By Oliver Treidler, TP&C GmbH, Berlin
On 16 January the German Federation of Industry (BDI) hosted its annual international tax conference in Berlin. The name and theme of the conference was “New World Tax Order for a Digitalized Economy.”
On the agenda was the unified approach proposed by the OECD, specifically, pillar one (the challenge to the profit allocation and nexus rule), pillar two (global anti-base erosion proposal or GloBE), as well as tax dispute avoidance and dispute resolution mechanisms.
The line-up of panelists featured the leadership from the OECD (Pascal Saint-Amans, Achim Pross), the Department of International Taxation at Germany’s Federal Ministry of Finance of Germany (Martin Kreienbaum) as well as leading representatives from the tax departments of large German and US MNEs (e.g., Siemens, Daimler, Johnson & Johnson, Procter & Gamble).
The audience got treated to an intriguing dialogue between the business community and the OECD.
The key-takeaway? Do not blink! 2020 will bring substantial changes to the world tax order. The OECD left no doubt that the train (for change) has left the station, and it is neither coming back nor slowing down.
Some of the main takeaways are summarized below.
The academic perspective – OECD is prone to overshooting policy objectives
The very first speaker, following opening statements, was Professor Christoph Spengel of the University of Mannheim, who provided an academic perspective (mostly) on pillar one.
Spengel raised some highly intriguing and excellent points on the fundamental architectural flaws of pillar one that should provide food for thought for all stakeholders.
He elaborated on the concept of value creation within the digital economy and emphasized that a sound and more nuanced technical understanding of the role of valuable people functions would be crucial to develop sustainable policy recommendations.
He stressed that data is not a rival good and should not be treated analogously to oil for tax purposes (i.e., mere data collection will most often not be a key value driver).
He repeatedly stressed that, in its current form, the pillar one proposal, especially the components going beyond the arm’s length principle, break with the concept of taxation at the point of value creation.
In his view, the pillar one and pillar two proposals reflect an “overshooting” of the original policy aims.
Most of his distinctly critical conclusions criticisms were voiced by various stakeholders during the OECD’s public consultation on pillar one and two; for example, that the unified approach adds complexity and has potentially little effect on tax revenues; that reliance on existing CFC legislation, thin-cap rules, and withholding taxes at source rules is preferable to the GloBE proposal; and that VAT ensures tax revenues at the market jurisdiction and is more in line with existing principles tax principles.
Spengel concluded that, viewed in totality, there are good arguments for not going forward with Amount A.
The OECD perspective – time for technical debate is over
While the other panelists seemed generally willing to acknowledge the conceptual validity of the points raised by Professor Spengel – at least no one was willing to debate the points – it became quickly apparent that the time for engaging in debate about fundamental or architectural issues is over.
This was made abundantly clear by Saint-Amans at the beginning of his much-anticipated speech. Saint-Amans, who is director of the OECD’s Center for Tax Policy and Administration, emphasized that the window for action is closing fast and, alluding to the political landscape, stressed that we are no longer looking a twelve month process of further deliberation, but rather that the sole concern is on what is happening “now” – with negotiations clearly outweighing any further technical work.
He also left no doubt that the negotiations are no longer exclusively addressing the digital economy (to the surprise of hardly anyone). In the further course of the conference, the proposed Amount A, Amount B, and Amount C as cornerstones of the new world tax order were largely taken for granted.
The position of Saint-Amans was readily seconded by Kreienbaum, Germany’s Director General of International Taxation at the Federal Ministry of Finance, who called for strong international coordination, going as far as hinting that continuing to question the proposal could potentially jeopardize the process of building consensus.
It became apparent that Germany will be quite likely to compromise on Amount A and Amount B, provided that an adequate solution for tax dispute avoidance and resolution mechanisms can be agreed upon.
Respective solutions were later sketched by Pross, albeit in rather vague terms. Pross, who is the OECD’s Head of International Co-operation and Tax Administration, explained his commitment to work toward ensuring that the new taxing rights (Amount A and respective nexus rules) should be “born” together (like “siblings,” even though he did not use this term).
Pross’s commitment includes exploring novel approaches for facilitating “early certainty” for businesses with respect to the calculation and subsequent allocation of tax payments. The list of open issues — blending rules, business segmentation, accounting for losses – to name just a few — was, however, conspicuously long.
