The success of Pillar One largely depends on the effectiveness of dispute settlement disciplines.

AuthorDavis, J. Brian
PositionThe New Frontiers of Dispute Settlement in a Pillar One World, part 2

Part One of this article, which appeared in the March/April 2022 issue of Tax Executive, discussed the evolution of the international tax system leading up to the modern proposal to implement an OECD-championed multilateral tax treaty to bring order to an increasingly complicated and digitized world. The recent impetus to complete a Pillar One treaty has been animated by the digitization of business and a growing number of trade disputes over digital services taxation.

In this second part, we focus on the challenges to a meaningful implementation of Pillar One. The need for effective dispute resolution mechanisms overshadows all of Pillar One, and the proposed multilateral approach will likely require new thinking in terms of managing global tax controversies and corporate risk. If the Pillar One output lacks the teeth to inspire confidence that commitments will be kept and controversies may be resolved with consistent and principled outcomes, then it will fail--and the patchwork of global tax measures and controversies will proliferate. Several potential solutions for harnessing the Pillar One deal may be found in international trade law, which provides a myriad of possible options for enforcing a tax deal. Such tools would also be useful in the event that the Inclusive Framework cannot reach a deal and corporate stewards are left to mitigate risk in an ad hoc environment.

None of the solutions, however, is without downsides. The best outcome would be for the Organisation for Economic Co-operation and Development (OECD) and the Inclusive Framework to adopt strong and nimble dispute settlement (DS) options within the treaty itself. In-house counsel and tax departments would be well advised to keep these options in mind, hope for the best, but prepare for the worst.

Challenges to Pillar One Success

As a project--the success of which already depends on securing not only political but also legislative agreement by sovereign countries to reallocate taxing rights--Pillar One naturally faces headwinds even in the best environment. (1) If one reflects on the fact that its market-is-the-measure approach represents a major deviation from the traditional international tax framework and could be perceived as a gateway to global formulary apportionment, then the outlook starts to dim. (2) Nonetheless, the swift reanimation of the business digitization and taxation narrative following the conclusion of the OECD/G20 Base Erosion and Profit-Shifting (BEPS) Project leads us to believe that the prospects for multilateralism are greater now than perhaps at any time in modern history.

Three main challenges, we believe, will determine Pillar One's success or failure: 1) the US governments willingness or ability to implement Pillar One, 2) the ability of the OECD to successfully simplify the substantive Pillar One design features that are not yet resolved and to unify the views of Inclusive Framework members in relation to them, and 3) a willingness on the part of the Inclusive Framework to commit serious time and resources to properly develop and implement meaningful tools and procedures to ensure that Pillar One's multilateral and bilateral dispute resolution frameworks function efficiently and that Pillar One commitments are not undermined.

The first challenge to Pillar One's success--the possibility that the United States may not implement it--is a wild card for several reasons, most important among which is the fact that a failure to implement by the world's largest economy will reverberate throughout the Inclusive Framework by weakening other members' commitments and emboldening unilateral action. The OECD has already seen countries back away from Pillar One due to design problems, and some in the tax community suspect that some countries may lose enthusiasm for Pillar One as the details are settled and the math is rerun on Amount A. (3) However, an effective retreat by a major G20 member would likely imperil the effort, notwithstanding that some may believe there could be a world in which Pillar One is implemented without the United States. (4)

One practical reason the United States might not implement Pillar One, or at least not soon, relates to politics and to the novelty of multilateralism in the tax domain. From the US perspective, the use of a multilateral instrument to allocate taxing rights is unquestionably novel. Although the execution of a multilateral tax instrument should in theory be possible--assuming the existence of adequate stakeholder protections (such as good dispute resolution tools)--the United States traditionally signs only bilateral tax treaties and, to our knowledge, has never signed a multilateral tax treaty that allocates taxing rights. (5) To do so, the United States presumably must craft new statutory taxing rights and ensure that its existing treaty network does not impede the operation of the Pillar One treaty--all of which suggests that implementation depends on a traditional legislative process involving the US Senate.

