UTPR in the Air: Making Sense of the OECD's Most Controversial New Rule

The UTPR, part of the Organization for Economic Cooperation and Development’s 15% global minimum tax plan, used to stand for the under-taxed payment rule. But as the policy has broadened, its connection to under-taxed payments became thin, and the OECD began calling it simply the UTPR. It’s an acronym without the acronym, like AARP or CVS.

To some critics, the UTPR not standing for anything is more than a little symbolic. No longer tethered to deductible payments, like earlier policies, it’s been called an unprincipled, extra-territorial cash grab that ignores global norms and maybe even international law laid out through tax treaties.

Countries are likely to use it to tax U.S. companies, due to Congress’ failure to implement the new OECD standards. This is creating not only a political headache for the Biden administration but potential roadblock for the smooth implementation of the global agreement.

The UTPR has clearly become the most important part of the OECD’s plan–which is ironic, since it was supposed to be a secondary enforcement rule. Making sense of it highlights the degree to which the OECD project departs from traditional international tax rules, moving the system closer to becoming a hybrid of different frameworks.

The biggest problem is that the UTPR would allow for extra-territorial taxation–it would be a tax levied on a domestic corporation, but based on income earned by a different subsidiary in a different jurisdiction. The overall system, also known as Pillar Two, is designed to prevent a company from ever having income taxed below 15% anywhere. Ideally, the company’s home country would tax the income through Pillar Two’s primary provision, the income inclusion rule. But in cases where the home country chooses not to, that income could be collected by other countries where that corporation operates.

Even if though those countries don't have anything to do with the income in question.

The UTPR seemed partially inspired by the U.S. base erosion and anti-abuse tax, and its pedigree also includes the anti-abuse rules some European countries use to protect their tax base against intercompany payments deemed to be abusive. The rules usually reduce or eliminate the domestic entity’s deduction, negating the tax benefits from the payment.

In those cases, the outbound payment clearly gives the tax authority jurisdiction over the matter. By untethering the UTPR from payments, the genie is out of the bottle, and the UTPR is a much different animal.

Rather than payments, the UTPR’s application is determined through a formula based on workforce and tangible assets, meant to be indicators of economic substance. (They’re also the same factors used to calculate the “substance-based income exclusion,” an exemption in the Pillar Two formula.) That at least prevents overlapping taxation from different jurisdictions. But it’s a departure from how taxing rights are currently divided.

The OECD may have hoped that the UTPR would be used so rarely, it wouldn’t merit too much scrutiny. Those hopes were dashed when it became clear that the U.S. wouldn’t pass implementing legislation for Pillar Two. Even if the tax on global intangible low-taxed income were deemed compliant–hardly a given today–the UTPR could apply in situations where a U.S. company’s domestic income fell below 15%, based on Pillar Two’s formula.

That the UTPR could allow France to tax a U.S. corporation because the taxpayer is using too many tax incentives in the U.S.–something that should be none of France’s damn business–has U.S. lawmakers and practitioners up in arms.

“That this Administration has encouraged foreign countries to assert new taxing rights against American interests, in violation of existing treaties, is unprecedented,” a group of Republican lawmakers wrote in a letter to the U.S. Department of the Treasury.

The OECD hasn’t said much about the thinking behind the UTPR’s allocation formula, or why it expanded its reach at all. According to the OECD’s Pillar Two commentary, using substance to divide up UTPR taxing rights “provides for a simple and transparent allocation key,” and ensures that countries collecting UTPR payments will have “more tax capacity (such as deductible expenditure) to absorb adjustments.” That doesn’t really get into the philosophy behind the tax.

The UTPR only starts to make sense if you take a step back and think of it as an addition to the current system, not part of it. What does it mean for a tax to be “on” a certain amount of income, anyway? The UTPR’s calculations are based on income that isn’t in the jurisdiction that’s applying it, but the tax itself is levied on a domestic entity. The UTPR departs from conventional concepts, such as the idea that income only exists in one jurisdiction or another.

