Rough Justice, Soft Application--the OECD's Amount B and the Future of Taxation

One of the most important parts of the Organization for Economic Cooperation and Development’s Two-Pillar global tax overhaul is also one of the least-discussed. I’m talking about the plan to introduce simplified formulas for routine distributing and marketing activities, called “Amount B” of the project’s Pillar One. The organization released a consultation paper on the topic earlier this month, its first in-depth look into the proposal.

Amount B is important because it’s one of the likeliest parts of the project to become actual policy. While “Amount A” of Pillar One, the primary new taxing system aiming to capture digital activity, is facing long odds for success at this point, Amount B is attractive enough to countries, especially developing countries, that it’s probably going to survive the project. Whatever happens to the rest.

But another reason it’s important is because it’s a sign of a trend that’s set to continue growing around the world, in both developed and developing countries. Amount B is based on the premise that both taxpayers and tax administrations would like to see simpler, more certain results, even if they’re not exactly the figures they want within the range of what current transfer pricing allows. It’s yet another move towards “rough justice,” an answer which acknowledges the somewhat arbitrary nature of taxation, and allows less flexibility to achieve reliability. But while the justice is rough, its application is also softer, if that makes sense–the OECD has yet to decide whether or not to make Amount B optional, but it’s likely to be closer to a voluntary safe harbor than a hard-and-fast rule.

If it works as intended, it’ll be an offer that taxpayers can’t refuse–or at least they’d be foolish to, if they really do prize stability and reduced compliance costs over tax minimization, as they often claim. But that will make the final decisions about Amount B’s nature all the more important, and likely to be subject to strong political pressure.

Amount B came about as the OECD attempted to build a strong, broad coalition for its tax overhaul. While the main goal was to get the U.S. and Europe on the same page about digital taxation, they also wanted support from developing and emerging economies as well. But those countries saw less benefit from the primary new proposals, and potentially significant costs. Inadequate taxation of the digital economy is a problem, but it’s kind of a First World problem. (To a degree). OECD leaders felt the project should have something addressing the concerns of poorer countries to keep them involved.

The sexy, big-ticket items in taxation–such as the valuation of IP and capturing income from new business models–get so much attention, sometimes folks forget that other areas can see significant problems as well. Commodities are an example I like to use: you’d think oil or minerals would be the easiest things to price, but some countries have found it so difficult they’ve invented new methods for compliance.

Developing countries have also struggled with marketing and distribution functions with large multinationals operating in their jurisdictions. These should be routine, without that much variation in their nature or situations. But they cause issues nonetheless, whether from companies looking to use more aggressive pricing strategies (such as through often controversial “commissionaire” arrangements) or from skeptical tax administrations applying enhanced scrutiny on routine functions. And cash-strapped tax authorities often lack the capabilities to even recognize routine activities, or price them based on accepted standards.

So narrowing the range on potential price margins for these functions, or even setting out a fixed number based on various factors, could be a win-win for everyone. Poorer tax administrations would be able to process these cases more quickly and easily, freeing up resources to focus on trickier issues and not feeling so overmatched by the huge multinationals. And corporations would be able to count on more reliable tax costs, without fears of audits for all of these entities.

Both sides would just have to be happy with a figure that probably isn’t quite what they wanted.

“This is a judgment call for all of us to make, are we willing to accept simplicity that doesn't have perfect accuracy in every instance?” said Achim Pross, acting deputy director for tax policy and administration for the OECD, during a tax conference in Washington, D.C. last week.

Pross noted the “quasi-religious” nature of the arm’s-length principle, the global benchmark that states that pricing for international tax purposes should be based on what independent parties would have paid. For ALP absolutists, there’s a true arm’s-length price for every internal transaction, and the goal is to discover it through rigorous research and analysis. But in the real world, arm’s-length prices are almost always ranges, sometimes wide ranges due to the subjectivity of the whole thing. Why not force that range to be narrower, to benefit everyone?

Of course, nothing is truly easy, or simple, or win-win-win in the world of global taxes. There are some hard questions that will need to be answered before this moves forward. How do you choose the numbers? How do you define the functions? Would this just move disputes from the profit margins themselves to definitional questions–companies arguing they should be in scope when they aren’t, or vice-versa?

And should this be required for all cases falling into the Amount B scope, or a safe harbor that companies could elect into or choose to challenge?

As I noted up-top, this has the potential outside of the developing world. Australia, for instance, has “practical compliance guidelines,” under its self-assessment system, in which companies can place themselves in different “zones” of risk for audit based on different profit margins. These cover off-shore marketing and distribution hubs but also more difficult issues such as arrangements with intangible assets and hybrid mismatch entities. They aren’t a requirement, or even a safe harbor. They’re just an informal assurance–if you meet these benchmarks, your arrangement will be in the “green” zone, and the chances it will be audited are much lower. The tax authority uses these factors to prioritize its own focus–why not just let companies know what they are, to get out of the hot seat?

Other countries have taken notice of Australia’s approach. There’s a conceptual, practical simplicity to it. But it also raises questions–if the Australia Taxation Office itself is setting margins, aren’t they basically making new tax law? And if these margins are so great, why not just make them the law? (That’s when you’ve officially left the arm’s-length standard, and are venturing into formulary apportionment.)

But, as the tax world trends towards formulas and set amounts over abstract principles, the Amount B approach holds a lot of promise. It’s not perfect–but what in international taxes is?

Note: I'll be taking a break next week for Christmas, but Things of Caesar will return the first week of January. And Happy Holidays!

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.

LITTLE CAESARS: NEWS BITES FROM THE PAST WEEK

The OECD is apparently ready to go home for the holidays, releasing three new pieces of guidance on the Two-Pillar project in the past week. More could come before the end of the year, but these were the most-anticipated items. First up is the draft on the withdrawal of digital services taxes as part of the multilateral convention to implement Pillar One. Of course, this step is a far way off, but the document still may be worth taking a look at to see how the OECD would define a unilateral DST--something that's sure to come up again.

The OECD also released two consultation documents on Pillar Two, the 15% global minimum tax. This is getting into the mechanics of how this tax would actually work, including an information return that companies would file that is already generating complaints about its complexity. The OECD also released a draft on "tax certainty" in Pillar Two, including dispute prevention/resolution and other mechanisms.

Most of the "tax extenders" affecting multinational corporations, such as extension of the TCJA's initial policies on expensing of R&D, got left on the cutting room floor for the 2023 omnibus spending bill. But one important tax item included, though not exactly with international, is a new limit on the tax deductibility for conservation easements. Meant to be a charitable deduction to encourage conservation and preservation of land, conservation easements have become a firestorm lately, with some firms accused of exploiting and selling the deductions to reap windfalls. They resulted in not only media attention and IRS audits, but criminal indictments as well.

PUBLIC DOMAIN SUPERHERO OF THE WEEK

The Scarlet Phantom, who appeared in All-New Short Story Comics #2 in 1943. An ace reporter who fights crime to avenge the murder of his father, Dr. Winstead. He uses a "phantom cloak," invented by Winstead to become invisible.