OECD Pillar One: a closer look at the proposal’s impact and the questions that remain

By Philippe Paumier, VECTOR TP, Paris

The beat goes on in the international tax and transfer pricing scene, with the public release of the OECD blueprints on Pillar One and Pillar Two, the supporting impact analysis, and the announcement of a public consultation.

While it has been recognized by the G20/OECD Inclusive Framework that the process might only reach the conclusive phase by mid-2021, it has equally been stated that the blueprints provide a “solid base for future agreement” and “a solid basis for a systemic solution that would address remaining BEPS challenges.”

Regarding Pillar One, the cover statement notes that work will “now focus on resolving the remaining political and technical issues.”

As the Director of the OECD Centre for Tax Policy and Administration, Pascal Saint-Amans, of put it during an OECD tax talk held October 12,  “there is no agreement but a good dynamic.”

Such dynamic confirms that there is still momentum for reshaping the international tax system; there is mass and speed.

Masses in motion: economic impact assessment on Pillar One

The OECD also released an economic impact assessment document, an incomplete document, as it aims to model the impacts of options that are yet to be agreed upon by the Inclusive Framework (scoping, thresholds, split factors, etc.).

While it might be tempting to immediately elaborate on the acknowledged limitations of the model, it is interesting to take note of the main trends outlined in the document.

Despite the many scenarios documented in the assessment, the communication of the OECD seems to be structured around the 10/20 scenario for MNEs with revenues exceeding EUR 750 million, with Amount A being triggered by group profitability above 10% (profit before tax) with a reallocation of 20% of the surplus to markets.

Despite the many scenarios documented in the assessment, the communication of the OECD seems to be structured around the 10/20 scenario for MNEs with revenues exceeding EUR 750 million, with Amount A being triggered by group profitability above 10% (profit before tax) with a reallocation of 20% of the surplus to markets.

Under those assumptions, the total amount of residual profits (above 10% profit before tax) would be in the area of USD 500 billion, triggering a reallocation of circa  USD 100 billion in taxable base. 

As expected, and in line with previous communications, the contribution of Pillar One to the global corporate income tax is modest and mainly driven by the reallocation of residual profits currently located on investment hub jurisdictions to markets (triggering a material tax differential).

Out of the USD 47–81 billion in additional revenues the two pillars could generate, roughly 10% are generated by Pillar One, while 90% are the result of Pillar Two.

It is difficult to ascertain the share of automated digital services versus consumer facing business that generate that 10% impact upon global corporate income tax.

The impact assessment, in Table 2.3 on page 35 provides nevertheless an interesting metric: between 79% to 85% of residual profits to be reallocated by Pillar One are sourced from consumer facing businesses and the share of automated digital services remains quite modest, not to say marginal.

Even if that split can partially be rebalanced when factoring the tax differential in the residual profit allocation; the fact might just be that consumer facing businesses are delivering the bulk of corporate income tax benefits of the so-called answer to the tax challenges arising from digitalization.

Finally, one can regret the absence of country-level data, which was not allowed by the member states, which would have provided us with a glimpse of the underlying dynamics of the Paretto efficiency issue within the Inclusive Framework, which occurs when it is impossible to make one party better off without making someone worse off.

Going forward: important technical intricacies that require actionable input

The public consultation document released on October 12 provides an interesting view of which debates will officially involve the practitioners and which will be solely discussed within the Inclusive Framework: technicalities for technicians, politics for the Inclusive Framework.

Comments are indeed sought “on the technical aspects of the Blueprint that may help to reduce cost and complexity and improve tax certainty in the administration of Pillar One for both tax administrations and taxpayers alike.”

Seeking practical input on a large number of items (38 specific issues at stake) where the business community and civil society can provide actionable and critical input is certainly a better option than the less technical, though crucial, issue of scoping (mor precisely, industry carve outs). .

Most of the topics addressed in the public consultation document tackle the complexity of the mechanisms that could be rolled out under Pillar One. It will be of the utmost importance that the business community provides evidence-based arguments when addressing items such as segmentation, carry forwards, or the identification of the paying entities within the MNE.

Providing sound guidance on many of these items is key to the design of the solution’s architecture.

For instance, the important question of segmentation of the amount A (business and geographical segmentation) can have far-reaching ramifications. Beyond the practical calculation aspects of Amount A, these options could have an impact on the value itself of Amount A.

A proper assessment and significant modeling should be initiated, if not done yet, by in-house professionals to identify the impact of the many options that could arise from these discussions.

In addition to the Amount A technical intricacies, the public consultation also embeds two sets of questions regarding Amount B, the baseline remuneration for marketing and distribution activities.

While conceptually simpler, the questions raised on Amount B are likely – in this author’s view – to be of paramount importance in generating consensus in the upcoming period.

As noted by Pascal Saint-Amans, most of the unresolved questions are deeply intertwined. If indeed solving some of the most important ones can pave the way to consensus, the reverse is equally true: blocking on one or two key aspects could generate a deadlock situation.

Pillar One: the future is always in motion

International taxation is never simple, and there is no such thing as a valid simple answer to a complex problem. But there are simple questions: is it all worth it based on the limited impact of Pillar One? To put things in context, the latest estimate of the VAT tax gap at the EU level was EUR 150 billion.

One can wonder if this level of creative destruction was really necessary, or whether adjacent tax tools (for digital) with a reinforcement of the implementation of the transfer pricing economics (for the markets remuneration) or a simplification of transfer pricing implementation in many jurisdictions (safe harbors with accurately adjusted metrics) would have yielded a similar outcome without the disruption.

Many believe that the arm’s length principle would have been able to live on vigorously and usefully and that it had in it the capacity to weather the ongoing and upcoming tax storms.

But in practice, most of us would recognize that the prevailing situation would have become unsustainable: not because of the arm’s length principle, but due to the limited capacity of tax administrations to effectively eliminate double taxation on a global level.

The deal that is being put in our hands is again simple: the reform of the international tax system might indeed be inevitable, as Pascal Saint-Amans said, and it will come with a cost for MNEs.

This time, and this was certainly not the case in the BEPS project, the elimination of double taxation has to be an integral part of the solution. It is only then that creative destruction might deliver its promise. So far, it is the case, but the blueprint does somehow evidence some level of difficulty with this aspect.

After the proof of concept, the truth will be in the (jurisdiction) numbers agreeing to an initiative where there will be winners and losers, unless there is a certain level of decoy effect, where Pillar Two is, at the end of the day, the ultimate goal.

While one can have serious doubts, can that option be fully discarded?