Report: Next steps critical for “complex” international tax framework, market warns
Implementation, harmonisation and timeline are all major sources of concern across the industry
Implementation, harmonisation and timeline are all major sources of concern across the industry
Elements of the Organisation for Economic Co-operation and Development’s (OECD) “ambitious” new framework for international tax reform will require critical buy-in from leading economies to successfully implement the new system, market participants say.
“One of the biggest challenges we still have is how the US is going to implement this from a domestic point of view so that it allows the treaty to be changed and we can then move towards global implementation,” says Aamer Rafiq, UK tax partner at PwC.
“They [the US] are a big, big unknown at this time in terms of how they are going to get that across the line,” says Rafiq.
While over 130 countries (including all of the world’s largest economies) have pledged to a high-level political agreement on the OECD’s proposals, it is thought that a number of significant technical and political challenges currently threaten the implementation plan deadline of October 2021.
A swell of Republican criticism towards the proposals in recent months has complicated matters further, with US tax treaty changes traditionally requiring support from a two-thirds majority in the Senate. “They certainly wouldn’t have the votes to approve a treaty of this kind”, said Republican Senator Pat Toomey in an interview with the Financial Times, going on to call the proposals “crazy”.
The OECD/G20 Inclusive Framework on BEPS 2.0 is comprised of a two-pillar approach that aims to address the digitalisation of the economy and its impact on taxation. Pillar One, however, which touts new profit allocation mechanisms to expand the taxing authority of market jurisdictions, is said to be significantly more complex where implementation is concerned.
Companies in scope of the Pillar One proposals will be multinational enterprises (MNEs) with a global turnover of €20bn and a pre-tax profit margin above 10 percent. A proportion of that margin (currently estimated to be 20-30 percent) will then be reallocated to market jurisdictions.
Though the threshold is expected to be lowered to €10bn after seven years, the parameters will only capture around 100 companies in the first instance. The influence of the Biden administration on the implementation of the framework is therefore pronounced, with many of those corporations headquartered in the US.
“The US is going to be a key driver in how quickly this can be implemented at a domestic level. That will pretty much drive the timeline for a lot of countries,” says Andrea Tolley, partner at KPMG.
“Getting that timing right is going to be critical from a US perspective.”
“A painful transition”
The international tax community has also expressed significant concern regarding the fundamental nature of the new framework, arguing that its complexity could fail to square with the OECD’s ambitious timeline.
Ben Jones, tax partner at law firm Eversheds Sutherland, notes the unprecedented nature of the proposals. While an overwhelmingly positive initiative, the measure of the task is daunting, he says.
“At the end of the day, there is no such thing as international tax law – there’s a whole range of domestic tax law. The objective that the OECD has here is to get countries to adopt a unified approach, and that’s almost unheard of in the tax space.”
Two key dates currently comprise the implementation timeline: a report on the finalisation of the agreement and the resolution of technical details to be submitted to the G20 finance ministers by October 2021, and full implementation to be in place by 2023.
“Even bilateral treaties between one country and another typically take many years to be negotiated and ratified into law. You’re asking nearly 140 countries to come to an agreement on the wording and delineation of the rules in a multilateral treaty – getting that off the ground is probably the biggest challenge,” says Jones.
Jones goes on to cite the original BEPS package implementation in 2015. He notes that while the aim was to establish a multilateral instrument, this never truly came to fruition in practice, with the result more closely resembling a series of bilateral agreements.
“You never really got a true multilateral treaty in the end. You got a sort of menu of choices, and every country had to match up their choices with every other country,” he says.
“That’s my concern about what’s to come with the Pillar One and Pillar Two blueprints, is that we end up in that very messy position.”
Others have raised similar concerns about whether a global consensus can be truly realised, with the measures outlined in the new framework likely to have varying impacts on one economy to the next.
