companies in the world. (4)
TEI supports efficient, predictable, and stable tax regimes because they promote long term investment, growth, and result in fewer disputes between taxpayers and tax authorities. We approve of the Consultation Document's approach to develop a balanced proposal under Pillar One, which generally attempts to address the relevant challenges in an efficient and predictable way. That said, the Consultation Document suffers from a number of flaws, including (i) the potential for multiple taxation and ensuing disputes: (ii) introducing excessive compliance costs from a cost/benefit perspective; (iii) general incompatibility with current bilateral tax treaty networks and associated relief from double taxation; and (iv) conflict with the current OECD transfer pricing guidelines. Below we expand on each of these flaws, provide other general comments, and answer the specific questions posed by the Secretariat.
The Necessity of Repealing Unilateral Taxes/Measures
The proliferation of unilateral taxes targeted at highly digitalized businesses or certain business models is a major impetus for the OECD moving forward with BEPS Action 1, the resulting "Pillar One" approach, and the unified approach in the Consultation Document. These unilateral measures include diverted profits taxes, a digital advertising or services tax, a withholding tax on services, equalization levies, multinational anti-avoidance laws, and other analogs. The measures impose a heavy tax and compliance burden on businesses and are intentionally targeted at certain industries, sectors, or business models in what TEI views as discriminatory manner. This discriminatory approach is in contrast to the OECD concluding the digital economy cannot be "ring-fenced" in the Final Report. TEI believes any OECD agreement on Pillar One must require these taxes be repealed as a condition of such an agreement. The purpose of the OECD's renewed work in this area would be unclear if these unilateral measures remained in place after an agreement was reached.
The Need for Multilateral Agreement
The unified approach set forth in the Consultation Draft will only lead to a simple and administrable system if countries agree to consensus, binding multilateral approach. Such an agreement would need to address the scope of the proposal, the allocation mechanism, review and audit procedures, and prevention/elimination of double taxation.
A multilateral approach should be captured in a multilateral agreement, similar to the multilateral instrument (MLI) under BEPS Action 15. It is critical for any such instrument to provide for interaction across multiple jurisdictions, rather than merely modifying current bilateral tax treaties. The Consultation Document anticipates reallocating taxing rights from residence to market/source jurisdictions. This will result in an allocation from more than one residence jurisdiction to a single (or multiple) market jurisdictions and a concomitant increase in disputes among those jurisdictions. Thus, any new MLI must address the potential for multijurisdictional disputes. (5)
Separately, the scope restrictions for application of the unified approach under any such agreement or instrument should be clear and easily administrable. Whether and what part of a multinational enterprise (MNE) is subject to the unified approach should be assessed in accordance with a single, global, consensus-based set of rules--not rules determined by local jurisdictions.
Finally, implementation of the new nexus and other rules, and the dispute resolution mechanism, must be deployed simultaneously by all countries. Disputes are guaranteed to arise if one country begins reallocating Amount A before another country even adopts the new approach.
The Need for Multilateral Dispute Resolution and Correlative Adjustments
The unified approach should introduce a truly multilateral dispute resolution mechanism with automatic correlative adjustments to reduce and hopefully eliminate double taxation resulting from the approach. The absence of a multilateral mechanism will lead to endless disputes and double taxation because the unified approach will allocate Amount A from one (or more) jurisdiction( s) to a market jurisdiction (or multiple market jurisdictions). The current dispute resolution mechanisms of bilateral tax treaties are incapable of settling such cross-jurisdictional disputes.
It is essential that any agreement re-allocating part of the non-routine profits of a multinational enterprise to market jurisdictions (i.e., Amount A) include clear rules for determining which entities in a multinational group earn such non-routine profits under existing transfer pricing rules as these are the entities entitled to double tax relief. Non-routine profits of many MNEs reside in different legal entities across multiple jurisdictions. Reallocation of such profits will therefore require a multilateral instrument covering all impacted jurisdictions because an agreed change in one bilateral situation will likely lead to multiple changes in other bilateral situations. Using a string of bilateral tax treaties is therefore unlikely to eliminate double taxation in a timely manner, if at all. Furthermore, not all countries allocated an Amount A will have double tax treaties with the countries from which Amount A was allocated and so there will be no bilateral tax treaty dispute mechanism to utilize.
Finally, the Consultation Document suggests the use of binding dispute resolution with respect to Amount C. TEI agrees with this, however, the use of binding dispute resolution should be available to settle disputes with respect to Amounts A and B as well.
Alternatives Withholding Taxes
Some countries may be considering imposing withholding taxes to collect Amount A. A pure withholding tax approach to Amount A would add another layer of administrative requirements and cost for taxpayers if the withholding tax is not considered the "final" tax. That is, if a taxpayer's tax is over or under withheld by a particular jurisdiction based on the imperfect information held by the jurisdiction, the taxpayer would need to engage in a second administrative proceeding (filing for a refund or filing an additional withholding tax return) to correct the erroneous amount withheld by the taxing authority. This may happen every year as it is unlikely that the market jurisdiction has the information necessary to properly determine Amount A.
A better approach would be to administer Amount A as if it were a fully creditable tax, rather than requiring a taxpayer without a physical presence in the jurisdiction to file a net income tax return. The taxpayer would merely pay over Amount A, as determined by the taxpayer's parent jurisdiction, as a "final" amount of tax...