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Executive summary
On 12 September 2022, the OECD held a public consultation meeting on the Progress Report on Amount A of Pillar One (the Progress Report (pdf)), which had been released by the OECD Secretariat on 11 July 2022 in connection with the ongoing OECD/G20 project on Addressing the Tax Challenges Arising from the Digitalisation of the Economy (the so-called BEPS 2.0 project). The Progress Report describes the proposed design for Amount A, reflecting the mechanics for the new nexus and profit allocation rules being developed under Pillar One with the aim of providing market jurisdictions with a greater share of the taxing rights over global business income.
During the public consultation, three panels discussed key elements of the proposed design for Amount A, including the marketing and distribution profits safe harbor, the approach for eliminating double taxation with respect to Amount A and other aspects of the rules.
Detailed discussion
Background
On 11 July 2022, the OECD Secretariat released the Progress Report on Amount A of Pillar One.1 The Progress Report is a consultation document that covers many of the building blocks with respect to Amount A and is presented in the form of domestic model rules. As noted in the Progress Report, it does not yet include the rules on the administration of the new taxing right, including the tax certainty-related provisions.
Together with the Progress Report, the OECD also released a Cover Note (pdf) by the OECD/G20 Inclusive Framework on Base Erosion and Profit Shifting (BEPS) providing a revised schedule for the work on Amount A. Under the revised schedule agreed by the Inclusive Framework, the Amount A rules will not come into force in 2023 as had been reflected in the original timeline agreed by the Inclusive Framework in October 2021.2
The Inclusive Framework requested written comments from stakeholders on the overall design of the Amount A rules reflected in the Progress Report, with plans to review the input received and seek to stabilize the rules at its October 2022 meeting. When the Amount A rules are stabilized, they will be translated into provisions for inclusion in a Multilateral Convention (MLC), to be signed and ratified by Inclusive Framework members. The agreed schedule reflects the expectation that this work will be completed so that a signing ceremony for the MLC can be held in the first half of 2023, with the objective of enabling it to enter into force in 2024 once a critical mass of jurisdictions has ratified it.
The deadline for submission of written comments was 19 August 2022. More than 70 comment submissions were received from businesses, industry associations, tax advisors and individuals. The global EY comment letter submitted to the OECD can be found here.
The public consultation meeting
On 12 September 2022, the OECD hosted a public consultation meeting to discuss the comments provided on the Implementation Framework. In addition to opening and closing comments from members of the OECD Secretariat and Inclusive Framework jurisdiction officials, the agenda of the meeting included the following:
1. Panel One: Marketing and distribution profits safe harbor
2. Panel Two: Elimination of double taxation
3. Panel Three: Other selected issues (scope, revenue sourcing, tax base and unilateral measures)
Opening comments
The consultation session began with opening remarks from the co-chairs of the Task Force on the Digital Economy: Gaël Perraud of the French Ministry of Finance and Michael Plowgian of the United States (US) Treasury Department. Perraud indicated that there would be significant focus during the session on the two most important new components of the Pillar One design reflected in the Progress Report – namely, the marketing and distribution profits safe harbor (MDSH) and the rules on elimination of double taxation (EODT) – as well as the commitments regarding the removal of unilateral measures. He also stressed the “tough deadline” they are facing, indicating that they must start drafting the MLC for Pillar One soon because they must have the signing ceremony by the end of the first semester of 2023. Plowgian noted the Progress Report is not final and was intended to provide enough detail for stakeholders to be able to engage in a meaningful way, stressing that they will need to work quickly to get to signing of the MLC in the first half of 2023.
Alan McLean, Chair of the Business at OECD (BIAC) tax committee, described the Progress Report as an important milestone and indicated that business stakeholders would like to see a focus on simplicity, clarity and certainty. Damon Silvers, representing the Trade Union Advisory Committee to the OECD, agreed with McLean’s focus on simplicity and clarity, describing the Progress Report as the most opaque document he has seen from the OECD. He expressed the view that the concept of double taxation is not coherent, the MDSH should not be a deduction, loss carryforwards should be very limited, and unilateral measures should not be eliminated until there are Pillar One rules in place.