An evolution of the OCED’s Base Erosion and Profit Shifting (BEPS) package adopted in 2015, the OECD/G20 Inclusive Framework on BEPS 2.0 is comprised of a two-pillar approach aimed at addressing the digitalisation of the economy and its impact on taxation.
Pillar Two secures an unprecedented agreement on a global minimum level of taxation of at least 15 percent, which has the effect of stipulating a floor for tax competition amongst jurisdictions. The proposal is aimed at preventing large multinational corporations (MNCs) – above a €750m threshold – from profit-shifting to tax havens.
However, countries like Ireland, which has relied on its comparatively low corporate tax rate of 12.5 percent to attract foreign investment is one of only nine countries not to sign on to the new framework. Estonia and Hungary – two other low tax EU countries – are also non-signatories.
“The fact of the matter is that different countries have different perspectives on this depending on what their own economies look like and where they are in terms of development,” says Alison Lobb, tax partner at Deloitte.
“Once you start making changes, there will be countries and some companies who will benefit or lose out more than others, and that’s just the nature of change.”
This range of perspectives could prove a significant barrier to European implementation of the new framework, with unanimity required to establish an EU directive, Lobb argues.
Aside from how the proposals will impact each jurisdiction, many concerns remain as to how the rules can be uniformly applied to corporations, with a one-size-fits-all solution feared to be unfit for many modern organisations.
For instance, who cedes taxing rights and how it is determined, is a big issue, according to Rafiq.
“This is a distribution, so you’re going to have to give up taxing rights in one jurisdiction to pass them onto others, but most multinationals have lots of different product lines, so it’s not a nice simple thing.”
He also notes the issue of segmentation, pointing out that there is currently no international standard in terms of how financial statements are segmented.
“The devil really in all of this is working out how you go from a high-level concept to actually working out how to administer it. That’s where the real complexity starts to come out.”
The path ahead
Despite both the G7 and G20 approving the OECD’s proposals as outlined in Pillar One and Two of its Inclusive Framework on BEPS 2.0, concerns still linger as to how the optimistic timeline will be achieved.
“Not only is it an ambitious project, but it’s also got a challenging timeline,” says Lobb. “There is a considerable amount of work that needs to be done, both technical and legal, in order to turn this into legislation and amendments.”
The “high-level” nature of the proposals in their current state paints a worrying picture, according to Tolley.
“The biggest challenge at the moment is that it’s a very high-level, principal draft, which is good from the perspective that all countries have been able to agree on the underlying principles, but the key concern is actually turning that into detail and how it will be implemented,” she said.
“Pillar One and Pillar Two have different objectives, and I think one of the key risks here is that one will move faster than the other or one might be able to be implemented faster than the other. And the other thing is that certain elements still haven’t been agreed, so even though we’ve been through the Inclusive Framework and the G20, there’s actually still some big numbers that need to be agreed by all those countries. Those sorts of issues are going to delay or hold up the implementation.”
But while implementation, harmonisation and timeline are all still major sources of concern across the industry, many still hail the BEPS 2.0 measures for their innovation and potential to formulate a fairer and more equitable global taxation system.
“No one likes change and change will benefit some and be detrimental to others, but if it can be made to work from an administrative perspective, and if it doesn’t lead to too much double taxation or disputes, then I think that is the fairest system of taxation,” says Jones.
“I can see the complexity in all of this, but it’s clear that if it can be made to work, it’s a fairer system of taxation and a better reflection of the global economy than the one we have now, which was developed over 100 years ago.”
Kevin Matthews, accounting professor at George Mason University, agrees with Jones, noting a bold new framework is required to modernise the global tax system.
“From a macro perspective, this is good because trillions of dollars are being lost to countries due to relocation strategies being used by these larger companies,” he says.
“It will also offer more of an incentive for artificial intelligence-based tax planning systems to adapt to the new rules to find ways companies can best utilise what rules are put into place. AI has been getting more sophisticated in recent years in auditing analytics, but this framework could offer more incentive to build it for the tax environment.”