Shortfalls remain in the OECD’s progress report on Amount A of pillar one, according to public comments published on August 25, with companies raising concerns over complex sourcing rules and an uneven playing field.
“The common theme in comments made by large corporates in respect of pillar one, both formal and informal, is that the proposed rules are incredibly complicated, difficult to understand in terms of practical application and that they still house some major gaps,” Leiza Bladd-Symms, partner at law firm LCN Legal in London, tells ITR.
Amount A has been designed to address tax challenges arising from the digitalisation of the global economy.
Under the rule, large profitable enterprises can be taxed by individual jurisdictions and have a portion of their profits allocated to the countries from which their sales originated.
If implemented, pillar one will target companies at a group rather than an entity level, and will apply to multinational enterprises (MNEs) with over €20 billion ($20.05 billion) in revenue. The group’s profitability measured against its total revenue must also exceed 10%.
Following the OECD’s progress report, which was published in July, MNEs have shown a significant reluctance to implementing the rules, leaving tax specialists to question their efficiency.
ITR takes a look at the biggest concerns that companies raised in the consultation, the results of which were published last month.
Sourcing rules lack simplicity
Most MNEs agree that pillar one sourcing rules remain complex and will be significantly challenging for taxpayers to implement in the future.
Michael Beard, senior tax manager at advisory firm Evelyn Partners in London, says that the length of responses illustrates that the framework lacks simplicity.
“The fact that businesses have so much to say with regards to the current proposal, and the fact that these views are not necessarily consistent or aligned, demonstrates that we are still very distant from making a global agreed approach to formalising pillar one.”
Revenue sourcing rules are designed to determine where revenue arises, sourced on a transaction-by-transaction basis. This way, MNEs identify the relevant market jurisdictions from which revenue is derived and allocate the profit.
However, pillar one rules set out complex requirements despite a very limited number of companies within scope – which has left many corporations to question the worthiness of the process.
Taxpayers will need to calculate what they are reallocating to jurisdictions and ensure they are not doing so to profit from what was already taxed. For this to happen, sourcing rules need to be clear and concise.
James Ross, partner at law firm Taylor Wessing in London, says the OECD’s work on sourcing rules has been a “hell of a job,” given the diverse interest in so many directions.
“To get a political consensus on this model is impressive,” he says. “The moment you start unpacking it you almost start again. The alternative to all of this is a whole load of unilateral action in individual countries.”
However, in the list of comments published by the OECD, Microsoft considered the sourcing rules to be “simply unworkable”, particularly for B2B models.
The company said the objective of the rules – to source revenue from the location of the end-user of the goods or services – was unrealistic.
“To reduce complexity, non-customer revenue should be excluded from the sourcing requirement,” suggested the company.
MDSH flaws detected
Multinationals source revenue from the jurisdiction in which they have a taxable presence. Under Amount A, the residual profit that will be allocated to the market jurisdiction will be capped by the marketing and distribution safe harbour (MDSH).
This is established to address issues related to double counting, such as when a country can tax residual profits of a multinational in two different ways – through profit allocation rules and Amount A allocations. The MDSH prevents such a situation.
However, corporations claim the MDSH does not meet the intended policy aim and could lead to discriminatory results, failing to create a level playing field among taxpayers.
Nestlé noted that the formula discriminates against smaller market jurisdictions, which means the pillar one rules will not achieve a stable international tax environment and could create even more inconsistency.
“In the situation where the threshold which distinguishes between routine and residual returns is not determined accurately, but is set at too high a level, there will be a remaining incentive for aggressive market jurisdictions to argue that more sales and distribution related profits should be taxed in their jurisdiction,” stated Nestlé in its response to the OECD.
“Hence, transfer pricing (TP) disputes will remain with all issues and costs connected,” added the company.
The formula sets the threshold between routine and residual profits too high, which could lead to the MDSH being ineffective, according to Nestlé.
Nestlé said the MDSH should be combined with a mechanism that eliminates double taxation that does not discriminate based on the market size.
“For the MDSH, we strongly believe a return on sale is more adequate in line with business reality and that the remuneration for routine returns should be set at 5% or less,” added the company.
Other multinationals including Unilever have emphasised this point. The group considers the MDSH to “not fully function as intended” and that “unintended double taxation of income or an uneven playing field” could result.
Technology company Microsoft suggested the MDSH should be amended to eliminate the risk of double counting.
“We were surprised to see various complex and burdensome limitations to the MDSH in the progress report,” stated the corporation.
“We recommend elimination of several elements of the MDSH calculation: the arbitrary ‘Y’ limitation; the use of return on depreciation or payroll, which appears antiquated and does not reflect all costs in a market jurisdiction; and the unexplained ‘higher of’ 40% threshold,” it added.
The Coca-Cola Company echoed Microsoft’s thoughts – proposing the threshold for the MDSH to be revisited as the current mechanism could be left unavailable to many local market enterprises.
“We were surprised and disappointed to see the definition of residual profits determined by reference to a 10% routine return on sales,” noted Coca-Cola.
“In practice, as also shown in statistical analyses, a 10% return for a distributor is not a routine, and we believe the experience of both multinational and governments bears that out,” it added.
In addition, the MDSH could increase administration compliance and complexities for multinational groups within scope, according to Unilever.
To carry out the calculation of the mechanism, taxpayers must complete all Amount A calculations – which means undergoing all the Amount A compliance burden despite the possibility that there is a minimal Amount A due.
It’s not achieving what it’s seeking
A key practical issue concerning pillar one is whether it achieves what the rules were initially designed for. In other words, is it achieving what it’s seeking – the appropriate reallocation of profit to jurisdictions and the elimination of double taxation?
“A number of corporations have identified concern as to whether the safe harbour mechanism would work properly,” says Ross of Taylor Wessing.
Unilever, for instance, claimed the rules fail to achieve their objective, particularly in regards to the mechanism of how profit is distributed.
The company said a key question is whether pillar one results in a partial reallocation of residual profits earned from consumers in a particular jurisdiction that are otherwise reported and taxed in another jurisdiction.
Taxpayers are also concerned over whether appropriate credit will be given for withholding tax purposes.
Withholding tax should be considered in the application of Amount A, according to Unilever, as it is already a source taxation in the jurisdiction to which the profit may be allocated.
“For the relieving jurisdiction, Amount A is also relevant as withholding tax may impact the amount of tax paid to the relieving jurisdiction,” stated the company. “In other words, double taxation and double counting may easily arise.”
Seema Kejriwal Jariwala, partner at law firm BMR Legal in Mumbai, tells ITR that withholding taxes have emerged as “the new bone of contention”, in which taxpayers want them to be included in Amount A.
This issue has been largely disputed by the intergovernmental group G24.
On August 15, the G24 – when commenting on the progress report – claimed the consideration of withholding taxes in amount A could lead to erosion of existing taxing rights and could jeopardise pillar one’s attractiveness for developing countries.
What next?
Corporations remain reluctant to implement the current design of pillar one’s Amount A, particularly as some, including pharmaceutical company AstraZeneca, are concerned about the specific implications for their industries.
Most taxpayers also want to review the entire pillar one system, instead of focusing solely on Amount A, before achieving any final decision.
While pillar one discussions may have brought together over 135 jurisdictions, reaching a global consensus on profit allocation rules remains a way off yet.
If the OECD fails to simplify pillar one, countries could enter bilateral discussions to achieve the results they want, especially if no alternatives are offered.
In the meantime, corporations may choose to focus on what they can control, according to Bladd-Symms. This means simplifying their corporate structures and TP policies, ensuring legal and operational substance in their arrangements, and continuing to use technology to streamline their tax compliance.
