BONUS CONTENT: The OECD's First Global Tax Overhaul

Examples of sequels which surpass their predecessor are few and far between.

Whether “The Godfather” or “The Godfather, Part II” is superior is still a hot and unsettled debate. It’s unclear if “The Empire Strikes Back” counts. Don’t even try to tell me that “Aliens” beats the unbearable existential horror of “Alien.” I contend that “The Dark Knight” is not only better than “Batman Begins,” but is likely the best superhero film of all time–but that’s only one.

We could also add, perhaps, the Organization for Economic Cooperation and Development’s second recent international tax overhaul–officially known as the “Two-Pillar Solution to Address the Tax Challenges Arising from the Digitalization of the Economy,” but often called simply BEPS 2.0.

BEPS 1.0 was the OECD’s Action Plan for Base Erosion and Profit Shifting, finalized in 2015 and comprising 13 reports addressing different aspects of the international tax system.

At the time, it seemed like a huge deal. All of the then-34 OECD members came together to unanimously back significant changes to global tax norms, admitting that the prior system was allowing too much corporate income to escape taxation. It included new “minimum standards,” which all of the countries committed to following to prevent further tax avoidance.

The OECD’s current project arose from a feeling that the BEPS project had failed–or at least, was incomplete. The 2015 BEPS plan included a report on taxation in the digital sphere, but had few concrete recommendations, instead opting to wait and see while focusing on tax avoidance involving intangible assets. This led countries to seek their own answers on digital tax issues, and the G-20 ultimately asked the OECD to return to the topic and seek a consensus solution.

Compared to the Two-Pillar project–which includes a sweeping new multilateral tax treaty and a global minimum tax–the BEPS plan seems modest. It focused mostly on fine-tuning OECD guidance, which countries voluntarily follow but does not have the force of law. On the other hand, there’s still considerable uncertainty and a lack of total agreement on the Two Pillars, which can put BEPS’s clear consensus and full implementation in a new and favorable light.

For that matter, there isn’t a clear verdict on whether BEPS achieved or failed its policy goals, even if it did fall short of its political ones. That’s partly just because this stuff can be very opaque and difficult to measure. But it’s also because there have been so many subsequent developments, including the 2017 Tax Cuts and Jobs Act, that sorting through the cause and effect can be impossible.

It may well be that the Two-Pillar Solution will get credit for things which BEPS quietly accomplished.

The heart of the BEPS plan is new guidance for the pricing of intangible assets–valuable properties like patents or copyrights, which can be involved in complex tax transactions due to their mobility and subjectivity in pricing.

OECD officials insisted that they weren’t changing the arm’s-length standard, the global benchmark stating that related-party transactions must be priced at what independent parties would pay. Rather, they were merely clarifying it for these new products and transactions.

This is where these proceedings can take on a religious quality, as the high priests of taxation undertake a Talmudic reading of the arm’s-length principle, and discover previously unseen dimensions to it which require new texts of interpretation. For whatever reason, a “clarification” is easier to build a political consensus around than an amendment or redefinition. (Although this leaves the tricky question of whether this new language can be applied retroactively–the tax gods would prefer that you just not try it.)

Under this new guidance, mere contractual assumption of “risk” (often used as a justification for receiving enormous profits, at least according to the OECD’s guidance) or legal ownership of intangibles is not enough to justify a large return. Governments should consider whether this entity has the capability to manage this risk or the financial capacity to bear it, when evaluating the transfer pricing structure. They also should consider which entities were involved in the development, enhancement, maintenance, protection and exploitation of the intangibles–what became known as the DEMPE functions.

These rules may not be perfect–given the complexity of the underlying technologies, companies may be able to find ways to argue around them. But that’s almost aside the point. Everyone knows the basic transactions and entities that this is meant to target, and BEPS gave tax authorities new tools to try to get at them.

The most important BEPS policy was probably the country-by-country reports, however. Under this new reporting scheme, companies must submit blueprints of their global operations, with factors such as income, taxes paid, and workforce broken out by country. These confidential reports are supposed to be used by tax authorities for “risk management,” or determining where to best allocate resources. It’s not a new rule for tax allocation, or even something that tax administrations can use as the basis for an audit. Nonetheless, it has likely affected taxpayer behavior, as companies may be reluctant to show governments where they’re reporting astronomical profits with small tax payments and no real workforce.

Now a regular part of tax-filing obligations, the country-by-country reports have taken on new significance. They’ve become an important tool for following the Two-Pillar plan, for instance. But activists and politicians have also continued to push for the reports to be made public, and while they have not yet achieved that goal they’ve made other significant strides towards full transparency.

The BEPS project also included new model legislation to deal with issues like earnings-stripping through related-party interest payments, and hybrid entities exploiting mismatches in national tax systems. While these were presented as options for countries to consider, many countries have passed them, including the U.S., which included the recommendations in the 2017 TCJA.

The overall endeavor was supposed to satiate the political urge to tighten the taxation of large multinational companies. But in a sense, it only whetted the appetite. Creating confidential country-by-country reporting increased calls for public country-by-country reporting. And the lack of clear policies to deal with digital transactions led to the proliferation of digital services taxes, which led to the BEPS 2.0 project.

But some of the principles of that first project–a focus on value creation and economic substance, sometimes through formulaic factors like workforce–have also lived on in these later efforts.

Tax policy is never really finished, but that doesn’t mean that there’s no progress.

Contact the author at amparkerdc@gmail.com.