US Treasury official defends “pillar one” safe harbor proposal for new global tax rules

By Julie Martin, MNE Tax

A senior US Treasury official on December 19  said that the US is recommending that the OECD’s proposal for a “unified approach to pillar one” be rewritten as an optional safe harbor rule because even a watered-down version of a mandatory rule would not gain the approval of US Congress. 

The US safe harbor proposal, announced in a December 3 letter written by Treasury Secretary Steven Mnuchin, has thrown global negotiations for a coordinated update to the international tax and transfer pricing rules into a tailspin because it was advanced at a late stage in the discussions and seems unlikely to gain the support of many countries that are members of the “Inclusive Framework on BEPS.”

The Inclusive Framework, comprised of 130+ countries, is trying to reach agreement on new rules for taxing multinational groups by the end of 2020. As a part of any deal, it is expected that countries would repeal or stop the enactment of unilateral taxes like digital services taxes on the revenue of large tech firms.

US business divisions

Speaking at a Washington DC tax conference, Lafayette “Chip” Harter, deputy assistant secretary for international tax affairs at the Treasury Department, explained that US businesses’ reaction to OECD’s unified approach to pillar one is “deeply divided,” with some supporting the global tax deal but others vehemently opposed to any rule that would dramatically change the historical global nexus or transfer pricing standards on a mandatory basis.

Moreover, a US effort to convince stakeholders to accept a weaker version of the OECD’s mandatory approach in exchange for international tax stability also failed, Harter said. 

The opposition to a mandatory pillar one proposal is strong enough to make it impossible for the unified approach to gain the 67 US Senate votes required to implement it into law. Harter said it would not serve any useful purpose for the US to sign on to a multilateral agreement that it is unable to put into effect. 

US pillar one safe harbor

The US’s alternate proposal for a safe harbor, Harter said, would allow a multinational enterprise within the scope of “amount A” to elect on a global basis to apply pillar one. In exchange for paying more foreign tax on account of the election, the multinational would obtain the benefits of enhanced tax dispute resolution and greater administrability, Harter told the conference, which was sponsored by George Washington University Law School.

Harter said that there is “a very significant appetite” for the tax certainty that pillar one could bring in terms of providing a more formulaic approach to transfer pricing and providing tax dispute resolution mechanisms that are mandatory, time-limited, and binding. Harter said that Secretary Mnuchin anticipates that a pillar one safe harbor proposal would be picked up “fairly broadly” by MNEs. 

Harter also said that unilateral digital services taxes are expected to go into effect in about six countries in 2020 and that he fully expects that the US will retaliate through trade actions. Moreover, he said it is likely that EU will retaliate against any US retaliation. “The world needs an exit ramp from a very messy situation and I hope that concentrates the minds of the countries around the table and leads to success,” Harter said.

OECD stays on track

Pascal Saint-Amans, director of the OECD’s Center for Tax Policy and Administration, said that the question of whether pillar one will be optional or not will be taken up by the Inclusive Framework only after there is an agreement on the architecture of pillar one.

Pascal Saint-Amans, director of the OECD’s Center for Tax Policy and Administration, said that the question of whether pillar one will be optional or not will be taken up by the Inclusive Framework only after there is an agreement on the architecture of pillar one.

The next step. Saint-Amans said, is for the OECD is to try to obtain consensus within the Inclusive Framework in January on an outline that will emphasize countries’ commitment to continuing a coordinated international tax update and which will note an expectation that agreement will be reached on items such as of amounts A, B, and C,  and on scope, nexus, and tax certainty. The outline will also note the US’s position on optionality and the reaction of other counties to the US position. It is possible that this outline will be agreed to “without prejudice,” Saint-Amans said. 

This outline will be presented to G20 finance ministers for their February meeting in Saudi Arabia at which time it will be made public, Saint Amans said.

After that, the OECD will focus on attempting to achieve consensus among countries on the main features of pillar one by July 2020. Only after the features of pillar one are set will optionality be addressed.

US efforts to convince taxpayers 

Harter said that discussions among US stakeholders about the OECD’s unified approach have been very divisive. He said that the unified approach’s plan to reallocate taxing rights only for consumer-facing business is particularly controversial. It is difficult to explain why wholly digital business-to-business sales are not covered.

Another area of contention is the low threshold for taxation. He said that under the OECD plan, taxing rights could be allocated to a market country wherever an MNEs goods end up, even if they got there through an unrelated distributor and if the MNE had no interaction whatsoever with the country. Moreover, MNEs are worried that this new nexus threshold would eventually be applied to areas beyond taxation. 

To respond to these concerns, the US advanced a pillar one proposal about one month ago, Harter said. Under this proposal, sales into a jurisdiction would not automatically create nexus and classic digital “scale without mass” business-to-business transactions would also be covered.

Under the US plan, nexus would be created and thus a country would be entitled to a portion of amount A if one of four conditions were met, namely, if any part of the global enterprise has taxable nexus in the country under the traditional rules, if the MNE is engaged in a classical offshore sale of digital goods or services, if there is substantial offshore expenditure of targeted advertising or brand development, or if there is licensing or franchising of consumer brands into a country from offshore. If an MNE’s products wind up in a country where none of those activities occurred, the country would not get a share of amount A.

Harter said the US believes that such a proposal would allow 90–95 percent of sales to lead to profit reallocation under amount A. This view was supported by Tim McDonald of Procter & Gamble who said that his company has a taxable presence in 71 countries but goods are actually sold in about 200 countries. McDonald said that over 99 percent of Procter & Gamble’s sales are in the 71 countries where the company has a physical presence.

The US proposal did not gain sufficient support of US stakeholders, though, Harter said.  “[T]here is no room or hope that the United States can actually implement agreements and legislation that dramatically change the historical nexus and transfer pricing rules on a mandatory basis,” he said.