Elements of the Organization for Economic Cooperation and Development (OECD) 's "ambitious" new framework for international tax reform will require critical approval from leading economies in order to successfully implement the new system, say market participants.
“One of the biggest challenges we have left is how the US will do this from a domestic perspective so that the treaty can be amended and we can then move towards global implementation,” said Aamer Rafiq, UK tax partner at PwC .
"They (the US) are a big, big stranger to how they're going to get this across the line right now," Rafiq says.
While over 130 countries (including all of the world's largest economies) have committed to high-level political agreement on the OECD proposals, it is believed that a number of significant technical and political challenges are currently jeopardizing the October 2021 deadline for the implementation plan.
The increasing criticism of the proposals from Republicans in recent months has further complicated matters, as changes to the US tax treaty traditionally require the support of a two-thirds majority in the Senate. "You certainly wouldn't have the votes to approve such a treaty," Republican Senator Pat Toomey said in an interview with the Financial Times, calling the proposals "crazy."
The OECD / G20 Inclusive Framework on BEPS 2.0 consists of a two-pillar approach aimed at digitizing the economy and its effects on taxation. The first pillar, which advertises new profit distribution mechanisms in order to expand the tax sovereignty of the market jurisdictions, is said to be significantly more complex in terms of implementation.
Companies falling under the first pillar proposals will be multinational companies (MNEs) with global sales of € 20 billion and a pre-tax profit margin of over 10 percent. Part of this margin (currently estimated at 20-30 percent) is then allocated to the market jurisdictions.
Although the threshold is expected to be reduced to € 10 billion after seven years, the parameters initially only cover around 100 companies. The Biden government's influence on the implementation of the framework is therefore pronounced, with many of these companies headquartered in the United States.
“The US will be an important driver of how quickly this can be implemented at the national level. That will pretty much determine the schedule for many countries, ”says Andrea Tolley, partner at KPMG.
"The right timing will be crucial from a US perspective."
"A painful transition"
The international tax community has also raised significant concerns about the fundamental nature of the new framework, arguing that its complexity may not match the OECD's ambitious timeline.
Ben Jones, tax partner at law firm Eversheds Sutherland, points out the unprecedented nature of the proposals. While it's an overwhelmingly positive initiative, the scale of the task is daunting, he says.
“Ultimately, there is no international tax law, but a whole series of national tax laws. The aim of the OECD is to get countries to adopt a unified approach, and that is almost unknown in the tax area. "
Two core dates currently cover the implementation period: a report on the conclusion of the agreement and the decision-making on the technical details, which is to be presented to the G20 finance ministers by October 2021, and full implementation by 2023.
“Even bilateral agreements between one country and another usually take many years to be negotiated and ratified into law. You are calling on nearly 140 countries to agree on the formulation and delimitation of the rules in a multilateral treaty – getting that off the ground is probably the biggest challenge, ”says Jones.
Jones continues to lead the original implementation of the 2015 BEPS package. He notes that although the aim was to create a multilateral instrument, it never really worked in practice, so that the result is more like a series of bilateral agreements.
“You never really got a real multilateral treaty in the end. There was some sort of menu of choices and each country had to compare its choices with every other country, ”he says.
"What is my concern, what will come with the Pillar One and Pillar Two blueprints is that we will end up in this very messy position."
Others have raised similar concerns about whether a global consensus can really be reached, with the measures outlined in the new framework likely to have different effects on one economy to another.
As a further development of the Base Erosion and Profit Shifting (BEPS) package adopted by OCED in 2015, the OECD / G20 Inclusive Framework on BEPS 2.0 consists of a two-pillar approach that aims to address the digitization of the economy and its effects on taxation .
The second pillar ensures an unprecedented agreement on a worldwide minimum tax level of at least 15 percent, which sets a lower limit for tax competition between legal systems. The proposal is intended to prevent large multinational companies (MNEs) – above a threshold of EUR 750 million – from shifting profits to tax havens.
However, countries like Ireland, which has relied on its comparatively low corporate tax rate of 12.5 percent to attract foreign investment, are one of only nine countries not to join the new framework. Estonia and Hungary – two other EU countries with low taxes – are also non-signatories.
“The fact is that different countries have different perspectives on this, depending on what their own economy looks like and how it is developing,” says Alison Lobb, tax partner at Deloitte.
"Once you start making change there will be countries and some companies that will profit or lose more than others, and that is simply the nature of change."
This range of perspectives could prove to be a significant barrier to European implementation of the new framework, as unanimity is required to pass an EU directive, argues Lobb.
Aside from how the proposals will affect each jurisdiction, many concerns remain about how the rules can be applied consistently to businesses, with a one-size-fits-all solution being feared as unsuitable for many modern organizations.
How and who, for example, relinquishes taxation rights is a big issue, according to Rafiq.
"This is a distribution, so you have to give up taxing rights in one jurisdiction in order to pass them on to another, but most multinationals have many different lines of products so this is not a pretty easy thing."
He also points out the issue of segmentation, pointing out that there is currently no international standard for segmenting deals.
“The devil of all of this is figuring out how to get from a high-level concept to actual management. This is where the real complexity comes to the fore. "
The way ahead
Although both the G7 and G20 agree with the OECD proposals as outlined in the first and second pillars of their inclusive framework for BEPS 2.0, concerns remain about how the optimistic timetable will be achieved.
"It's not just an ambitious project, it's also a challenging schedule," says Lobb. "It takes a lot of effort, both technically and legally, to translate this into legislation and changes."
According to Tolley, the "senior" nature of the proposals in their current state paints a worrying picture.
“The biggest challenge right now is that it is a very high level main draft that is good from the point of view that all countries have been able to agree on the underlying principles, but the main concern is to actually get that into the details and how. "It will be implemented," she said.
“Pillar one and pillar two have different goals, and I think one of the main risks here is that one can progress faster than the other, or that one can be implemented faster than the other. And the other thing is that certain items have still not been agreed upon. So even though we've gone through the Inclusive Framework and the G20, all of these countries have yet to agree on some big numbers. Such problems will delay or delay implementation. "
Yet while implementation, harmonization and timing remain a concern across the industry, many still applaud the BEPS 2.0 measures for their innovation and potential to formulate a fairer and more equitable global tax system.
"Nobody likes change and change will be good for some and harm others, but if it works administratively and if it doesn't lead to too much double taxation or disputes, then I think this is the way to go in the fairest tax system," says Jones.
"I see the complexity in all of this, but it is clear that if it works, it will be a fairer tax system and better reflect the world economy than what we have now, which has been developed over 100 years."
Kevin Matthews, an accounting professor at George Mason University, agrees with Jones, noting that a bold new framework is needed to modernize the global tax system.
“From a macro perspective, this is good because the relocation strategies these larger companies employ are losing trillions of dollars to countries,” he says.
“It will also provide more incentive for artificial intelligence-based tax planning systems to adapt to the new rules in order to find out how companies can best use the introduced rules. AI has become more sophisticated in audit analysis over the past few years, but this framework could provide more incentives to develop it for the tax environment. "