Simplification was a key theme of the public consultation on the OECD’s two-pillared international tax reform proposal. Zoe Andrews has already commented on the consultation responses on Pillar One which seeks to re-allocate taxing rights to market jurisdictions. This post focuses on the consultation responses on Pillar Two which seeks to establish a minimum level of corporate taxation across the world through a pair of global anti-base erosion (GloBE) rules, the income inclusion rule (IIR) and the under-taxed payments rule (UTPR). Recordings of the public consultation meetings on both Pillars and copies of the presentations can be access through the OECD website.
Simplicity by design?
Given the economic fall-out from COVID-19, national governments are focussing on resilience projects, the UK’s 10-year strategy to build a trusted, modern tax administration system published in July 2020 being a case in point. For the reform of the international tax system, this means that countries should be looking for a robust and sustainable solution. The aim should be to develop rules which can be readily understood and applied – including by tax authorities in the developing countries – in a manner which improves tax certainty and avoids litigation, and, for that, simplicity is key.
Achim Pross, Head of Division- International Cooperation and Tax Administration at the OECD Centre for Tax Policy and Administration, acknowledged that, ideally, the GloBE rules should be simple by design, meaning that, ideally, their scope should be defined so as not to require an additional layer of simplification measures to make the rules workable without imposing disproportionate compliance costs on businesses. As things stand, this is unlikely to be achieved.
Indeed, the GloBE rules were described as having reached a “state of over-complexity” – and at least some of the solutions proposed to various design issues identified as part of the consultation are likely to further increase their complexity. Two examples will illustrate the point.
- The substance-based carve-out excludes a fixed return, calculated by reference to expenditures for payroll and tangible assets, from the scope of the GLoBE rules. Academic commentary suggested that the logical consequence should be to also exclude any cash tax referable to the carved-out amounts; otherwise, the cash tax associated with profits in excess of the carved-out amount (which would fall within the scope of the GloBE rules) could be artificially inflated. Whilst appealing from a purist perspective, this proposal seems close to unadministrable for businesses.
- Treating the US GILTI rules as an implementation of the IIR – which seemed to be generally supported – would only go part of the way towards achieving a satisfactory level of rule co-ordination. For instance, it was noted that, if the US did not agree to disapply GILTI for US sub-groups beneath a holding company whose jurisdiction had implemented an IIR, there would likely be double-taxation unless the GloBE rules or associated guidance dealt with the co-application of GILTI and the relevant IIR in these circumstances.
In the absence of simplicity by design, Chapter 5 of the OECD’s Pillar Two Blueprint proposed four potential simplification measures. While respondents seemed broadly in favour of further developing all of these, unsurprisingly, the proposal of additional tax authority guidance on the GloBE rules received most support – although it was noted that the process of producing such guidance would need to be transparent and non-political. In addition to such guidance, some respondents called for a “white list” of jurisdictions where profits would be deemed outside the scope of the GloBE rules.
Equal measures of support appeared to be given to the proposed safe harbour based on country-by-country reporting (CbCR) data and de minimis profit threshold – although the usefulness of either simplification would depend on the extent to which additional data points and calculations would be required. The proposal to allow businesses to rely on one set of effective tax rate (ETR) calculations (the GloBE rules would apply to the extent ETRs are below the to-be-agreed reference rate) for several years received the least support. Again, this is unsurprising – the Blueprint itself noted that a “key disadvantage of this simplification measure is that MNEs would be required to establish all the necessary processes and systems in every jurisdiction”.
Carry-forwards or deferred tax accounting?
Mere timing differences in the recognition of income and expenses for tax and accounting purposes should not increase business’s tax burdens. The Blueprint envisaged dealing with this issue through credit and carry-forward rules, rather than through taking into account deferred tax positions in the relevant business’s accounts.
Business respondents were strongly in favour of revisiting this position. Using deferred tax accounting, something provided for by the same accounting standards as form the basis for the computation of GloBE-profits, rather than a complex set of substitute rules would be regarded as a significant simplification. It would be particularly welcome for insurance and capital intensive industries given the long-term nature of relevant timing differences which the proposed time-limited carry-forward rules would fail to adequately address. It was noted that, in some cases, the negative tax-effects of a decision against the use of deferred tax accounting could be large enough to impact investment decisions, and that this would disproportionately impact resource-rich countries.
Having heard those arguments, John Peterson, Head of Unit- Aggressive Tax Planning, International Cooperation and Tax Administration Division at the OECD Centre for Tax Policy and Administration – stepping out of his role as moderator of the second panel discussion – seemed compelled to explain the concerns associated with the use of deferred tax accounting (which, he noted, would be unlikely to provide a complete solution in any event as there could, for example, be a local tax loss carry-forward without a matching deferred tax item in the accounts): deferred tax accounting is something of a black box for tax authorities, fearing they would not be able to properly audit the relevant calculations, it would give taxpayers the time value of money by allowing expected future tax liabilities to be set off against current ones, thereby building a preference towards tax deferral into the system, and it could allow a long-term or even indefinite deferral of tax liabilities with which countries may not be comfortable in all circumstances.
In addition to the GloBE rules, Pillar Two includes a proposal for a subject-to-tax rule (STTR) which would allow source jurisdictions to impose additional tax on certain categories of payments up to an agreed minimum rate. Given that the STTR would apply on a gross basis, it creates a risk of over-taxation and there were widespread calls to narrow its scope to interest and royalty payments and large multinationals.
These requests sit rather uneasily with NGOs’ submissions, indicating that the STTR is seen as crucial to ensuring that source countries receive a fair share of the additional tax revenues expected to be generated by Pillar Two. There were even suggestions that developing countries expecting an increase in tax revenues through the application of the STTR should consider terminating their tax treaties to the extent that they are unable to negotiate the changes required to apply the STTR.
The proposals will be further discussed during the second day of the Inclusive Framework meeting towards the end of January 2021 and at the G20 Finance Ministers’ meeting on 26 and 27 February 2021. And then there is the ambitious mid-2021 deadline to reach agreement on the proposals…