Safe Spaces

“Safe harbor” is first and foremost a maritime term, of course, and refers to the longstanding custom that a port is obligated to take in any ship in distress. That’s the broad idea, anyways–in practice, it often doesn’t work that way if there are political or environmental issues.

That’s something to keep in mind as policymakers and taxpayers mull the idea of further safe harbors for the stormy waters surrounding the Organization for Economic Cooperation and Development’s 15% global minimum tax. In taxes, safe harbors are optional positions that a taxpayer can take to guard against the risk of audit or enforcement. Since the global minimum tax agreement was first announced in 2021, the OECD has outlined several safe harbors to ease with administration for the new and likely unwieldy tax regime.

In order to work, a safe harbor needs to be a win-win for both tax administrators and taxpayers–in theory, both benefit from increased certainty and easier enforcement even if the resulting tax payments aren’t exactly what either would want. A safe harbor normally applies either in situations where there’s a lot of uncertainty, or for transactions which should be routine but often end up being disputed.

The OECD minimum tax seems like one where safe harbors could make everyone’s life a lot easier. It is enforced by every individual country, which enacts both a primary taxing rule on its own taxpayers’ foreign income, and has the option to enact a “qualified domestic minimum top-up tax” on domestic entities, whether they're local taxpayers or subsidiaries of foreign multinationals. Because the QDMTT takes priority, it’s likely the one that taxpayers will spend the most time dealing with.

It’s also the part of the regime where individual countries have the most flexibility in enacting their own rules. They can require that taxpayers use their local accounting systems to draw up income statements, for instance. For that reason, it’s expected to be where a lot of the administrative headaches will arise.

“For most companies, if I was to say the thing that they’re most concerned about, is this possibility that there will be ever-so-slightly different implementations in different countries,” said Alan McLean, executive vice president at Shell plc and chairman of Business at OECD’s tax committee on a recent Bloomberg podcast. “That, of course, is problematic because it requires a significant amount of tracing and tracking with what different countries are doing, but also because it means it becomes really difficult to create systems approaches that are consistent on a global basis.”

The work is likely to be inversely proportional to the amount of tax that’s ultimately raised, McLean added.

“The cost of compliance is seen by most as being well in excess of any tax which is likely to be due,” he said.

This is exactly the situation that a safe harbor is supposed to be beneficial–there’s relatively little money at stake and huge compliance burdens for small details which ultimately won’t matter in terms of the overall goal of the tax.

But while the OECD has outlined a few safe harbors that should grease the wheels a bit, there are reasons not to get too optimistic.

U.S. Treasury Department official Michael Plowgian noted during a November 2023 conference that policymakers at the OECD aren’t eager to replace the rules that they spent years hammering out, for simplified versions.

“The response that you get is, well, if we thought that a simpler rule actually protected the policy interests that we were concerned about, then we would have just gone with a simpler rule in the first place,” said Plowgian, who left Treasury at the end of 2023.

One possibility that’s getting some attention is to make permanent a transitional safe harbor that the OECD outlined in December 2022, that allows companies to use data from the country-by-country reports that they already prepare for tax authorities. (The CBCR system was created by the OECD’s 2015 Base Erosion and Profit Shifting project.) If a taxpayer can use that simplified data to show that they fall under a 15% effective tax rate in a jurisdiction (or fall under the substance-based carveout), or a global de minimis rule, they don’t have to worry about further compliance. (With a lot of caveats.)

Plowgian said that making the transitional CBCR safe harbor permanent is “worthy of consideration,” but cautioned taxpayers that it wouldn’t be easy and could end up looking very different.

“If it were made permanent, it would have to be more complicated, and closer to the actual [minimum tax] calculations,” he said.

The current transitional safe harbor could be simple because it only covered three years, and once a taxpayer shows that it falls under one of its exemptions, it’s out for the rest of those years. That obviously wouldn’t be possible under a permanent safe harbor.

And despite the transitional safe harbor’s simplicity, the OECD has already had to issue follow-up guidance that includes an anti-abuse rule responding to taxpayer planning to exploit some of the different tax and accounting systems.

Another safe harbor that the OECD has introduced for the transitional period is one for the under-taxed profits rule–a secondary tax which targets the low-taxed income of a company in a jurisdiction that’s not fully applying the primary taxing rules. For 2026, the UTPR Safe Harbor essentially turns off the tax when the headquarters jurisdictions’ statutory tax rate is 20% or more. That’s a lifeline for companies based in the U.S., which has not yet enacted legislation to implement the global minimum tax.

That seems like something that could maybe be built into a permanent rule–maybe simplified rules for companies in 20%+ tax jurisdictions? But the OECD hasn’t made any indications it is looking in that direction.

Safe harbors may prove to be an important lubricant for this system, but they likely won’t solve any of the key problems. They’re probably not an answer for the companies worried that the new regime will reduce the value of U.S. research and development credits, for instance.

For those questions, taxpayers may have no choice but to navigate the rocky waters themselves.

DISCLAIMER: These views are the author's own, and do not reflect those of his current employer or any of its clients. Alex Parker is not an attorney or accountant, and none of this should be construed as tax advice.

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LITTLE CAESARS: NEWS BITES FROM THE PAST WEEK

• D.C. is abuzz with chatter that Republican and Democratic lawmakers may be close to a deal on several important tax measures. However, House Speaker Mike Johnson apparently isn’t on board yet, so even if there is an agreement, it’s not clear if there’s a way to get it through Congress and onto the president’s desk. This bipartisan agreement would likely include the expanded child tax credit and the favorable amortization schedule for research and development expenses, both of which expired at the end of 2021. But it would also likely include the loosened restriction on interest deductibility that I wrote about back in November. While there are plenty of reasons to be skeptical that Congress can figure this out before the filing season begins at the end of January, these are all issues that it will likely need to deal with sometime before 2025.
• While negotiators try to hammer out a tax deal, there’s also still the small matter of keeping the government’s lights on, with full funding set to run out on Feb. 2. Over the weekend, House Speaker Mike Johnson announced an agreement with Democrats over topline spending numbers–the first step towards final budget legislation. The agreement includes a $10 billion cut in the Internal Revenue Service’s new funding increase, but that’s really just accelerating cuts that Democrats agreed to before. It could affect some of the agency’s aggressive new offshore tax enforcement efforts, although the White House seems unconcerned. Meanwhile, Secretary of the Treasury Janet Yellen said that, in the one week since new beneficial ownership rules went into effect, the department has received more than 100,000 reports, which can aid international tax evasion enforcement efforts.
• There’s still a lot of ambiguity about just how much the OECD’s global minimum tax will actually raise. The organization tried to clear that up a bit on Tuesday with a new economic impact assessment claiming that the policy, once fully implemented, will decrease profit-shifting by about 50%, while also raising global tax revenues by $155-$192 billion per year. Of course, as is always the case with this kind of analysis, there are a lot of caveats and uncertainty–due to both lack of complete available data and the unpredictability of behavioral responses. Still, this is about as detailed an estimate of the tax that you’ll find, and it seems to show that it’s going to make quite an impact--although it's slightly reduced from prior estimates. The OECD hosted a webcast on Tuesday to release the findings.

PUBLIC DOMAIN SUPERHERO OF THE WEEK

Every week, a new character from the Golden Age of Superheroes who's fallen out of use.

Luckyman, first appearing in Gold Medal Comics #1 in 1945. Yep, his superpower is good luck. That's about it.

Contact the author at amparkerdc@gmail.com.