The original purpose of Pillar Two was to put an end to profit-shifting through mobile intangible assets. Low-taxed income is presumed to have been shifted from some other source–and the origin is assumed to have been those countries which have economic substance, under the UTPR’s allocation key. Those countries don’t have a right to tax this income under traditional global taxing norms, but under Pillar Two they’re entitled to try to grab back income that’s been taken from them. Under these admittedly crude and broad formulaic assumptions.

This is, in short, formulary apportionment, a concept which has long been advocated by critics of the current global tax system and is used, to a degree, by U.S. states. Under a formulary system, countries drop all of the arbitrary divisions which companies arrange to divide themselves, and look at them globally to determine taxable income. The company’s overall income is then divided up by factors such as workforce, sales, assets, or whatever else the formula dictates.

This is in contrast to the current system, based on the arm’s-length standard, which states that assets be priced at what independent parties would have paid. Under this system, tax authorities respect the separate entities which corporations establish, and ensure that transactions between them are priced at arm’s-length, market prices. Then those prices are used to determine taxable income between jurisdictions.

From the start, Pillar One–the other big part of the OECD project, a new system for capturing digital income–was openly a new formulary system, being grafted onto the existing one. Pillar Two applies it in a sneakier way, and only added it late in the design. But it does build on existing formulaic aspects, such as how the GILTI deduction is determined. It’s a big leap, but a leap from the present day.

This isn't necessarily a defense of the UTPR. To critics, the fact that it's a formulary system is all the more reason to oppose it. The OECD's project is supposed to be helping to preserve the current system in the face of global pressure to disrupt it. But will the OECD be planting the seeds of its destruction?

If Pillar One and Pillar Two are eventually adopted–and, to a degree, even if they aren’t–the global tax system will become more and more of a hybrid. The arm’s-length standard will still rule supreme, but it will be surrounded and buttressed by formulary, its polar opposite. They’re locked in an awkward embrace, and the big question for tax policy analysts is whether they can eventually coexist peacefully, or if one will ultimately consume the other.

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.

LITTLE CAESARS: NEWS BITES FROM THE PAST WEEK

• More than two years after revealing some preliminary data, the OECD on Jan. 18 released an revenue assessment for both Pillars of its tax overhaul. The study doesn't include country-by-country data, but it does give a global view, and the big news is that the global minimum tax is projected to bring in more than $200 billion over ten years, much more than what had previously been estimated. Without country-specific estimates it's a bit hard to know what to make of it, but Daniel Bunn at the Tax Foundation notes that it seems to show that much of the revenue would come from non-U.S. companies. You can see an hour-and-a-half webinar about the findings here.
  
• Speaking of the OECD, the organization also announced last week that it has hired Manal Corwin, principal in charge of KPMG LLP's Washington National Tax Practice, to be the next director for tax policy and administration. She follows Pascal Saint-Amans, who had held the position since 2012 but left at the end of 2022. Corwin is one of the most well-respected practitioners in international taxes, and she's also no stranger to the OECD--as deputy assistant secretary for international affairs at Treasury, she kicked off U.S. negotiations in the 2013-15 Base Erosion and Profit Shifting project. Corwin's appointment would seem to confirm rumors that the OECD wanted an American to fill the spot, but she'll have her work cut out for her in pulling the U.S. into the Two-Pillar project.
  
• Did you make it to the World Economic Forum in Davos, Switzerland this year? My invite somehow got lost in the spam filter. Taxes weren't a major topic during the elite conference, but there was one panel with speakers from both the developed and developing world, as well as Prof. Gabriel Zucman from the University of California at Berkeley. Zucman, one of the most well-known voices in the left-leaning international tax sphere, was strongly critical of the OECD project.

PUBLIC DOMAIN SUPERHERO OF THE WEEK

Moth, first appearance in Mystery Men Comics #9 in 1940. Is he man or moth? Does he have moth-based superpowers or a flying moth-suit? It's apparently not clear for this short-lived and mysterious crime-fighter. He only lasted for a few issues, presumably because criminals figured out that a strong light pretty much takes care of him.