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The podcast episode’s transcript below has been edited for length and clarity.
In this episode, Barbara Angus, global tax policy leader at EY, shares her thoughts on the OECD’s Pillar 1 consultation draft after Tax Notes chief correspondent Stephanie Johnston provides an update on its proposed profit allocation and nexus rules.
David Stewart: Welcome to the podcast. I’m David Stewart, editor in chief of Tax Notes Today International. This week: pillar 1 proposal. The OECD has released a discussion draft outlining a partial solution to the taxation of the digital economy. A little later, we’ll talk to EY global tax leader Barbara Angus to get her take on the direction the OECD is taking. But first, we’ll turn to Tax Notes chief correspondent Stephanie Johnston to talk a bit about what we’ve learned. Stephanie, welcome back to the podcast.
Stephanie Johnston: Thanks for having me again.
David Stewart: What is this new draft?
Stephanie Johnston: The OECD recently proposed a so-called unified approach under pillar 1 of their two-pillar work plan. If you’ll recall, the OECD is working on building out action one of the base erosion and profit shifting project, which was about addressing the tech challenges of the digital economy. Now the OECD originally said that they would revisit the issue in 2020, but there was political pressure to act sooner so the OECD has now picked up this line of work again. They issued a work plan in May, which outlined technical work to be done under two pillars. Pillar 1 was on profit allocation and nexus rules and pillar 2 was about global effective minimum taxation.
David Stewart: How does this draft deal with pillar 1 issues?
Stephanie Johnston: This draft basically consolidates three competing approaches under pillar 1 in the original work plan. Those three approaches all reflected different points of view that countries had at the time. One option was profit allocation based on user participation. This was favored mostly by France and the European countries. The second one was profit allocation based on marketing intangibles, which the U.S. was in favor of. The third one was about a new nexus, which countries like India favored. This unified approach is meant to draw from these three options so that everyone can agree on something. The hope was that this approach would reinvigorate discussions and negotiations in the hopes that the countries will agree on something by the end of 2020.
David Stewart: How does this consolidation work?
Stephanie Johnston: The proposal has several features. The scope will apply to consumer-facing businesses, broadly speaking, with potential carveouts for certain industries like extractives or financial services. Work still needs to be done on this particular issue. What’s in scope? Who’s going to be affected? Is it going to apply only to business-to-consumer companies? Or business-to-business companies that also have consumer-facing activities? It’s unclear at this point what that is. The second part of this is the new nexus for taxpayers that fall within a scope. This will be largely based on sales, not on physical presence, and there may also be a large revenue threshold for the companies that are affected. For example, the €750 million threshold that we see in the country-by-country reporting standard. The unified approach also calls for a three-tiered mechanism for profit allocation, which would tax multinationals that fall within the scope of the new nexus on three categories of group-wide profit in market jurisdictions and the discussion draft refers to these three categories as amounts A, B, and C.
Amount A would consist of some portion of the groups’ deemed residual profit, defined as the excess of group profit over a routine return. An internationally agreed fixed percentage of the total deemed residual profit would be allocated to all market jurisdictions and that amount attributed to market jurisdictions would then be allocated among countries based on agreed variable like sales. Again, the details are yet to be determined. Amount B, which is the return on routine distribution activities performed by a permanent establishment or subsidiary in the market country, would be some return on distribution activities that approximates an arms-length return. Amount B would be determined by fixed percentage instead of traditional transfer pricing methods. Amount C would be any local group functions that go beyond the routine activities accounted for in Amount B and this amount would be determined under the arm’s-length principle. Perhaps most importantly, the approach also calls for any disputes arising between market jurisdictions and taxpayers under this proposal to be subject to binding and effective dispute resolution, which is also yet to be determined.
David Stewart: There’s a lot still up in the air on this. When will we get more information on this proposal?
Stephanie Johnston: The discussion draft is open for comments until November 12 and then the OECD is holding a public consultation November 21 and 22 in Paris.
David Stewart: Pillar 2 is still out there. When do we expect to see something on that?
Stephanie Johnston: The OECD will also release the draft proposal for pillar 2 sometime in November with public consultation in December.
David Stewart: Well we’ll definitely have to follow up on this with you when we learn more. Stephanie, thank you for the update and thank you for being here.
Stephanie Johnston: Thanks so much.
David Stewart: And now we’ll go to my interview with Barbara Angus. Joining me in the studio is EY global tax policy leader Barbara Angus. Barbara, welcome to the podcast.
Barbara Angus: Thank you. Pleasure to be here.
David Stewart: What are your first impressions of the new pillar 1 consultation draft?
Barbara Angus: Well, a couple of things. One, the form in which it’s been delivered is interesting. It’s a secretariat draft, which means that it doesn’t yet reflect the agreement of all the participating countries. We’re seeing it as the countries are still considering it. Also, putting that secretariat draft out in the form of a consultation draft provides a welcome opportunity for stakeholders to provide feedback at this stage of the process. A couple more important things about the document: It makes clear that despite the name of the project, it’s no longer limited to digital businesses or digital business models, but includes other consumer-facing businesses. The document makes clear that the arms-length principle isn’t being abandoned, but will be replaced for some key computations. It also makes clear that the permanent establishment standard is not being abandoned, but will be replaced in at least one area.
David Stewart: Now you mentioned that this is a secretariat document. Is the approach that the OECD has outlined here something that is workable and can be agreed to by the member countries?
