Safe Harbor Could Shelter OECD Global Tax Hopes

When the United States demanded that the Organization for Economic Cooperation and Development’s digital tax proposal be made into a safe harbor three years ago, it nearly torpedoed the project.

But could a safe harbor save it–or at least, ease the way for the U.S. and the OECD to move forward in the same direction? We’ll find out in the coming months.

On Tuesday President Joe Biden signed the Inflation Reduction Act, which contained hundreds of new tax provisions, including a new corporate “book” minimum tax. But one area it didn’t cover was the international tax code, after Sen. Joe Manchin (D-WV) insisted that the Biden administration’s proposals be axed as part of a final agreement.

Biden’s signature leaves barely any hope that Congress would take steps to implement the 15% global minimum tax, a key part of the OECD global tax agreement announced last summer, in this administration’s first term. That’s a significant setback for the organization, but not fatal. The tax, called “Pillar Two” of a two-pillar agreement, doesn’t require that all countries participate. It’s a recommendation for self-executing national tax rules which countries can enact at their leisure.

It never bodes well for the U.S. to be outside looking in, though.

Neither the OECD or the U.S. Treasury Department have given any indication of how they see the project proceeding. As I laid out earlier this month, there’s still some hope that the OECD could simply deem the U.S. compliant, papering over differences between the federal tax code and the OECD standards. That may be a long shot at this point, with many OECD nations wary of giving the U.S. a free pass. (They used to call this "grandfathering," but backed off that term due to its history with segregation and Jim Crow. I wonder if this rhetorical patch has hindered the process, by de-emphasizing the crucial fact that the U.S. has a pre-existing global minimum tax, the tax on global intangible low-taxed income.)

Proposals to ease the administrative burdens of Pillar Two through safe harbors–policies which promise protection against tax adjustments and a guaranteed amount of tax liability if the taxpayer hits certain metrics–may be another route towards closing the U.S./OECD gap, or at least giving U.S. companies some relief and wiggle room.

When the OECD asked stakeholders to comment on the latest Pillar Two plans, it floated the notion of a safe harbor to “reduce compliance costs” for multinational corporations. Most of the taxpayers responded enthusiastically to the idea, claiming the rules are too complex to be administered fully for every taxpayer, in every jurisdiction, every year.

Pillar Two works by identifying a slice of income–defined through the project’s own measurements, including a carveout for tangible property and payroll–that is taxed at less than 15% in whatever jurisdiction it’s in. The corporate taxpayer’s home jurisdiction is invited to tax that income through an “income inclusion rule.” If they decline, countries where that corporation operates through subsidiaries or branches can tax it (or deny deductions at the same amount), through the UTPR rule. This applies even if the income is earned in the home jurisdiction originally.

There won’t be any global authority to carry this out. Individual jurisdictions will enforce this policy, putting a lot of the reporting and compliance burden on the taxpayer. Even for those companies that end up owing nothing under this system–which, if it works as intended, would be most companies–it could end up costing a lot in terms of administrative burden. According to commenters, a safe harbor could ease that considerably, allowing corporations that clearly play by the rules to continue with their business smoothly.

Safe harbors have gotten a bad rap since the U.S. in 2019 proposed that Pillar One, the other plank of the OECD’s project, be turned into one. Critics claimed this was tantamount to optional taxation. The Biden administration dropped the demand when it came into power in 2021.

But the toxic connotation has more to do with how then-U.S. Treasury Secretary Steven Mnuchin stretched the meaning of the term past recognizability in his December 2019 letter. Safe harbors are supposed to be reasonable approximations of what the tax system would normally produce–more than what the taxpayer would like, less than what the tax authority might hope for, but close enough that both will take the deal and move on. On the other hand, the whole point of Pillar One was to be a new tax system patching holes in the old one. Why would companies elect into it?

These new proposed safe harbors at least try to approximate the result that Pillar Two mandates. One option floated by some commenters, such as Ernst & Young LLP, the Silicon Valley Tax Directors Group and the American Petroleum Institute, would be a “whitelist” or “angels’ list” of jurisdictions considered to be low-risk for profit-shifting or low-taxed income. These could be “where a jurisdiction’s statutory tax rate is sufficiently high (at least 15%) and its tax base is sufficiently broad,” the SVTDG suggests. PricewaterhouseCoopers LLP noted that aside from the rate, the rules could look to whether the jurisdiction has any tax incentives considered harmful by the OECD standards, which typically require economic substance. Through this safe harbor, potential Pillar Two income in these blessed jurisdictions would be deemed to be 0.

