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Self’s assessment: signs of a ceasefire in the digital trade war?

In our continuing series, Heather Self reviews tax issues that make the headlines in the national press. This week, the impact of the new US proposals on international tax reform.

Last July, I summarised the status of the OECD’s attempts to find a new way to tax digital multinationals (‘Self’s assessment: a digital trade war?’, Tax Journal, 3 July). At that time, I was pessimistic: the OECD pillar one and pillar two proposals seemed hugely complex (particularly pillar one) and the US, as expressed in a letter from Treasury Secretary Steve Mnuchin, was a long way from the negotiating table.

As a brief reminder, pillar one would allocate more profits to the ‘market jurisdiction’ (broadly, where customers are based) while pillar two would enable countries to impose a minimum tax on digital businesses. At the time, the aim was to reach agreement by the end of 2020, although due to the pandemic this has now slipped to mid-2021 – still an ambitious target.

The change from the Trump to Biden administration in the US has brought about a fundamental shift in the US approach. As reported in this journal on 9 April, the US is now seeking to raise its own rate to 28%, and is proposing a global minimum rate of 21%. The US has also sent a detailed submission to the OECD. The US slides which were resented at the OECD Inclusive Framework meeting on 8 April were published by MNE Tax here.

The relatively simple piece is the proposal for a global minimum rate of 21%. Not only would the US strengthen its own rules (and of course, it could have done this at any time – it has had subpart F rules since 1962!) but it wants the rest of the world to agree to similar rules. The home country of the multinational could impose the minimum rate on any low-taxed profits, but if the home country does not do so, the ‘host’ country (i.e. the local country) could also impose the minimum tax. One of the concerns this raises is that the main flows are likely to be to the big economies – smaller countries who want a low rate of corporation tax to encourage investment will find that any benefits are negated by tax in the home country.

Countries such as Ireland, which have long had a 12.5% rate, are unlikely to be keen on a minimum rate as high as 21%. My own view is that, if it gets support, it will be at a rate closer to 15%, at least initially.

Although the US has said it will be ‘flexible’ in setting nexus thresholds ...this still feels more like paternalism than participation

However, the US makes clear that pillar two is inextricably linked to pillar one, which is needed to ‘stabilise the international tax architecture’. It is proposing a ‘standstill and rollback’ process, to freeze and then eliminate the unilateral digital tax measures which have been proliferating (including the UK’s digital service tax) to establish a ‘stable and equitable allocation of taxing rights’.

I completely agree with the point at slide 10 of the US presentation: ‘Compliance and administrative burdens disproportionate to expected tax benefits: simplification is highly desirable’. As I said in my article last July, is it really worth going to all this trouble for such relatively small rewards? Of course, the magnitude of any additional tax is subject to intense debate. A recent blog by the Tax Justice Network suggested that the UK would get as much as £13.5bn a year from the Biden plan, although my own view is that it is likely to be much less: as we have already seen with the US GILTI rules, once US multinationals accept that they are going to have to pay tax somewhere, they are much more likely to shift activities back to the US and pay the tax there.

Where the US proposals to the OECD are truly radical is in suggesting that the main benefits of pillar one could be achieved by focusing just on the top 100 multinationals. This would not be sector-specific; the qualification would be by reference to total revenues and profit margin. In practice, this would include the obvious targets such as  Google, Amazon and Apple, but it could also include other large and profitable entities. Although there will inevitably be details to thrash out, the proposal, in my view, makes good use of the ‘80:20 rule’: if you can get (at least) 80% of the benefits with 20% of the effort, then focus on that and accept that getting 100% requires too much complexity.

But there is a sting in the tail. Later in the slides, the US says that: ‘A binding, nonoptional dispute prevention and resolution process is a key aspect of meaningful tax certainty.’ While taxpayers will welcome the push towards binding dispute resolution, smaller countries are likely to be suspicious that this will favour, yet again, the stronger party in any dispute. And although the US has said it will be ‘flexible’ in setting nexus thresholds so that developing countries can see some benefit from pillar one, this still feels more like paternalism than participation. As I said to a journalist yesterday, developing countries are at the table in the inclusive framework, but they may not get much to eat.

Overall, the US proposals represent a significant step forward in reaching consensus on the OECD’s project. US support is a necessary, if not a sufficient, condition to any agreement. It remains to be seen whether the target of mid-2021 can be reached, but the signs are much more hopeful than they were last year.

First published in Tax Journal.

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