There are still many unanswered questions about the future international tax framework, even after the OECD managed to secure G7 support for a two-pillar solution. One of the largest omissions from the G7 July statement was any reference to profit allocation.
A global minimum corporate tax rate could be applied with formulary apportionment, but it wouldn’t necessarily have to go down this route. This is why multinational companies are now debating the strengths and weaknesses of different options.
Uber has just come out in favour of a modified residual profit split (MRPS), for instance, but the company remains highly sceptical of the other options on the table – particularly fractional apportionment.
“It is difficult, if not impossible, to identify allocation keys based on principles to which all countries would agree,” said Francois Chadwick, vice president of tax at Uber, in a recent article.
“Absent such principles, we are concerned that even the most formulaic approach could give rise to concerns of unfairness, resulting in inconsistent administration and increased disputes,” he explained.
It may be possible to target a fraction of a multinational’s global profits, but the distinction between routine and non-routine returns could be lost. This would require a break with existing principles. It would also mean greater complexity and could lead to a drastic redistribution of profits from some countries to others.
The company also considered distribution-based approaches, but ultimately concluded that there was no effective way to address advertising. It is possible to target adverts at non-paying users in one jurisdiction while the paying users are in another.
Not only does the approach lack clear principles for allocating revenue, Uber was concerned that this proposal would lack longevity, as well as open up more space for disputes and disagreements over administration. This may be another reason why US companies are happy to accept a minimum rate.
“We’ve had the experience of the minimum tax rate,” said one tax director at a US pharmaceutical company. “We’ve had the same debate for a decade and we took the aggregate approach in the end.”
“We don’t think the per country approach to a minimum rate would work,” the director said. “An aggregate approach would be better in administrative terms.”
The G7 may have anticipated losing out in this struggle over tax revenue and backed mandatory binding arbitration as a pre-emptive trade-off. However, this bet is far from certain and the next test is just around the corner. The OECD has plenty of work to do before the G20 meets in January 2020.
Four keys, one formula
Just as the OECD is trying to find a consensus, the EU is working on its own proposal to reallocate income and one possibility is to use research and development (R&D) costs as part of a common fiscal policy.
“We started with the CCCTB allocation keys and added a fourth factor, R&D costs,” said Krister Andersson, who drafted the EU paper, in a recent interview. “So you would allocate profits not just on employment, assets and sales, but also on R&D costs.”
“The goods and services that yield residual profits are often connected with marketing intangibles,” he explained. “These intangibles are the result of R&D investment.”
The traditional three keys – employment, sales and assets – would still apply, but the idea was to add a fourth key to tackle marketing intangibles. At the same time, Andersson hopes there will be space to ensure that the arm’s-length principle will remain partially in force.
“We should try to maintain as much of the ALP as possible and not embark on a completely new system,” the Swedish economist said. “We should stay as close to arm’s length pricing as possible.”
This would help to shift taxing rights to the country of origin, where the R&D investment takes place, where marketing intangibles are developed and the business line functions; but this is where the debate gets political.
“Developing countries will only get more aggressive in the future,” said one head of tax at a financial services company. “They don’t think they’re getting their fair share. They will push for some kind of formulaic approach to attribute profits in their favour.”
At the same time, there are NGOs pushing for exactly this kind of formulary system too. The Independent Commission for the Reform of International Corporate Taxation (ICRICT) wants to base its fourth key on the scales of development.
“All apportionment rules for either unitary or digital taxation are essentially arbitrary, in other words politically negotiated,” said Edmund Valpy Fitzgerald, ICRICT commissioner.
“The application of the standard Massachusetts formula would mean a massive shift in the tax base away from developing countries to developed countries,” he argued. “There is a strong case for considering an additional fourth weight in any apportionment formula – apart from assets, employment and sales – and that would be the level of development.”
This is, no doubt, why countries such as Brazil, China and India are increasing assertive in the global tax debate. Yet these countries have a greater advantage because of the size of their markets and the sway they hold over international trade.
“It is possible that there will be international space for full apportionment approaches – but the wheels grind slowly,” said Alex Cobham, chief executive of the Tax Justice Network.
“OECD members will continue to resist measures that significantly reduce the global inequalities in the distribution of taxing rights from which they benefit,” he continued. “Lower-income countries in particular may therefore increasingly see formulary alternative minimum taxes as a powerful option to protect their fiscal sovereignty.”
There is, however, plenty of room for the project to be derailed. The NGOs want one solution, while the OECD has to find a compromise between numerous nations that have opposing interests. Those companies hoping for a solution which restrains fiscal nationalism could be waiting for a long time.