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Procter & Gamble responds to Johnson & Johnson on BEPS 2.0

As the OECD tries to find a tax solution to the digital economy, the business community is thinking about what would work best out of the proposals on the table.

Johnson & Johnson (J&J) stunned the tax world by presenting a fleshed-out proposal for marketing intangibles on March 3 as part of the OECD’s consultation on the digital economy. The company was inundated with complaints, as many companies felt that the proposal did not suit their particular business model.

“We were one of the companies that complained about the J&J proposal,” said Amy Roberti, director of global tax policy at Procter & Gamble (P&G).

“We’re glad the proposal has evolved since March and I want to commend Katherine Amos for putting this proposal out there,” she added. “It’s a difficult thing to do.”

Katherine Amos, J&J’s vice president for global transfer pricing and tax disputes, drew up the proposal to take a positive line on OECD plans to tax the digital economy.

“We want a solution that’s certain, simple and keeps the arm’s-length principle [ALP] in place for the rest of the supply chain,” Amos said. “The arm’s-length principle works best when it’s a more complicated fact pattern.”

“We are nervous about any move away from the ALP, but we could move away from arm’s length in certain areas and under limited risk models,” she explained. “It’s possible to reach a trade-off.”

The J&J proposal has since become one of the blueprints for the OECD’s plans. However, this was not the aim of drawing up the plan. The hope was to show how the organisation could approach marketing intangibles.

“We are not bound by the method we put out there,” Amos said. “We wanted a method that focuses on simplicity and would cut down the number of disputes.”

Getting back to reality

Any multinational company with a vast amount of intellectual property (IP) will be vulnerable to taking a hit from the digital tax debate. This is why tax professionals were surprised to see J & J make its own case for tax reform.

The original J&J plan uses a formulaic method that starts with setting a base rate of 3% and uses three levers:

  • Assessing group profitability and profit allocation in local markets;
  • Analysing business marketing expenditure on a country-by-country basis;
  • Setting profitability targets for local market activities to limit the impact from other parts of the supply chain.

Around 30 companies came to J&J seeking to understand what the proposal would mean for their tax liabilities. The concern was that the proposal assumed higher profit margins than most businesses enjoy.

“Twelve per cent is the average operating margin for a large global company. I’ve been told that if I looked at a smaller company, the margin would be more like five per cent,” Amos said. “That seems low to me.”

Not every company was concerned about the same issue. In the case of P&G, the problem was more so that the re-allocation of profits would not suit its business model because of the way it structures its IP holdings.

“Global profit allocation doesn’t work for our business because more than 60% of our profits are in the US,” Roberti said. “That’s where all of our IP is based.”

“We’ve decided to take an enhanced redistributor return (ERR) approach rather than a residual profit split precisely because our IP is in the US,” she said. “It’s a fact and circumstances approach.”

Many multinationals do not have a physical presence in every single jurisdiction in the world, despite operating globally. Such companies can sell goods across an entire region and concentrate operations in a few countries.

At the same time, the consumer base can vary from country to country and these factors have implications for any proposal to reallocate profits to market jurisdictions.

“We have different profit rates in different countries because our product lines vary,” Roberti said. “Certain skin care products are hugely popular in Japan and China, but not in every other country where we sell our goods.”

“We earn higher profit margins on our US sales and 90% of the products we sell in the US are made in the US,” she explained. “We have separate US and international operations. This takes us back to political reality.”

Shaping the debate

The advantages of taking a positive stance on the OECD proposals was that it allowed J&J to exert influence over the digital tax debate in a way that no other company has done. Businesses could look at the proposal and assess the details.

One tax director at a software company said: “I was impressed by the J&J proposal. I feel like it was rooted in a practical sense of reality.”

After reading the feedback, Amos reconsidered some of the details and adjusted some of the numbers in the proposal. One serious criticism was that the method could end up ignoring actual business activity in some cases.

“There should be a distinction made between the tech companies that don’t have a physical presence and the companies with big sales forces and warehouses,” Amos said. “But there are two opposing views on what this should mean.”

“There is the view that companies without a presence should pay more than the companies who are really active in these jurisdictions,” Amos said. “My view is that the companies are more active in a country should ultimately pay more.”

Plenty of business leaders believe the OECD will end up with half-measures that leave international tax somewhere between the existing system and formulary apportionment. This could be a terrible mess for companies trying to navigate the post-BEPS world.

The OECD could reform profit allocation rules and inadvertently create more imbalances in the global tax system. Nevertheless, corporate taxpayers are asking themselves what would be the least painful of the options on the table.

“It’s not going to happen unless it’s a modest reallocation,” Roberti said. “The formulaic approach is the best way to achieve a modest redistribution.”

“The answer needs to be rooted in principles,” Amos said. “Otherwise we will be talking about BEPS 3.0 in a few years.”

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