Routine Matters

It’s now been over a month since the Organization for Economic Cooperation and Development was supposed to deliver text of the implementation agreement for Amount A of Pillar One, a new taxing system to capture online transactions along with a portion of all sales in a jurisdiction.

The next approaching deadline is for the treaty to be signed by all participants by the end of June, although I’m not sure if that’s even feasible at this point. The OECD has done an admirable job of producing real accomplishments on this project over the past year–or at least, the appearance of progress–but if they delay this much longer it may be hard to continue to take it seriously. If it’s even being taken seriously now. Everyone knows that the U.S. is unlikely to ratify the agreement, which would keep it from ever going into effect. This all may amount to a stillborn delivery.

For now, though, the parties remain at the negotiating table. Even though it’s unlikely to ever put this into effect, the U.S. continues to make several demands about the current treaty language. Other countries may be a bit fed up with the U.S. issuing ultimatums while it’s unable to guarantee delivery, and this could be contributing to the holdup.

Maybe a bit confusingly, one of the U.S. “red lines” doesn’t even have to do with Amount A, but rather Amount B, something that isn’t supposed to be covered by the treaty in the first place. But it’s part of the same project–Amount B is a new framework to simplify the transfer pricing of routine distribution activities so both taxpayers and tax authorities can focus their resources elsewhere. It was seen as crucial to getting buy-in from developing countries for the OECD project, but is also strongly supported by businesses. This was as close to a win-win-win as you’re likely to see in tax policy, although maybe that was too much to hope for.

According to a Treasury official, a U.S. “red line” for agreeing to Amount A treaty language is that Amount B should be “robust,” and that it “provide meaningful tax certainty.” That would probably mean an Amount B system that’s mandatory and binding to both the taxpayer and tax administration, although he stopped short of saying that outright. (Isn’t the idea with red lines that they be clear?)

It’s apparent that the U.S. sees both Amounts of Pillar One as kind of a deal–they’ll agree to a new, consumer-based pricing system but they’ll also need a new system for simplicity and certainty in routine functions. If either side can opt out of Amount B then the deal falls apart.

Both Amount A and Amount B use formulaic systems to replace traditional transfer pricing based on arm’s-length comparable pricing of related-party transactions. That can be more complicated than it might seem at first, because it requires some way to define the borders, or there’s a risk of double taxation under both systems.

It’s a demonstration of just how interconnected and complex this whole thing is, that whether Amount A ever makes it into treaty language could end up hinging on existing transfer pricing regulations. Let me take a minute, or maybe a few, to explain how.

A persistent fear throughout the Amount B process has been that, without clear definitions of what routine activities are, the system could end up creating as many disputes as it resolves. Instead of disputes about the pricing of routine activities, there would be disputes about what is or isn’t routine.

According to Bill Morgan, who until recently was an economist with the U.S. Treasury Department, the U.S. pushed to resolve this by ensuring that the scoping criteria were formulaic and quantifiable, just as the pricing tools would be.

“I think in the U.S. view, and certainly in my view, the ability to exercise discretion by both tax administrations and taxpayers is really an enemy of tax certainty,” Morgan said during an American Bar Association conference in Washington, D.C. last Friday. “If there was a way to quantify those who would be in scope easily, we would have tried to do that.”

That wasn’t possible in every case, however, and in the absence of quantifiable factors the OECD opted to lean on existing transfer pricing rules, Morgan said. Guidance issued by the organization in February states that to be in-scope, a transaction must be able to be reliably priced using “one-sided” transfer pricing methods, which only look at one entity’s functions when determining the arm’s-length price.

But as Robert Stack, a Deloitte Tax LLP managing director and former Treasury deputy assistant secretary who participated in OECD tax negotiations during the Obama Administration, this doesn’t totally excise qualitative judgments from the analysis. Speaking at the same panel as Morgan, he noted that the OECD transfer pricing guidelines state that the transactional net margin method, one of the most common one-sided transfer pricing methods, is likely not reliable if both entities involved make “unique and valuable contributions” to the arrangements.

Unique and valuable? By definition that’s not something that’s quantifiable. Now we’re back to the type of determinations that can be endlessly argued over, once again.

Of course, not everyone at the OECD or the 145-jurisdiction Inclusive Framework agrees that qualitative scoping criteria are necessarily a bad thing. Some developing countries have pushed to narrow the scope of Amount B further by defining “non-baseline” activities, likely through a determination which might give aggressive tax authorities some additional flexibility.

The U.S. knows it won’t win every fight, and it’s unlikely to get everyone on board with a mandatory Amount B if people don’t agree on the scope.

"The U.S. has said that we want a mandatory Amount B," Morgan said. "But then the question becomes, what compromises are we willing to make to get there? ... There are a series of decisions to be made about how far the net benefit is over net cost."

That gets especially tricky when Amount A’s future is murky, but many expect Amount B to live on in some form, even potentially outside the Two-Pillar project. A theoretical concession may turn into a reality sooner than expected.

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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This Friday, I'll look into how the current international tax system is increasingly combining formulary and arm's-length principles.

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LITTLE CAESARS: NEWS BITES FROM THE PAST WEEK

• The Institute on Taxation and Economic Policy--the progressive think tank that produced President Biden's favorite tax stat, the 55 Fortune 500 companies that paid no tax in 2020--released a report last Thursday looking at effective tax rates of corporations before and after the 2017 Tax Cuts and Jobs Act. The report states that 296 profitable companies in the Fortune and S&P 500 saw their tax rate fall from 22 percent to 12.8 percent from 2013 to 2021. Aside from the drop, ITEP claims that the data also shows that the gap between statutory rates and effective tax rates grew slightly after the TCJA passage, despite promises to scale back loopholes. This study could address critics who claim that ITEP's past statistics only provided snapshots rather than long-term views of tax rates. I'll be curious to see whether this changes in the post-2021 years, as some of the timing benefits even out--although the study notes that many of those policies remain up in the air as Congress debates extensions.
• With Pillar One floundering, the prospect of digital services taxes is becoming more and more real for American companies in the tech sphere. But this was already the case with Canada, which decided to move ahead on its digital tax regardless of the OECD outcome. (Although it has still not yet been enacted.) The Computer & Communications Industry Association issued an analysis last Thursday claiming that the 3% tax on digital revenue will cost U.S. companies as much as $2.3 billion annually, and could result in 3,140 job losses in America. Given the size of the U.S. economy those figures may not be eye-popping, but consider if they multiply exponentially as most of Europe and countries around the world enact similar levies once Pillar One fails.
• Surging gas prices may have tipped off spiraling inflation in the United States, but they also led to a surge of revenue in Latin America and the Caribbean between 2021 and 2022, according to an OECD study released on Tuesday. The average tax-to-GDP ratio in the region rose by 0.3 percentage points over that period, while non-energy taxes actually fell. Goods and services taxes generated almost half of the region's revenue, much higher than most of the rest of the world, according to the report.

PUBLIC DOMAIN SUPERHERO OF THE WEEK

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

Stardust the Super Wizard, premiering in Fantastic Comics #1 in 1939. A resident of deep space who patrols the cosmos fighting all manner of space crooks and pirates, he arrived on Earth to save the U.S. president from assassination and continued to catch terrestrial evil-doers. He appears to have limitless, Superman-type powers which are actually all technology-based. These include flight, invincibility, invisibility, invulnerability to the elements, and many different rays, including one that "forced murderers to see the skeletons of those they had killed." That must come in handy in outer space.

Contact the author at amparkerdc@gmail.com.