Most importantly, Pross also left no doubt that various stakeholders from developing countries are unlikely to substantially compromise on the issue of arbitration.
It remained unclear how brokering a consensus may actually be feasible under these constraints.
Other notable remarks of Saint-Amans and Pross — notable because they seem to give a glimpse into the general thrust of the political side of the debate — were targeted at the key issues of sovereignty and complexity.
In respect to sovereignty, Saint-Amans tried to characterize the rationale of the unified approach as “strengthening tax sovereignty by limiting tax sovereignty.”
While this may arguably be an appropriate characterization of the unified approach, it reflects a somewhat questionable idea of the concept of sovereignty (and tax competition).
Also, such a statement seems to border on a declaration of failure regarding the effectiveness of the earlier BEPS reforms.
If the BEPS reforms were considered successful, could there really be a strong reason to curtail the (tax) sovereignty of individual (low tax) countries? In other words, does the impact and success of BEPS need to be obscured to facilitate progress on finding a consensus on the unified approach?
Some panelists, notably Katherine Amos, Vice President of Global Transfer Pricing and Tax Disputes at Johnson & Johnson, explicitly commented on the fact that the earlier BEPS reforms, including such vital concepts as DEMPE, were conceptually sensible and still to be regarded as being in an early stage of implementation (i.e., no sound empirical evidence on the success or failure of the effort to better align value creation and taxation is available at this time). These comments were unfortunately not addressed by the OECD representatives.
Other, more explicit, critical remarks on the erosion of sovereignty were made by Channing Flynn, EY Global International Tax and Transaction Services Partner.
Flynn’s comments were, however, met head-on by Pross, who seemed genuinely taken aback by this notion and emphasized that the OECD prides itself on acting as an honest broker facilitating consensus between all countries concerned. He called this “building a bridge that actually holds-up.”
No reform would be implemented that was contrary to the expressed consent of elected politicians of each country, Pross said.
The somewhat toned-down notion evoked by business representatives, namely that the OECD would be “holding the pen” with which the agenda is written and thus obviously yields quite substantial power over the agenda, remained uncontested.
In respect to the other key issue, namely, increasing complexity, Saint-Amans expressed the opinion that the existing transfer pricing system was already highly complex and that, to him, the criticism of the complexity of the unified approach was not understandable.
He actually made attempts to ridicule such notions, which seems somewhat odd, as the unified approach is applied on top of the existing system (not replacing it).
Saint-Amans notions also beg the question of whether sufficient effort to reduce existing complexities was made during the earlier stages of the BEPS project.
While business representatives did not argue this issue directly, it was made clear that the additional complexities inevitably connected to the unified approach are cause for grave concern from their perspective, with the segmentation between digital and non-digital business apparently causing the most serious headaches.
Unsurprisingly, almost every business representative emphasized that finding pragmatic (smart) solutions featured high on their wish lists.
The perspective of the business community – more time and damage control
As can be seen from the reactions to the two key-issues above, the responses from the business representatives were a bit timid and mostly addressed specific concerns about challenges of implementation.
Fundamental or systemic issues did not seem to feature high on their agenda. The one thing all business representatives unequivocally expressed, in comparatively strong terms, was that more time is needed for finding pragmatic solutions that contain the administrative burden and reduce tax uncertainty.
On balance, the business representative displayed a far-reaching willingness to cooperate with the OECD on crafting the technical issues. While the political pressure exerted on the OECD to swiftly present solutions (“now”) was acknowledged by the business representatives, not a single commentator seemed inclined to accept that the tradeoff – the forced adoption of half-baked solutions — would be beneficial for business or any other stakeholder.
Multiple representatives questioned whether the current situation is indeed one of high risk (in terms of potential revenue losses for tax authorities).
Further, the argument was made that the timeframe of BEPS was somewhat mispresented by the OECD. While the initial BEPS project was targeted at aggressive tax structures used by a few big MNEs, the unified approach now on the table clearly has a much wider scope (a new world order for all taxpayers) and should consequently be allocated an amount of time that is commensurate with the transformational nature of the task at hand.
The OECD representatives did not disagree, but it seemed rather obvious that this call to reason will likely remain futile. The “now” voiced by Saint-Amans still seemed to hang in the air.