But the Senate is almost evenly divided between Democrats and Republicans, and even though the US Treasury may be willing to move forward on Inclusive Framework priorities, its engagement with the US Congress to date appears to have been so limited as to have drawn repeated sharp rebuke from all Republican members of the Senate Finance Committee. (6) Given the fate of other Biden administration initiatives (for example, the Build Back Better Act and voting rights efforts), and the ongoing crisis involving Russia, there is a real risk that the US commitment to Pillar One could suffer a negative political outcome at least in the near term. (7) Considering the pace at which the G20 finance ministers and the OECD seek to move Inclusive Framework initiatives forward, it would not be unreasonable to also conclude that such a delay might weaken the political agreement reached in October 2021.

The second challenge to Pillar One's success relates to the myriad design features, rules, and definitions that must be engineered to animate the proper application of Pillar One but which as of this writing are just beginning to be socialized for stakeholder input. Proper construction of these "building blocks" is critical not only to ensure that the Pillar One system functions properly in a vacuum but also to build confidence among all stakeholders that it will be durable when unleashed on the world and can live up to the promises made in arriving at the political deal. Yet public consultation periods have been abbreviated (that is, each is approximately two weeks), and topics considered only in piecemeal fashion as the universe of elements have not yet been developed for holistic public review. (8) This approach is understandable, since Pillar One is a monumental undertaking-one requiring both fundamental revisions to work done by the League of Nations in the 1920s and the development of mechanisms to ensure that new and existing tax systems interact properly--and is constrained by a political timetable, but it creates significant opportunity for confusion and error and is akin to Julia Child preparing beef Wellington in a microwave oven. We can appreciate not wanting the perfect to stand in the way of the good, but the political schedule (which envisages completion of technical work in 2022 and operability in 2023) may simply be too ambitious. (9)

To date, the Pillar One technical drafts released for consultation have reflected quantum-level complexity and left abundant room for subjective interpretation--foreboding signs of the multilateral (not mere bilateral) disagreements and controversies looming on the horizon. Given reported post-BEPS audit challenges associated with misinterpretations of core BEPS concepts, one can wonder whether Pillar One might eventually collapse on its own given its propensity for complexity, its potential for subjectivity, and the timing constraints imposed on its technical work development. (10)

The third challenge that we see to Pillar One's success relates to the willingness of the OECD and Inclusive Framework to treat the technical work on dispute resolution tools and processes (both from taxpayer-to-government and government-to-government perspectives) as on at least an equal if not greater footing when compared to all other Pillar One technical work. Pillar One itself is the embodiment of multilateralism, an approach that has long been theorized as an ideal model for addressing tax matters in an international setting.(11) Yet it is inescapable that multilateralism has played a very limited role to date in allocating taxing rights (as opposed to less politically sensitive matters such as information sharing), whereas bilateralism has proliferated within that realm. (12) And though we recognize that the prevalence of bilateralism in the tax domain can be viewed as the progeny of a historical compromise, its durability over the past century is better explained in simple and practical terms: it is easier to engage with and resolve matters bilaterally. Thus, in our view the true "heavy lifting" of Pillar One is the work to be done in relation to the rules that dictate how multilateral interactions among stakeholders (taxpayers and governments alike) will operate to resolve disputes and achieve legal certainty consistently and preferably efficiently. Tax history implies that this work will be hard, but it arguably is the legal foundation upon which all of Pillar One and its political agreement rest. (13)

When designing dispute resolution tools and processes for Pillar One, the OECD and the Inclusive Framework must pay special attention to taxpayer rights and remedies since in-scope multinational enterprises (MNEs) will be the subjugated party left swaying in the wind as disagreements (particularly those among governments) arise. After all, Amount A is designed to serve and to benefit tax authorities, and thus the principal benefits to be...

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