Tax nationalism goes to the World Economic Forum

French Finance Minister Bruno Le Maire and US Treasury Secretary Steve Mnuchin will meet in Davos on January 21-24 to discuss the two country’s differences over fundamental transfer pricing (TP) issues like profit allocation. The stage is set either to find a solution to the tax dispute or a confrontation.

The French government has asserted its taxing rights in the form of a digital services tax (DST), while US businesses say such a measure is discriminatory. What happens in 2020 could make or break international TP rules.

“There are a lot of ways this could fall apart,” said one tax director at a US multinational company. “We’re trying to be supportive of governments and the OECD.”

“The international tax system is getting more and more arbitrary and unilateralist,” the director said.

The OECD will be watching events in Switzerland closely because the end of tensions could help hasten a political agreement on the unified approach. The Inclusive Framework is set to hold a plenary session in the hope of reaching an agreement in February.

“Tax nationalism might be curtailed,” the tax director said. “That would be a good thing for businesses everywhere.”

One of the strange dynamics in recent years is that the international community is moving away from fiscal sovereignty and traditional TP norms like the arm’s-length principle – this is despite the rise of nationalism all around the world. No one expected the US to be pushing for a global minimum tax rate, but there is concern about pillar one and profit allocation rules in particular.

“There is more uncertainty and more potential negotiation with pillar one, so it’s harder to tell if they will get it right,” said the tax director. “We’ve not changed the jurisdictional right to tax in a hundred years and we are seeing a dramatic shift.”

“This is why it has to be cautious and modest,” the director stressed. “If the intention is to compensate third party distributors and the methodology in place undervalues them, most people think a modest version of pillar one is defensible.”

The OECD will have to persuade the Indian government to accept some equivalent to arbitration before more developing countries would sign up to such a system. Many emerging economies are reluctant to give up their right to take unilateral action and use tax as a lever to secure greater investment. This is a big problem for businesses.

“Some companies would love to have more clarity and certainty about TP, but no one wants to pay more tax, particularly if they don’t have an office or an agent in a country,” said one tax executive at a financial institution. “I don’t think the idea of suddenly having to pay tax in such a country is particularly appealing.”

As much as the WEF meeting may be crucial, the OECD has to grapple with emerging world powers and the reality that the old international tax order is crumbling. Even powerful players like the US and France have to accept there are more than 130 countries involved in this debate.

These countries do not all have the same interests in this struggle to reform profit allocation rules. “There are at least 80 countries in the Inclusive Framework that don’t have the resources to do TP analysis correctly,” said one head of global tax at a pharmaceutical company.

“They don’t have the economists on staff. They don’t have the databases,” the head of tax told ITR. “So how can you do a comparables search without a database?”

However, the US-France talks in Davos could set the mood for the upcoming G20 meeting in Saudi Arabia. Finance ministers from the G20 countries are set to meet and discuss the digital economy on February 1-2 in Riyadh, several months ahead of the G20 leaders’ summit scheduled for November.

The OECD hopes it can finalise an agreement on the basic architecture of the proposals in February and fill in the details over the coming months and put together a final agreement by the end of 2020.

The trade tensions between France and the US are a good example of what is at stake here. Meanwhile, the European Commission has made it clear it will return to establishing its own digital tax if the OECD fails this year.

If the OECD does not make the unified approach a reality this year, the international community may see more clashes over DSTs between developed economies and taxing rights.

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