Other intriguing observations and comments made by business representatives included that the media have been a driving force for creating the perception that companies were not paying their (fair share of) taxes.
In this context, Krister Andersson (Vice-Chair of the Business at the OECD Tax Committee and Chairman of the Tax Policy Group ‘Business Europe’) said that the economic facts were not sufficiently taken into consideration to facilitate a more rational discussion. This point seems highly relevant, as it explains the “overshooting” nature of the proposals criticized by Professor Spengel and could further be seen as constituting a strong argument for allowing for more time to make more informed and targeted reform proposals (let alone allowing for a more fundamental rethinking of the desired architecture of a new world tax order).
Unfortunately, this aspect was not commented on by OECD representatives. In a refreshingly blunt contribution, Georg Geberth, Director Global Tax Policy at Siemens, pointed out that the unified approach is a “total departure from BEPS” insofar as it is also departing from the premise of aligning taxation at the place of value creation as it was understood in the context of BEPS.
While the unified approach may be quite appealing for (some) ministers of finance the details and impact on the tax world could be quite horrible, he said.
Lastly, one of the most striking and memorable observations was made by Amos, who cautioned that the introduction of formulary apportionment (coinciding with the departure from the traditional understanding of value creation) could well turn out to be a cuckoo’s egg that will substantially weaken arm’s length based transfer pricing.
Again, the systemic departure from BEPS and the arm’s length principle was (strangely) not discussed further.
Final observations – new world tax order will be based on political negotiations not on economic considerations
My overall impression was that the OECD is no longer keen to actively engaging in a dialogue with the business community on systemic issues.
Beyond listening a bit, however, the OECD at this stage seems exclusively focused on brokering a consensus between the countries based on the existing draft proposals, with a distinct emphasis on speeding up the process. Likely, the OECD will release an update of the Unified Approach proposal in late February at the G20 meeting and a detailed report should be due in April.
Great surprises seem unlikely. My bet is that the updated proposal will include Amount A and Amount B (which was commented on generally favorably by many business representatives) in largely unchanged shape and form.
Amount C and pillar two have more potential for surprises and further, albeit comparatively minor, changes or additions seem more likely than not.
Brokering a consensus seems to hinge on offering the non-market countries an increase of (perceived) tax certainty that is (just) sufficient to make them feel comfortable with surrendering a slice of their tax base to the market-countries.
Whether a consensus can eventually be reached will ultimately depend on the size of that slice. The OECD seems committed to move heaven and hell to achieve a consensus – but adoption of the proposal is not a foregone conclusion at this point. That may be good or bad, depending on one’s point of view.
The business community seems to be largely in “damage control” mode. While many quite serious concerns were voiced, the volume of the voices was rather muted.
It was, maybe a bit reluctantly, accepted that as the train has left the station and that there is no turning back. Provided that the most pressing concerns are appropriately addressed, the business community seems generally willing to support the OECD in their further efforts, as most (not all) representatives, seemed to evaluate the consequences (i.e., countries adopting unilateral measures) of a failure to reach consensus as potentially more harmful than arranging themselves with the unified approach.
The academics can probably safely return to their universities. While their input would clearly be valuable in shaping an informed discussion on the architecture of a new world tax order, their impact on the political negotiations will likely be negligible.
In other words, any hopes of seeing a thorough rethinking of the building blocks of the future world tax order can be safely buried.
Some of the participants may have actually paused to wonder how broad the scope for discussions of the unified approach was to begin with. Was the public discussion just elaborate window-dressing for a fait accompli?
In sum, it was a great conference, providing a great illumination of the realities of the state of play on the unified approach.
Going home, however, I was thoroughly frustrated, as the realization settled in that the new world tax order will almost exclusively be determined by the (perceived) necessity by politicians to adopt an ever-stricter stance on taxation and to further broaden their tax bases.
There was not a single person in the room that did not agree that the world tax order needs an update. Most participants further seemed perfectly happy to accept that such an update would result in allocating additional tax revenues to market-countries. Most of all, there seemed to prevail a general confidence that a solution for a sensible (less radical and more principled) new world tax order can be found – provided that time commensurate with the transformational nature of the task is available.
If anything, the conference has illustrated that more, not less, dialogue on the fundamentals of the tax system is required.
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