1. Introduction
Why has the global tax community agreed on a new, almost hopelessly complicated, multilateral and supranational, sales-based corporate tax framework, under which the OECD will function as a "World Tax Organization" and both produce content and monitor implementation and application?
Today's events only make sense if one considers the international tax developments of the last decade from a strictly American perspective
Why is the OECD suddenly willing to sacrify established tax principles and deprive countries of their tax sovereignty on a global basis?
Why is the OECD taking such a detour to "modernize" the international tax framework. Pillar 1 is basically an exception to the exception. The main rule is that countries have full tax sovereignty within their territory. A country's right to tax within its territory is limited only by its practical ability to enforce its laws. Through the conclusion of tax treaties, countries make certain exceptions to their tax sovereignty to promote international trade. Pillar 1, in turn, makes an exception to the tax treaty exemptions through the introduction of rules that partially render treaty rules inapplicable.
Why cannot the OECD leave the world alone? Why is it a problem for the OECD that digital services taxes are used to tax a handful of digital giants that otherwise would escape corporate taxation in source countries?
After all, the OECD cannot argue that digital services taxes violate "established tax principles" because Pillar 1 does exactly the same. Nor that digital taxes are gross-based, as virtually all digital services taxes adopted at the national level, including UN Model Article 12B, offer a net taxation alternative. And neither that these taxes lead to “global tax chaos”, as virtually all adopted digital taxes worldwide follow the same template.
Today's events only make sense if one considers the international tax developments of the last decade from a strictly American perspective.
2. OECD is the US’ Right Arm
I have both in Tax Notes International (1) and previous blog posts emphasized the central role played by the United States in the OECD. Nothing can be done without US approval. Admittedly, there are two different US governments operating at the OECD, one Republican and one Democratic. Republicans make all decisions at home and then force the OECD to follow suit. The Democrats instead use the OECD as an instrument to market American tax principles to the rest of the world. On paper, the Democrats' actions may appear to be more respectful to other countries, since they act on a multilateral rather than a unilateral basis, but in the end the result will still be the same. The American view governs the work of the OECD.
3. The Origins of the BEPS Project
The official reason for launching the BEPS project was to combat aggressive international tax planning at the corporate level. This reason is not wrong, but neither the whole truth.
BEPS was based on an American initiative. The US wanted to use the project to improve its ability to tax its own MNEs without undermining their relative competitive position. The plan was to persuade countries with home country-based MNEs to agree to increased residence taxation. The US assumed that it would be relatively easy to market such an initiative as it would generate more government revenue for all MNEs’ resident countries. Furthermore, the US considered the proposals as competition-neutral.
However, BEPS took an unexpected turn for the US. On the one hand, the rest of the world turned out to be uninterested in the US proposal for increased residence taxation of MNEs, and on the other hand, American MNEs, and especially the GAFAM-companies, were made solely responsible for all aggressive tax planning over the past twenty years. In the end, BEPS was just about how the rest of the world could tax American MNEs. No wonder the United States was so disappointed with the BEPS outcome.
4. Post-BEPS Work
From an American point of view, all post-BEPS work has been about "damage control" and above all about stifling all incentives created during the BEPS project to tax the American (digital) industry with new legislative tools.
The United States therefore blocked all further work in the OECD on the taxation of the digital economy (BEPS Action Point 1) and threatened countries with trade sanctions if they attempted to tax US digital giants.
5. Pillar 1 Under the Trump Administrationen
However, the US policy was unsustainable in the long run, especially with regard to the GAFAM-companies. The latter not only avoid corporate taxation in the EU and the rest of the world, but also make huge profits, which are used to either buy up or eliminate all competition.
In an attempt to gain time and in order to undermine the European Commission's attempt to tax the GAFAM-companies on an EU-wide basis, the OECD Secretariat was commissioned to draft a compromise, i.e. the Pillar 1 proposal, which was published in October 2019.
The Pillar 1 proposal is a reasonably favorable solution to the United States, as its sales-based rules reward countries with large domestic markets. Notwithstanding, the Trump administration rejected the proposal because of its complexity and because the OECD would obtain far too much control over the design and application of the proposed tax framework.
6. Pillar 1 Under the Biden Administrationen
As stated above, Democrats are more open to using the OECD as an instrument for their purposes. The Biden administration therefore agreed to use the Pillar 1 proposal as a basis for a global solution. However, it has revised the proposal substantially to make it (even) more favorable to the United States.
Had the US had attached importance to maintaining the coherence of current international rules, the OECD would instead have been instructed to revise Articles 5 and 7 of the OECD's model agreement
Following the agreement on October 8, work continues to define, amongst other things, the Pillar 1's nexus rules and to determine what “unilateral” taxes must be phased out. You can safely assume that the outcome of this work will essentially benefit the United States.
7. It's All About US Interests
The US is undoubtedly aware that Pillar 1 is, to say the least, a technically cumbersome and bureaucratic approach to "modernizing" the international tax framework. Nevertheless, it chooses to invest in this solution because all other presented alternatives are considered less favorable to the US.
Instead, US action is all about correcting the – from the US perspective – unacceptable outcome of the BEPS project
The Biden administration's version of Pillar 1 ensures that other countries' MNEs are also in-scope and that the US can obtain a larger share of the corporate profits redistributed under Pillar 1. It is still unclear how Pillar 1 will affect countries' tax bases. But there are those who claim that the US - despite that Pillar 1 is mainly about redistributing profits of American GAFAM-companies - may benefit from Pillar 1!
Had the US had attached importance to maintaining the coherence of current international rules, the OECD would instead have been instructed to revise Articles 5 and 7 of the OECD's model agreement in order to adapt the provisions to digitally based commercial activities. Such an approach would have preserved both the structure of tax treaties and most of their basic principles and the revisions could have been implemented on a multilateral basis. But this was never an option since it would have benefited third countries far more than the US.
Instead, both tax treaty rules and countries’ tax sovereignty are being dismantled at record speed to meet US interests. Large countries such as Germany, France, the UK, India and China have joined the agreement, partly because they also benefit to some extent from the new framework, and partly because they have no choice.
We can thus conclude that the US cares little about OECD’s established international tax principles or global equity. Instead, US action is all about correcting the – from the US perspective – unacceptable outcome of the BEPS project.
The dirty job of punishing countries adopting domestic digital services taxes will in future be handed over to the OECD. In this way, the US no longer has to threat “uncooperative” countries with trade sanctions, which from a PR point of view appears to be as morally defensible as the British gunboat diplomacy of the 19th century (see previous blog post on this issue here).
Through the Pillar 1 agreement, the US has achieved the first of two policy goals with its post-BEPS work. Its second goal is achieved via Pillar 2. I will address this issue in my next blog post on 15 December.
Finally, it is somewhat ironic that Sweden ended up playing a central role in the US' efforts to reach its objectives in the post-BEPS work (see previous blog post on this issue here). The head of CTP, Pascal Saint-Amans, also thanked Sweden, on behalf of the United States, by recalling in a French news magazine in June 2019 how he quite brutally dismissed Swedish concerns with the ongoing Pillar 1 discussions. (2) His statements were widely circulated and also attracted some attention in the United States. “Singing the songs of the powerful seldom generate benefits”, says Plato. Hopefully, Sweden has now learnt that lesson.
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(1) Fensby, “Will the BEPS Project Survive the Trump Administration”, Tax Notes International, May 15, 2017.
(2) See Society, “Un homme contre l’évasion fiscale”, No 108, 13-25 juin 2019.
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