Taxes and Tail-ends

Since the beginning of the Organization for Economic Cooperation and Development’s global tax overhaul project, the effort has been bedeviled with accusations that it’s only geared to the interests of developed countries.

Despite the involvement of the “Inclusive Framework,” a roughly 140-jurisdiction coalition which allegedly had veto power over the entire proceedings, many poorer countries claimed they were never involved on an equal footing with the OECD’s Western members. Ultimately, a handful of nations, including Kenya and Nigeria, refused to sign onto the agreement, and the schism has lead to a renewed effort by the United Nations to take a greater role international tax affairs.

This dynamic was, to a certain degree, baked into the tax project from the beginning. It was originally a response to concerns that the current tax rules do not adequately capture income from digital transactions, as well as lingering questions about how the last big OECD project dealt with tax avoidance involving valuable intangible assets. Those are huge problems–but they’re also problems more associated with high-tech, evolved economies.

The OECD tried to address this through “Amount B,” an additional policy which aims to simplify transfer pricing enforcement for cash-strapped, overwhelmed tax authorities. The project also talked about “ending the race to the bottom”--curbing the intense pressure that developing countries feel to offer generous tax benefits to potential investors. But representatives from the developing world felt the 15% global minimum tax had too low a rate to address their revenue needs, and the inclusion of a substance-based carveout further lessened the impact.

But increasingly, the OECD has been emphasizing that Amount A of Pillar One–one of the primary new policies of the project, a multilateral agreement to shift taxing powers to market jurisdictions–has the potential to benefit poorer countries, despite their skepticism. Most recently, an updated economic impact assessment of Pillar One found that lower-income countries will gain the most in terms of relative new revenue, although the policy will boost all nations aside from “investment hubs,” the organization’s preferred euphemism for tax havens.

In part, this isn’t so surprising. While dressed up in concerns about the digitalization of the economy, Pillar One is ultimately about tilting the global balance in tax revenues away from residence countries and towards market jurisdictions, where the consumers are. It’s meant to discourage and replace digital services taxes, which countries had begun to enact collecting revenue from targeted online transactions. Rather than selectively focus on the online realm, Pillar One enacts a new taxing regime for a portion of income from all types of transactions, whether the corporate taxpayer is physically present in the jurisdiction or not.

This means that it captures new online spheres, but includes most traditional transactions as well. According to a presentation from the OECD last week, digital businesses account for 53% of expected Pillar One revenues. Which means nearly half of Pillar One comes from more traditional industries, which are more likely to be present in poorer countries.

Additional tweaks to the Pillar One policy go further in advancing the interests of developing countries, according to the OECD. Pillar One exempts extractive industries such as oil and mining, which–somewhat counterintuitively–benefits developing countries since they’re more often the source of these valuable resources, than the destination of their ultimate consumption. The new designs also include de minimis rules and thresholds that will also further help developing countries, without giving them additional administrative burdens.

One of these provisions especially caught my eye, however. The latest Pillar One design includes a rule that a certain amount of “tail-end” revenues, where the taxpayer is unable to determine where the final transaction occurred, are automatically allocated to lower-income jurisdictions. This is according to a Explanatory Statement which accompanied text for a multilateral convention implementing Amount A, released last week. The provision will use criteria from the World Bank to determine which jurisdictions are considered lower-income. If the taxpayer can show that the transaction didn’t occur in a given lower-income country, then it’s removed as a recipient of the tail-end revenues.

The phrasing of this almost makes it sound like developing countries are getting the scraps at the end of the table, long after the feast is done. But take a step back and consider the implications–as far as I know, this is one of the few, if any, times that allocation rules will apportion some tax revenue not based on any criteria of where it originated, but solely based on political decisions needed to maintain a consensus.

Imagine if the global tax rules tossed aside all notions of value creation, arm’s-length prices and objective determinations of economic origin and simply allocated income to whoever we think needs it, or deserves it, most? Actually, you don’t have to imagine this, some tax policy experts have been advocating for this approach for years. Allison Christians, a tax law professor at McGill University, has published several papers questioning the concept of “value creation,” claiming it is less a truly scientific concept and more a rhetorical rationale for the status quo, which she claims benefits wealthy elite jurisdictions.

“The fact that taxing income according to value creation enjoys apparently universal embrace among all sectors and across political and ideological lines suggests that it is convenient and flexible rhetoric, adaptable to the speaker’s or hearer’s broad and disparate assumptions, but sure to confound agreement once its contours are visible in the light of practice,” she wrote in a 2018 piece.

Rather than crafting increasingly fine-tuned and complex rules to trace this elusive concept of value creation, Christians asks, why don’t we recognize it as an inherently political and arbitrary determination, and then ask ourselves what other political decisions we could make?

It’s a radical idea–but is this tail-end revenue concept tucked into a 200-page proposed treaty draft a precedent in that direction? And what would it mean moving forward–many argue that tying taxable income to value creation, however arbitrary or subjective, is a principle that holds the global tax system in line, and prevents more nakedly self-interested revenue grabs.

Recognizing this process as political doesn’t mean you’re going to like the political decisions that get made, after all.

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

• I haven't written a ton about the Moore v. United States Supreme Court case since it was announced, because...what else is there to say, other than that a decision for the plaintiffs could tear apart the existing global tax system? While the Moores are accumulating supporters in their case (as well as questions about the original nature of their tax position), more and more experts and tax practitioners are beginning to set off the alarm bells. The government submitted its legal brief on Monday, laying out its case for why the complaint is both historically and legally wrong. They don't dwell on the potential repercussions, but do note the "disruptive consequences" of a ruling that this part of the Tax Cuts and Jobs Act is unconstitutional, including $340 billion in lost revenue and invalidating longstanding tax code provisions like Subpart F.
• At a time when (as of this writing) the U.S. Congress is literally paralyzed by dysfunction, there's not much new of bipartisan progress. But the tax-writing committees of the Senate and House of Representatives are moving forward with legislation to enact double taxation relief for business activity in Taiwan, in lieu of a formal treaty. The top Democrats and Republicans on both committees released on Thursday legislative language for the agreement, which was approved in principle by the Senate Finance Committee last month. As I've noted before, this bill tries to approximate the effects of a traditional tax treaty, which Taiwan's status as a disputed territory makes impossible. One factor in this legislation's progress--a potential conflict between the Senate Finance and Senate Foreign Relations committees over jurisdiction on this matter may have been defused after Sen. Robert Menendez, D-N.J., stepped down as Foreign Relations chair amid his corruption scandal.
• Margrethe Vestager, the European Commissioner for Competition, announced on Twitter (sorry, "X") that she was a candidate for president of the European Investment Bank, and would be taking leave from her current position. This could be the end of her time at the European Commission, during which she pursued high-profile and unprecedented (although controversial) investigations into the complex tax practices of multinationals doing business in Europe, redefining this issue as one of trade policy, state aid and anti-competitive practices, not solely taxation. This approach really riled the U.S. Treasury Department but earned her plaudits from many commentators and tax justice advocates on both sides of the Atlantic. She was inarguably one of the most important figures in the international tax world for a while, and I wouldn't be surprised if, as EIB head, she continues to focus on this area.

PUBLIC DOMAIN SUPERHERO OF THE WEEK

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

Prince Mengu, first appearing in Moon Girl and the Prince in 1947. A suitor for Moon Girl (profiled in my very first newsletter) who she defeated in ritual combat, he eventually agreed to fight crime as her partner.

Contact the author at amparkerdc@gmail.com.