Beyond Dispute

With a project as big and lumbering as the OECD’s Pillar Two global minimum tax, some issues get filed away in the drawer marked “We’ll Cross That Bridge When We Come To It.”

Dispute resolution is one of the items you might find if you rummage through that pile. There was the negotiation of the key points, the drawing up of model legislation, overseeing the implementation of that legislation, and then creating a peer review process to ensure those laws all gel together–there’s hardly been any time to think about what to do when countries differ on a single case or taxpayer.

But, the issue is increasingly becoming a concern for companies around the globe as they deal with the practicalities of Pillar Two compliance. It’s already clear that this system is so complex, different interpretations of the rules could lead to drastic divergences in results–there’s no way for the Organization for Economic Cooperation and Development to delve into every scenario with proactive guidance.

Resolving disputes is always an issue when new rules are applied. But what makes Pillar Two different from developments in the past is how much of the system relies on countries taxing income outside of their borders, without the protections from double tax treaties that have traditionally mediated cross-border disputes. The system is all a matter of national laws, applying through a complex determination of profits and expenses based on slightly different measurements, the consideration of tax subsidies and incentives, factual determinations like workforce and asset valuation, as well as interpretation of untested OECD standards.

When these come into conflict, it could be anyone’s guess how it will play out.

So far, the OECD has spent some time preparing a peer review process for countries to decide whether or not a given jurisdiction’s rules are in compliance or not. That in turn will decide which countries’ rules apply first. This has the advantage of being a process that the organization and its member states have tried in other contexts, and has some precedence to rely on. But it would only look at the laws of implementation–not individual cases where those laws would be applied.

The “front line” of Pillar Two, in a sense, is the qualified domestic minimum top-up tax, which countries can impose on their own domestic income. The OECD rules give countries leeway to use local accounting standards as the basis for QDMTT taxation, so long as it still meets enough of the guidelines to be “qualified.” If most countries use this tool, it could leave countries with little to dispute in the first place.

But absent that unlikely outcome, some countries will impose their own income inclusion rule and undertaxed profits rule on the foreign income of corporations present in their jurisdictions. Even though the OECD guidelines try to ensure uniform application, tax authorities will no doubt still use these rules in slightly different ways. Companies that find themselves with income that two or more countries think should be theirs may have little choice but to pay them all, without assurance that they will be re-compensated through foreign tax credits.

Tax credits could be a particularly dicey issue. The current rules see nonrefundable credits and other tax-based incentives as a reduction in tax, which could lower a corporation’s effective tax rate to below 15% and trigger Pillar Two taxes. Refundable tax credits only count as an increase in the company’s income, creating less of a risk for tax liability. But how to differentiate those two–especially after the OECD decided that transferable credits would be counted the same as refundable–could come down to decisions made by individual tax authorities.

OECD officials recently confirmed that they’re working on new administrative guidance on dispute resolution. In both comments and a public consultation document released almost two years ago, the OECD has suggested that the existing mutual agreement procedure and dispute resolution mechanisms in double tax treaties could be leveraged for the Pillar Two system–although it also admits that there would be some significant limitations.

Using the treaty procedures without explicit authorization from the treaties themselves would require a lot of trust between jurisdictions to respect the results. The OECD could mandate this, but would everyone comply? That’s the whole idea with a treaty, to have a document that binds the participants to an agreed process.

There are other options, but they tend to run into the same types of problems. All of the countries that signed onto Pillar Two agreed to the overall idea, but in application they’ll be motivated by the usual things that motivate tax authorities–desire for more revenue and investment, as well as local customs, court precedents and laws. Those forces will tend to pit countries against each other more often than they lead to a well-coordinated outcome.

Some are still hoping that the OECD might consider a multilateral convention to manage disputes, but this remains unlikely absent a wholesale renegotiation for the entire project. For reasons both practical and political, the OECD opted to do this entirely within the realm of national domestic laws, with enhanced controlled foreign corporation rules as the primary mechanism.

Negotiations over the measurement of income between jurisdictions is the domain of transfer pricing rules and bilateral tax treaties–to apply treaty dispute resolution procedures to CFC rules is akin to rebuilding them from scratch. The whole idea of CFC rules like Subpart F is that they sweep up a whole category of income. Until now, there hasn’t really been a reason to mediate between them.

You never know–I want to be careful not to rule anything out–but it’s important to understand the distinctions here and why mixing the two systems would be difficult and unprecedented. Building the Pillar Two system through national laws without requiring treaty negotiations (or ratification processes) may have seemed like the easier option to the OECD, but they may be paying for that apparent ease with a lack of reliability on the other side.

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

• This newsletter is coming out a day earlier than normal because, as you may have heard, it’s election day in the U.S. This could be the most consequential election of my lifetime–and because we’re the biggest superpower (at least for now), the rest of the world gets to come along for the ride. While this campaign season has focused on former President Trump and what it will mean for the future of democracy if he returns to the White House, in terms of actual policy the biggest consequences will probably be in the tax sphere. But most voters have barely heard anything about this, in part because the issues are dense and complicated, but also because it’s difficult to tell what the actual stakes would be. Negotiations over the expiration of large parts of the Tax Cuts and Jobs Act next year are likely to be drawn-out and complex, and will involve a lot of give-and-take. International taxes aren’t as big a part of this as some of the other issues, but they're still in the mix. So is Pillar Two, but that fate is unclear as well. This Friday, when we know more, I’ll have some more thoughts for Emperor Subscribers on the repercussions. (And for my American readers--if you haven't, don't forget to vote!)
• The overwhelmingly bipartisan effort to forge the equivalent of a double tax agreement between the U.S. and Taiwan has been one of the more interesting sideshows in international taxes over the past year. Because an outright treaty with the jurisdiction is apparently impossible given the situation with China, lawmakers have drawn up a creative way to potentially achieve the same benefits–such as reduced withholding taxes and agreed-upon methods of income allocation–through legislation alone. The plan was to pass legislation allowing the executive branch to negotiate an agreement with Taiwan–but the legislation never made it past the Senate. Last week, the Department of the Treasury announced it would begin negotiations anyways, allegedly building on the Congressional initiative. Republican lawmakers, however, were quick to respond, claiming that the announcement was politically motivated and could undo the framework Congress had constructed. Is this a serious problem, or just more partisan rhetoric? We could find out next year, when this will surely be wound up into the 2025 negotiations.
• Last year–fresh off its apparent victory in forging a global tax agreement–the OECD outlined an ambitious plan to become a sort of central clearinghouse for differing climate change mitigation approaches around the world. They weren’t proposing to set outright goals or mandate a certain approach, but to become the forum where these approaches could be compared and global standards could be developed. One of the key issues is carbon pricing–how countries can use their tax systems to better recognize the cost of carbon emissions and discourage the use of fossil fuels. (Paid subscribers can view my interview with climate expert Shuting Pomerleau about these issues here.) On Monday, the organization released a report outlining how difficult this task will be–how the lack of data, verification and coordination between countries can make “more accurate, timely, and granular product-level carbon intensity metrics” difficult to achieve. In a sense, this is making the case for why a global arbiter like the OECD is needed. Definitely worth a read; as I keep saying, this will likely be the international tax issue of the future.

PUBLIC DOMAIN SUPERHERO OF THE WEEK

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

American Eagle, first appearing in America's Best Comics #2 in 1942. A lab assistant who was unwittingly part of a secret Nazi plot, Tom Standish was accidentally imbued with the strength and flying ability of an eagle. He goes on to fight America's enemies, along with a sidekick Eaglet.

Contact the author at amparkerdc@gmail.com.