Blacklists, whitelists and lists in all shades of grey have long been a source of controversy. Critics claim they’re based more on politics than objective criteria. And no matter how fine-tuned the rules are, subjective determinations must be made. Could the United States–with its pre-existing GILTI rules, 21% corporate tax rate and its new 15% book minimum tax–potentially qualify for one, without igniting a firestorm?

Commenters also suggested that the OECD leverage information from its own country-by-country reporting system, created in 2015, to create country-specific safe harbors. The CBC reports, part of the original Base Erosion and Profit Shifting project, include information such as workforce, income and taxes paid per jurisdiction. That information is reported by companies and then transferred between tax authorities where it operates, to use for risk assessment. If a company shows a high effective tax rate based on those metrics, there’s no need to continue with the more complicated Pillar Two calculations, supporters of this idea argue. This rule wouldn’t exempt the U.S. specifically, but could benefit many U.S. companies with high-taxed domestic income.

There were several other safe harbor ideas in the public comments, including one based on a corporation’s overall global effective tax rate, and on the amount of workforce or economic substance a company has overall or in a given jurisdiction. All of these could benefit U.S. companies hoping to avoid Pillar Two’s enforcement provision, the UTPR.

And who knows, is a U.S.-specific safe harbor out of the question? It may be a non-starter, but tax policy has certainly seen crazier things.

A safe harbor would recognize a key fact in this dynamic–while the U.S. may not be technically following the rules, it does have measures in place to address profit-shifting and ensure a basic level of taxation for its corporations. Maybe it’s letting some avoidance slip through–although this is hotly debated among tax experts. But is the GILTI/Pillar Two difference so strong as to give U.S. companies a significant economic advantage, or encourage foreign companies to invert into the U.S.? If the answer is no, the central policy justification for the UTPR to apply to American businesses is negated, and a safe harbor could be a way to recognize this.

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.

OTHER NEWS OF THE WEEK

Is the era of Ireland’s infamous patent box near an end? The Ireland Department of Finance’s Tax Strategy Group issued a corporate tax report on August 10, which stated that the current version of the policy, the knowledge development box, is under review due to slow uptake. One thing that caught my eye–the low use of the KDB is partially due to the difficulty for taxpayers in showing that the IP receiving the benefit was developed in Ireland, to meet the OECD’s “modified nexus” standard. Research and development is a complicated process for multinationals. Pinning a new formula or lucrative software program to a particular jurisdiction--when dozens were involved--could be quite a task. Does this point to issues with the OECD standard generally?

Kim Clausing, a former official at Treasury and one of the architects of the Biden administration’s approach to the OECD negotiations, laments the failure of Congress to implement the agreement in a Foreign Affairs essay. But she says it would be in businesses’ long-term interests for the U.S. to follow the new standards, and hopes that lawmakers may reconsider in the future.

I wrote about how the U.S. has a hybrid worldwide/territorial tax system last week, but one area where it’s still strongly worldwide is in the taxation of individual citizens, including those who move abroad. The Foreign Account Tax Compliance Act’s impact on expatriates remains one of the touchier issues in taxation, with many claiming it has made their financial lives hell. American Citizens Abroad wrote a letter to Treasury August 11 calling on the department to ease the reporting rules.

I noted the African Tax Administration Forum’s recent criticism of the OECD tax project last week–on August 7 another ATAF statement claimed the 15% rate agreed-to for Pillar Two “is too low to deter multinationals from deploying aggressive tax evasion and avoidance practices,” and advocated for a rate of 25% or more. This is an important issue for cash-strapped developing nations, which often find themselves deep into the “race to the bottom” for investment. But, as the statement also notes, African countries don’t necessarily all see eye-to-eye on policy issues like this.

Just a thought--it's not my exact area, but many have noted the importance of the transferability of the Inflation Reduction Act's new energy tax credits. Presumably, this means that they will be protected against the UTPR, as OECD officials have said they may a transferable credit as a refundable credit, which isn't considered a reduction in taxes. (It still counts as income, lowering a company's ETR a bit, but less dramatically.) But the details on this could be crucial, stay tuned.

PUBLIC DOMAIN SUPERHERO OF THE WEEK

The Phantom Detective, created by D.L. Champion as a pulp magazine character in 1933, and eventually turned into a comics character for Thrilling Comics. Richard Curtis Van Loan, a wealthy socialite and World War I veteran, craves the excitement he experienced on the battlefield, and begins to solve crimes in disguise. Hmm, sounds a bit familiar, no?