Countries won’t abandon arm’s length principle in global tax overhaul, US official says

by Julie Martin, MNE Tax

Despite language in a recent “Inclusive Framework on BEPS” policy note, there is little chance that countries working to achieve consensus on new rules to govern which country can tax multinational group profits will agree to “radical” proposals such as formulary apportionment or a tax on highly digitalized business models, Treasury Deputy Assistant Secretary for International Tax Policy L.G. “Chip” Harter said February 1.

Rather, it is more likely that consensus will build around a US proposal for a modest increase in market jurisdiction taxing rights coupled with a global minimum tax, said Harter, who spoke at a conference cosponsored by Georgetown Law’s Institute of Economic Law and the International Tax Policy Forum.

Harter said that a policy note released January 29 by the Inclusive Framework on BEPS, an OECD-led coalition of 127 countries, makes it clear that the international community is fundamentally reexamining of how to allocate taxing rights over MNE profits between nations.

The US will release in 2–3 weeks its own 25-page paper discussing two pillars mentioned in the Inclusive Framework’s policy note, Harter said. Treasury seeks input from taxpayers on this topic.

“Although a very broad range of approaches are clearly on the table, it is important to bear in mind that the OECD process is a consensus process. I predict that the range of approaches that are actually capable of achieving consensus is pretty narrow. I am confident that there will not be a consensus to fully abandon the arms-length standard or adopt full unitary taxation. Similarly, it is becoming clear that there is relatively little support for pursuing an approach that applies only to narrowly defined classes of challenges facing the international tax system – they go far beyond how to tax search engines and social media companies,” he said.

Harter acknowledged that India, Columbia, and other G20 nations are exploring a “substantial economic presence” permanent establishment threshold coupled with formulary apportionment to bring more tax revenue to market countries. The UK and others are interested in a targeted tax applying only to highly digitalized businesses.

Pragmatic solutions

The US will continue to develop its own “pragmatic” solution of a minimum tax plus a modest increase in tax allocated to market jurisdictions based on the concept of marketing intangibles. The US believes the approach is capable of achieving consensus within the 127-nation Inclusive Framework, Harter said.

Harter that while market countries are demanding the right to tax a larger share of MNE profits attributed to goods and services sold in their markets, this share would come at the expense of headquarters and export countries. Some smaller Nordic counties derive over half their tax from MNEs that earn 90 percent of their profits in foreign markets, he noted.

To get all countries on board with revised allocation rules, the additional taxing rights granted to market jurisdictions must be “clearly defined and fairly modest,” Harter said. Moreover, headquarters and exporting countries cannot view the exercise as just the beginning of a “slippery slope” toward full destination taxation, Harter said.

Harter also said that the US is aware that developing nations are  also “at the table.” Thus, to get anything approved, the proposal must be simple to implement.

He said that a marketing intangibles approach addresses all these concerns.

Less precise, more administrable

Harter said that one could just deem marketing intangibles to be owned in a market jurisdiction where there is a taxable presence and then perform a traditional transfer pricing “facts and circumstances” analysis to figure out what the appropriate return would be.

Such an approach, however, would not be acceptable to developing nations concerned that a lack of comparables would make the plan unworkable.

As such, other less precise but more administrable plans are under consideration, he said.

“Perhaps [the solution is] something as simple as reaching an agreement that market countries are entitled to tax a percentage of revenue from in-country sales that would vary with the multinational group’s local profit margin or, perhaps, on a line of business basis. One could imagine a very simple formulary approach that defines some minimum spread that could be taxed and then have that spread adjusted upwards or downwards based on the global profitability of the line of business,” he said.

Thus, to the extent that the global line of business is returning large margins, the market jurisdiction profits can be ratcheted up. If there is no extra return, then maybe the marketing jurisdiction will receive no spread or just a low-risk distributor spread, he said.

Harter said that the information needed by tax administrations to compute the tax would come from country-by-country reporting or publicly available financials.

He added that the tax might even be collected through withholding, further enhancing its administrability.

Minimum tax

Harter also said that the US also supports a consistent and widely adopted minimum tax to level the playing field among nations.

He acknowledged that it would be difficult to get tax havens, which are also now part of the Inclusive Framework, to sign on to a minimum tax. He suggested, though, that their approval might not be necessary.

As long as a large majority of countries agree, the plan could succeed. One can incorporate defensive measures into the design the tax that would apply to any country that does not adopt the primary rules, Harter said.

Harter said that the minimum tax will be discussed in the coming Treasury paper.

He added that while some countries are looking into a per-country minimum tax architecture, they do not yet realize that this would be very complicated and will put pressure on transfer pricing. Coordination rules would also be needed if multiple countries adopt this tax, he said. 

Julie Martin

Julie Martin

Founder & Editor at MNE Tax

Julie Martin is the founder of MNE Tax. She edits the publication and regularly contributes articles on new developments in cross-border business taxation.

Julie has worked as a tax journalist and editor for more than 13 years. Prior to that, she worked as an in-house tax attorney in New York. She also holds an LLM in taxation from New York University School of Law.

Julie can be reached at

Julie Martin
Julie can be reached at

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