Achim Pross of the OECD Secretariat expressed appreciation for the comments received, expressing the view that they reflect that the overall approach to Pillar One has the support of a large segment of the business community. He noted the questions raised in the comments about the use of Return on Depreciation and Payroll (RODP) in both the MDSH and the EODT rules. He noted the support from business stakeholders for taking withholding taxes into account in the MDSH and for the use of the exemption method for EODT. He indicated that he expects that they will release a package on withdrawal and standstill with respect to unilateral measures soon.
Panel One: Marketing and distribution safe harbor
The first panel was moderated by Gaël Perraud of the French Finance Ministry and Co-Chair of the Tax Force on the Digital Economy, focusing on several issues including the treatment of withholding taxes, key undefined aspects of the MDSH formula (“Y” and the “multiplier”), potential alternatives or supplements to the MDSH, and other aspects of the MDSH formula.
Treatment of withholding taxes
Fundamentally, Amount A is intended to address the concern of some policymakers that market jurisdictions do not have “enough” taxing rights under existing international tax rules. The MDSH provides potential relief with respect to the Amount A allocated to a jurisdiction to the extent that jurisdiction has taxing rights on net-basis residual profits without regard to the new Amount A. However, the MDSH formula included in the Progress Report does not take into account one measure of jurisdictional taxing rights: gross-basis withholding taxes on deductible payments. In this regard, the Progress Report indicates that there are divergent views on whether withholding taxes should be taken into account under Amount A and that withholding taxes are not addressed in the report because discussions are ongoing in the Inclusive Framework.
The business panelists were unanimously of the view that failure to take into account withholding taxes would be contrary to the policy intent of the MDSH and would inappropriately incentivize countries to impose withholding taxes, contributing to international tax instability.
A panelist representing a non-governmental organization (NGO) responded that including adjustments for withholding taxes would be a “deal breaker” for developing countries, and that pushing for such an adjustment may force developing countries to reject the overall Amount A deal and consider imposition of new unilateral measures. He further noted that preliminary revenue estimates indicate that Amount A taxes in developing countries are “puny.” In his view, the non-inclusion of withholding taxes in the MDSH and in the EODT rules was part of the overall negotiation that allowed the residual allocation to be as low as 25%. In this regard, Perraud raised the question of how an adjustment for withholding taxes could differentiate between withholding taxes associated with residual profits (theoretically eligible for an MDSH adjustment) and withholding taxes associated with non-residual profits (theoretically ineligible for an MDSH adjustment).
Undefined parameters in the MDSH formula
The MDSH formula in the Progress Report contains a broad scaling factor, “Y,” that could ratchet up or down the MDSH calculation. Business panelists questioned the rationale for such a scaling factor, and one suggested that it be dropped entirely because even setting Y at 1.0 could be seen as inviting adjustment at a later point. Similarly, business panelists questioned the rationale for having a “multiplier” by which the MDSH reduces the amount of jurisdictional profits subject to elimination of double tax (e.g., a multiplier of 1.0 would mean a dollar-for-dollar reduction in the profit base for elimination of double tax). Perraud indicated that these two parameters reflect an area where there is not yet consensus among Inclusive Framework jurisdictions. The business panelists requested that the OECD explain the rationale for the threshold for the RODP, which is fixed at the higher of 40% or 10% of group sales expressed as a return on group depreciation and payroll.
Alternatives or supplements to the MDSH
A business panelist expressed disappointment that the domestic business exemption that had been included in prior drafts of the Amount A framework was not retained, noting that such an exemption would be in keeping with the intent of Amount A relief as it would be targeted to companies with decentralized business models and limited intercompany transactions.
Other aspects of the MDSH
The business representatives on the panel discussed the impacts and implications of other aspects of the MDSH formula, primarily the measure of non-residual profits, which is a fixed return on jurisdictional depreciation and assets. They expressed the view that this provides distortions between different business organizations and within a business organization, depending on, among other things, the amount and allocation of intangibles, the treatment of tangible property (e.g., depreciation/amortization treatment), low-cost versus high-cost jurisdictions, and new versus aging capital investments. During the subsequent panel, Michael Plowgian of the US Treasury Department and Co-Chair of the Tax Force on the Digital Economy said that he didn’t understand why the MDSH formulation resulted in intra-group distortions, as the RODP threshold effectively establishes a reference point that is based solely on the group’s depreciation and payroll and so it should already account for differences in depreciation and payroll between different companies in different industries.