Barbara Angus: I do think it’s important that it hasn’t been agreed to yet. There’s a real tension, a natural tension, between the political urgency of this project and the need to have an agreement on all of the technical details. In some ways, the project may well be unprecedented for the OECD because of the broad participation. There’s 134 countries participating in this project from the very beginning. Also, because it’s a project that’s being approached with the objective being consensus and commitment by countries to implement the agreed rules, that’s quite different than most of what was done under the first BEPS project, which was in the form of recommendations. The reason for requiring consensus is that you need all countries participating to be applying the same rules in the same way in order to avoid more than one country saying they have taxing jurisdiction over the same dollar of profits.
David Stewart: Do you see any parts of this that might present a problem for reaching that consensus?
Barbara Angus: I think there’s significant political momentum behind the project and that’s important. This is a project that will lead to winners and losers with respect to countries in any given situation. If the aim of the new rules is to provide additional taxing rights to allocate additional share of the profits to market countries, that means that there’s another country that needs to give up or reduce its share of the profits. There is a view that this project in the OECD is the way to address these issues in a coordinated way to provide certainty to both taxpayers and tax administrations to avoid double tax. I think there’s a lot of incentive for countries to reach agreement, but there’s an important road ahead to get to that agreement.
David Stewart: Have you heard anything back from businesses or from your colleagues with concerns about the draft from the business side?
Barbara Angus: I think tax professionals are still parsing the document, both what is addressed and the layers of details not yet addressed. One possible area of concern is the need for much more technical detail to ensure that any agreement reached is fully informed, solid, and grounded in the ability to avoid double tax. The unified approach laid out in the document has several elements where they’re proposing formulaic rules, but they haven’t filled in any numbers in those formulas. That obviously will be the subject of significant political debate, but it is clearly also of great interest for businesses. Will this be a modest reallocation of profit or a more significant reallocation of profit? Certainty and avoidance of double tax are real priorities for businesses. Maybe another big priority for businesses that isn’t addressed in detail yet in this document is the need for robust new dispute resolution mechanisms and the need for new tools to prevent disputes from arising in the first place. The document acknowledges the importance of that, but building that out and reaching an agreement on those mechanisms is a step to come.
David Stewart: Given that there is a lot of uncertainty around how this draft will ultimately play out, how would you advise businesses to respond to be ready for what might come down the road?
Barbara Angus: Well, you’re right. There is a lot of work left to come, but I do think there’s a lot that businesses can be doing now. Businesses can monitor the developments closely. They can work to understand the perspectives of the various countries that are part of their business’s geographic footprint. They can do some work modeling the potential impact of the proposals. They could think about the implications of what are likely to be new reporting requirements going beyond the existing country-by-country reporting and the potential for new compliance obligations in countries where they’re not today a taxpayer. They can be thinking about communicating with both internal and external stakeholders about these concepts and the potential implications. And importantly, they have an opportunity to be a part of the debate and to engage with the OECD and country officials to provide feedback and input.
David Stewart: This is the second take at the BEPS project. How do you view this as the way to getting an ultimate answer on the taxation of digital economy? Or are we going to have the same problem a few years down the road where market jurisdictions don’t feel like they’re getting enough of the tax base and we’ll be at this project again in the future with BEPS 3.0?
Barbara Angus: That’s really the $64,000 question. I think really all participants in the project are aiming to avoid that and want to reach an agreement that will be lasting. The project is quite different than the BEPS project in that what’s at stake are changes to fundamental elements of the international tax architecture and the potential for countries to be a winner or loser, depending on whether they’re gaining or losing taxing rights. It also is a project that while digital is in the name and part of the driver for the project, it isn’t just about digital anymore because the document makes clear that they’re bringing in the whole range of consumer-facing businesses. Whether an agreement can be reached and how lasting that agreement is, I think really is, it requires more of the detail work to be done and for the countries to start the discussions on things like the numbers. There’s a lot at stake here and potential benefits for all participants.
David Stewart: As we’re sitting here, we’ve seen the pillar 1 consultation draft and we’re currently waiting on a pillar 2 consultation draft. Now, the minimum tax concept in pillar 2 as described seems somewhat similar to the international provisions of the Tax Cuts and Jobs Act. You served as chief tax counsel on the House Ways and Means Committee during the development of the TCJA. How do you view the pillar 2 solutions?
Barbara Angus: I think everyone is eagerly awaiting the consultation document with respect to pillar 2. There’s been much less publicly discussed about that work, but there is a significant amount of technical work going on behind the scenes. In the design of global minimum tax rules, I mean, that really is also breaking new ground for the OECD and it’s also a part of the project that has both substantial political issues and complex technical questions. The rules that were included in the TCJA were developed in a very different context. In the TCJA, the new rules were part of a fundamental reworking of the U.S. international tax system and were aimed at protecting against base erosion and avoiding tax-driven location incentives in the setting of that new international tax system. I think the OECD documents and discussion have made clear that the pillar 2 work is really not about BEPS concerns. It’s not about creating anti-abuse type rules. It’s really about ending tax competition and that’s a different objective. Based on my experience working on the TCJA, I find it hard to imagine crafting complex legislative language on something like minimum tax rules in a process that involves 133 of my closest friends.
David Stewart: Do you have any predictions for us to leave on what you expect to see out of this OECD process?
Barbara Angus: I would not be quick to bet against the OECD. I think in many ways you could say that failure is not an option for the OECD. If this project were to be abandoned, you could have some form of chaos: unilateral measures, more digital services taxes, perhaps countries adopting concepts that were discussed as part of this process in a unilateral way. It is important to continue the process and to get that benefit of coordinated set of rules. One area that perhaps may change is the timeline. This is a really complicated project, and from my perspective, it seems key that the consensus will take time. I think we could well see the process continuing as they make progress and can demonstrate that progress to the countries that are involved. I’m hopeful that they will take the time that’s needed to make sure that the project’s fully grounded.
David Stewart: Well, we’ll see how this plays out. Thank you for being here.
Barbara Angus: Thank you.