OECD First Pillar Amount A consultation and response from the Tax Foundation

The Tax Foundation has engaged constructively with the OECD Pillar 1 and 2 process since its launch in 2019. The Pillar 1 Progress Report consultation provides another opportunity for this. However, at this stage, it is difficult to be constructive when the policy seems designed to fail.

The progress report reveals that ongoing technical work has continued to increase the complexity of the policy.

OECD Pillar 1 Amount A is intended to reallocate the taxable profits of large multinationals, mitigate double taxation of profits and avoid a damaging tax and trade war.

To achieve these goals, however, the policy must be attractive for governments to adopt, simple enough for agencies to administer, and clear enough for companies to comply with.

The cover note suggests that a multilateral convention to implement Amount A will not become law “until ratification by a critical mass of countries, which will include the jurisdictions of residence of the Ultimate Parent Entities by a substantial majority of the target companies”. whose profits will be subject to the right to tax Amount A, as well as the additional principal jurisdictions which will be assigned the obligation to eliminate double taxation otherwise resulting from taxing Amount A.

The United States would have to ratify for the phrase “substantial majority” in the quote above to be satisfied. Ratifying such a tax deal would require a two-thirds majority in the United States Senate, an extremely unlikely outcome.

The OECD Secretariat has clearly made progress in developing a policy that works in theory and perhaps has a slim chance of working in practice. However, no progress has been made in developing a policy that achieves the goals of the project while enabling elected government officials to be willing to adopt it.

These rules favor bureaucracy and complexity rather than simplicity and transparency.

At the start of the process, one of the main criticisms was that trying to build a new structure on top of the existing set of international tax rules could create a fragile superstructure. The fragility of the potential superstructure has not been resolved as more details of the A-pillar have emerged.

It seems likely that instead of solving the problems created by the current system, Amount A would introduce many new areas of litigation. Tax security processes and procedures become necessary and critical as this policy could lead to increased litigation. Despite the attempt to use a form approach to apportion taxes and eliminate double taxation, the design lends itself to interpretations that will be challenged.

The complexity of the proposal does not escape the authors of the document. Footnote 4 shows a small window into policy challenges. Referring to Section 9 of Title 5: Allocation of the Obligation to Eliminate Double Taxation with Respect to Amount A of Profits, the footnote states: “Work is in progress to review and, if necessary, remove any logical inconsistencies from the elimination framework.”

The logical inconsistency is to think that this complicated policy can be easily adopted by governments around the world.

Because the general policy is complex, it requires shortcuts to define the extent of the tax base, the source of revenue, and the identification of the tax base that is being given up. But these simplifications themselves will lead to questionable (if not questionable) results.

The process of identifying a segment in scope should include a measure of overall business profitability to avoid a business that is generally in a loss position calculating and paying Amount A.

When identifying the tax base, one formula is used to identify excess profits, and then another formula to determine which domestic profits should be excluded. The formula seeks to identify excess returns. Excess returns are generally those that are greater than the normal return on an investment and that normal return being profit greater than what the time value of money and inflation would provide.

As inflation has risen across the globe, it has become more important to assess whether A-mount metrics should refer to profit margins after excluding a measure of inflation. A company that makes 15% profit when inflation is 2% should not be treated the same as a company that makes 15% profit when inflation is 10%.

Inflation adjustments should be widely applied throughout the proposal.

Safe Harbor makes a critical error by not including withholding taxes in the calculation of taxes already paid in a market jurisdiction. This could lead directly to double taxation and miss an opportunity to incentivize jurisdictions to adjust their withholding tax approaches.

The revenue source approach provides several allocation keys, but it remains unclear whether the allocation keys are general purpose or if the transaction-by-transaction approach is still preferred in most cases. As Tax Foundation has previously published, the global distribution key for the source of income seems more consistent with the identification of major economies rather than indicators specifically related to cross-border trade.

The process of eliminating double taxation relies on formulas that seem to have no clear rationale other than to provide a level of convenience in identifying which jurisdictions should return profits.

In summary, the rules reflect a high level of complexity as well as a handful of shortcuts that reflect rough approximations or show weaknesses in the plan. This is a bit like the current system of profit sharing across borders.

New policies that will generate disputes are being developed and therefore new dispute resolution mechanisms are being designed.

This design seems unlikely to be an acceptable solution for governments as an alternative to existing complexity and conflict.

There may be an opportunity to salvage a part of the project that is most likely to provide more certainty and avoid disputes; perhaps Amount B, which could provide an agreed benchmark for profits attributable to certain defined activities, would make that reduction. However, a successful rescue effort would require careful attention to designing a package that would be acceptable to the governments that would have to administer and enforce the rules.

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