Perraud offered brief closing statements, noting that many of the issues raised by the panel, and also raised in the written comment submissions, are appreciated and well understood by the Inclusive Framework participants. He noted that some of these issues involve matters that simply are not yet agreed. He further indicated that the OECD needs to better explain several technical aspects of the MDSH formula, such as the RODP threshold.
Panel Two: Elimination of double taxation
The second panel was moderated by Michael Plowgian of the US Treasury Department and Co-Chair of the Task Force on the Digital Economy, focusing on several issues including what secures effective protection from double taxation, the results of modelling by businesses, the method of EODT and the use of RODP to identify the relieving jurisdictions.
Plowgian began the panel by indicating that a choice was made to use a qualitative and objective basis to determine the relieving jurisdictions. In his view, this prevents complex issues when there are borderline questions.
Plowgian noted that in using RODP as a basis for identifying the relieving jurisdictions, a comparison is made with the RODP factor of the consolidated group. He expressed the view that this should prevent distortions in assessments between more capital intensive and less capital intensive business models, as an assessment is made which determines an entity’s position relative to its group and not its position compared to another business. As reasons for using RODP, Plowgian noted that tangible assets and employees are less mobile. Moreover, because tangible assets and employees can easily be moved between separate entities, a jurisdictional approach was chosen instead of an entity approach.
Plowgian also made the point that a distinction should be made between different types of complexity: complexity to understand versus complexity to apply.
What secures effective EODT?
The panelists began with thoughts on what is required to secure EODT, expressing the view that the mechanism should be effective, simple, certain and timely.
Effective EODT in the context of Amount A would mean that compared to the current situation merely a re-distribution of profits results. As a consequence, there should be limited effective tax rate change. The question on EODT is wider than just the formula for identifying the relieving jurisdictions, but also includes the issue of the treatment of withholding taxes as discussed in the first panel. The business panelists all were of the view that it is essential that withholding taxes are taken into account.
Moreover, the panelist noted the importance of having a backstop rule that addresses the question what happens if a relieving jurisdiction does not sign the MLC.
Results of modelling exercises
The business panelists noted distortions resulting from the EODT rules reflected in the Progress Report. For example, they indicated that outcomes of modelling illustrate that these rules would result in market to market shifts (local market income would be surrendered to another market), investment hubs surrendering profits to unrelated markets and reallocations between investment hubs. Given these outcomes, the view was expressed that the rules are designed for centralized business models without taking sufficient account of other business models, in particular decentralized business models. They stressed the need for a market connection factor. The multiplier in paragraph 6 of the EODT rules, which involves the MDSH being subtracted from Elimination Profits is not viewed as an effective substitute for such a market connection factor, and therefore is not considered to be an appropriate replacement for the domestic profits exemption.
The method for EODT
The business panelists were unanimously of the opinion that the only reliable method to eliminate double taxation would be the exemption method. Because EODT in the context of Amount A relates to economic double taxation, not juridical double taxation, and application of the credit method would require an allocation of Amount A to the different entities of the group in the jurisdiction, use of the credit method would be complicated and unreliable.
The use of RODP
The business panelists were also unanimously of the opinion that RODP is not a solid basis for identifying the relieving jurisdictions. The panelists noted that this metric does not take account of differences in profitability between markets, the specificities of different business lines within the same group and differences in business models. They expressed the view that using this metric would be detrimental for research and development intensive businesses and likely would favor businesses with a high carbon footprint, which raises questions on compatibility with the interest in getting to a sustainable tax system.
Questions
Following the presentations by the panelists, Plowgian raised two questions. First, he referred back to his opening remarks on RODP being applied in a way that compares the jurisdictional RODP to the RODP of the group. Given this comparison, he asked how the conclusion could be drawn that the metric is distortive in the sense that it favors capital intensive businesses? In response, one of the business panelists noted that within a group, tangible assets and payroll can be distributed in a way that leads to distortions. For example, in relation to similar activities, the business may choose outsourcing in one jurisdiction but not in another jurisdiction. This would create distortions between these jurisdictions even though the comparison would be made to the consolidated group RODP.
Plowgian followed up with a question on how to define the baseline for identifying distortions. One of the business panelists gave examples of outcomes of the EODT rules which in their perspective conflict with the policy intent, including the absence of a connection between the investment hub and the market to which it would surrender profits and situations where clearly domestic market related profits would be identified as elimination profits. Another panelist indicated that some people may like the purely formulaic approach taken, but that most think a market connection is needed to prevent outcomes that are distortive relative to the policy intent.
Panel Three: Other selected issues (scope, revenue sourcing, tax base and unilateral measures
During the third panel, moderated by Achim Pross of the OECD Secretariat, a variety of other issues was discussed.
Scope
In relation to scope, the main focus of the business panelists was on the absence of an exemption for businesses that operate largely domestically. The October 2020 Blueprint on Pillar One included a description of a potential “domestic business exemption,” aimed at reducing the instances of double counting. During the consultation, it was noted that for certain multinational enterprises (MNEs), not having such an exemption could lead to significant distortions. This could be caused by the fact that local businesses might have significantly different levels of profitability compared to the group overall, for instance because of different local circumstances or because of the different nature of the activities in a company operating as a conglomerate, such as use of a licensing model for certain markets and own manufacturing for other markets.
A business panelist expressed the view that a domestic business exemption would contribute to simplification and would avoid distortions, which would also be relevant for the tax revenue of certain countries. The effect of this would become more pronounced after the planned reduction in the threshold for in-scope companies.
It was suggested that a domestic business exemption could be implemented in a way that requires that particular criteria be met, such as absence of significant intercompany charges.
Revenue sourcing
The business panelist addressing this issue began by noting that the concept of revenue sourcing in the Progress Report had moved from a transaction-by-transaction approach toward a more practical approach. However, he made several points related to the availability of data and the impact on systems. In particular, he questioned how the requirement in the Progress Report to account for differences per market such as differences in goods, property and services could be met without collecting data on a transaction-by-transaction basis. Furthermore, he expressed the view that it would be highly unlikely that data from third party customers on the end user of products and services could be obtained. The panelist suggested allowing businesses to perform the revenue sourcing based on data obtained in the ordinary course of the business, considering the taxpayer circumstances and allowing reasonable business judgment. Another approach that could be considered would be to apply different standards and sources of data for smaller product lines and for recently acquired businesses.
On the requirement included in the Progress Report for in-scope MNEs to have an internal control framework endorsed by the board of directors that evidences the revenue sourcing, business panelists noted that such MNEs can be expected to already have an internal control framework in place, subject to evaluation by the financial auditor and that no additional requirements with respect to the framework should be introduced. It was also suggested that it would be valuable to have more examples, incorporated directly into the rules, to make clear that such guidance is binding.
Pross responded that work is needed on the status of the commentary and examples. In relation to the internal control framework, he indicated that the underlying idea is essentially that such framework could be a mechanism in the early tax certainty process as a kind of simplification where tax authorities and MNEs agree on something already in place that provides confidence to the tax authorities. He noted that it was not intended to suggest that MNEs should not rely on what is already in place.
Tax base
The panelist who discussed this topic addressed several issues in relation to tax base. She questioned the rationale for accepting the carryforward of losses, including limited pre-regime losses, but not profit shortfalls (i.e., profits below the 10% threshold). This could disturb the level playing field for companies that report profits around the 10% margin. Furthermore, the carryforward period was considered limited compared to regular country practices. Finally, the question was raised as to how such carryforward would interact with the Global Anti-Base Erosion rules under Pillar Two and whether it would create a deferred tax asset.
Based on the Progress Report, the profits of less than 100% owned consolidated entities would be fully included in the various calculations. It was noted that this approach could create potential distortions, with a recommendation to include such entities on a pro rata basis for the various Amount A calculations.
Some of the tax base related rules were identified as leading to a significant compliance burden for MNEs, such as the reversal of the effects of purchase price allocations and the requirement to spread asset gains and losses, in particular when related to transactions and periods before the introduction of Amount A. It was suggested that removing such requirement and replacing it with an election for the taxpayer to apply such rules if it would provide a simplification.
Finally, it was noted that withholding taxes should be taken into consideration when determining the EODT. In absence of this, there could be an obligation for a jurisdiction to pay a tax refund without any tax having been collected.
Pross responded that the minority-owned shareholdings situation is subject to discussion within the Inclusive Framework, which was signposted by the explicit request in a footnote in the Progress Report for comments. On withholding taxes, he noted the potential implications of the current exclusion and the need to resolve this issue, both in relation to the elimination tax base and the MDSH. On profit shortfalls, he commented that various stakeholders had different views on this and that the debate around this was part of a wider discussion on averaging of results.
Unilateral measures
The panelists discussing unilateral measures emphasized that part of the agreement of the Inclusive Framework was the commitment to withdraw all unilateral measure and not introduce such measures in the future. The narrow definition of unilateral measures, combined with the list of exclusions (value added-taxes, transaction taxes, withholding taxes and rules addressing the abuse of the existing tax standards) could potentially lead to unilateral measures remaining in place, with the risk of proliferation of measures in the “grey area.” The introduction of unilateral taxes such as significant economic presence taxation and online sales taxes in 2022 by Inclusive Framework members fuels this concern. One of the panelists noted that any tax measures that discriminate against particular industries or that would create trade barriers should not be allowed. Clarification on the treatment of diverted profit taxes was requested. Furthermore, the analysis of unilateral measure should not just be done on a de jure basis but also on a de facto basis.
The view that the requirement to abolish unilateral measures should also apply to subnational taxes was expressed, although it was noted that in certain countries, such as the US, this could be difficult to effectuate.
Clarification of the consequences of introduction of unilateral measures by individual countries was requested. Furthermore, the economic risk of introduction of such measures was stressed.
In response to a question from the audience on whether the exclusion for Regulated Financial Institutions would be reviewed in the future, Pross responded that if the current guidance on where to draw the line would not be clear, this should be looked at. However, he stressed, every line drawing will raise some challenges. Companies that have comments on the current distinction are encouraged to engage with the OECD Secretariat or the country delegates.
Closing remarks
At the closing of the consultation, Pross indicated that the written submissions and the discussions during the consultation were extremely rich. He indicated that there is more work to be done on the MDSH, including the need to do more to minimize distortive results. On revenue sourcing, he said it was a journey from the extreme transactional approach in the initial consultation document to the Progress Report, noting that the work has come a long way but there still is a long way to go. He stressed the importance of the treatment of unilateral measures and also the need for a workable certainty system. He expressed the view that in order to stabilize the system, Pillar One needs to be beneficial on a widespread basis. Finally, he noted the role of Pillar One in alleviating trade tensions.
Implications
The public consultation provided a valuable opportunity for businesses to share practical perspectives on key features of the proposed design for Pillar One Amount A. Comments from the OECD Secretariat acknowledged that there is work still to be done, including in particular more work on revenue sourcing, the design of the MDSH and the design of the EODT rules. The importance of the commitments with respect to unilateral measures and the need for workable tax certainty processes was also stressed. At the same time, the Co-Chairs of the Tax Force on the Digital Economy emphasized the deadline for getting to signing of the Pillar One MLC by mid-2023 which will require that the work advance quickly.
It is important for businesses to continue to monitor developments with respect to Pillar One over the coming months, including the proposals related to Amount B that are expected to be released by the end of 2022. Businesses also may want to model the potential implications of the proposed design for Amount A for their tax profile and consider engaging with OECD and country policymakers as they continue to work to further flesh out the mechanics of Amount A.
For additional information with respect to this Alert, please contact the following:
Ernst & Young Belastingadviseurs LLP, Rotterdam
- Ronald van den Brekel
- Marlies de Ruiter
- Maikel Evers
Ernst & Young Belastingadviseurs LLP, Amsterdam
- David Corredor Velasquez
- Konstantina Tsilimigka
Ernst & Young Limited (New Zealand), Auckland
- Matt Andrew
Ernst & Young LLP (United States), New York
- Tracee J. Fultz
- Joana Dermendjieva
Ernst & Young LLP (United States), Washington, DC
- Barbara M. Angus
- Mike McDonald
For a full listing of contacts and email addresses, please click on the Tax News Update: Global Edition (GTNU) version of this Alert.
