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This week in tax: Pillar one and pillar two documents are leaked

In the week that the OECD’s pillar one and pillar two documents were leaked, the tax world also grappled with more US regulations and a range of tax cuts and expected future rate rises.

Allison Christians, tax law professor at McGill University in Montreal, Canada, published the leaked pillar one and pillar two blueprints on her blog this week. Christians said the draft reports had been circulating between law firms and multinational companies before they made their way to her.

The pillar one blueprint attempts to simplify the proposals and includes numerous flowcharts to demonstrate the application of Amount A in the three-tier profit allocation rules. The pillar two blueprint includes detailed definitions of in-scope and excluded entities.

The scope in the pillar one blueprint states that revenue thresholds, segmentation and profit allocation will be used to determine which entities will be liable for tax, but it does not specify the thresholds. In addition, Annex A of the blueprint provide a process map, illustrating how the new taxing right under Amount A will apply in practice.

The document states that some final decisions on technical and political issues, such as on profitability thresholds, are still pending. As a next step, the document states that further work will be undertaken to finalise the definitions of automated digital services (ADS) and consumer-facing businesses (CFB) and excluded sectors, as well as to consider any other issues where further practical guidance is necessary for implementation.

The documents will be discussed during the OECD plenary meeting of the Inclusive Framework on October 8 and 9 and then at the G20 meeting of finance ministers. G20 leaders will also consider the proposals when they meet on November 21 and 22.

Meanwhile, the United Nations has launched a consultation period on proposed changes to the UN Model Tax Convention on September 1. The discussion draft proposed including “computer software” payments in the definition of royalties in paragraph 3, Article 12 of the UN Model Tax Convention. The consultation period is open until October 2.

US issues final BEAT regulations

The US Internal Revenue Service (IRS) issued final regulations on September 1, providing additional guidance on the base erosion anti-abuse tax (BEAT) that focuses on large US corporations that make deductible payments to related foreign parties. The final regulations provide guidance under sections 59A, 1502, and 6031 regarding certain aspects of the BEAT.

“The final regulations provide detailed guidance regarding how to compute certain BEAT calculations for groups of related taxpayers,” the IRS said in a press statement. “The final regulations also contain rules permitting taxpayers to waive deductions for purposes of the BEAT, and additional guidance regarding partnerships and anti-abuse rules.”

KPMG said in a tax report that the final regulations provide “helpful changes that limit the potential scope of the anti-abuse rule”.

When the 2019 final regulations were created, many taxpayers raised concerns about the anti-abuse rules creating a cliff-edge effect. 

"The main worry around the rule was that any amount of pre-transaction basis step-up could disqualify an entire transaction from qualifying for the specified non-recognition transaction exception, even if the basis step-up was relatively small,” KPMG explained. The final regulations, however, resolve this issue.

Tax rate changes

While the US remains focused on the Tax Cuts and Jobs Act and the upcoming federal elections, the focus across Europe has been on tax rates.

Ireland reduced its standard VAT rate from 23% to 21% as of September 1 2020. This VAT cut, which is part of the July jobs stimulus package, will last for six months until February 2021.

However, in Germany, where the government announced a temporary VAT cut, the lower rate will not be extended beyond the end of 2020. Finance Minister Olaf Scholz told German newspaper Rheinische Post that the VAT cut was only for a limited period.

“This is how it creates the maximum economic effect. Because the tax cut came unexpectedly, was sufficiently large in volume and because it is temporary. We don't want anyone to postpone their purchase decision because of the crisis,” said Scholz in the interview.

Instead, the German finance minister intends to rely tax incentives and rate cuts for individuals in 2021 to support taxpayers.

In Oman, the VAT law may be implemented after January 2022. Local news reports said a joint committee of the State Council and Shura Council suggested the timeframe and have sent a draft law for approval to Sultan Haitham Bin Tariq Al Said.

Meanwhile, in the UK, concerns have been raised of tax rate increases affecting companies and the wealthy that are likely to feature in the next budget statement, expected in November or December. Several UK newspapers this week suggested tax rises are inevitable as the government tries to stabilise revenues. These will most likely relate to income tax, national insurance contributions and VAT.

However, some economists and commentators say rate increases will not be fruitful without wider reforms.

Helen Miller, deputy director of the Institute of Fiscal Studies, said: “Our best options involve not just raising taxes but reforming them.”

“It’s hard to think of a tax that couldn’t be substantially improved. This offers a significant prize. Put simply, it is the quality as well as the quantity of any tax rises that determine how economically harmful they are. If there was ever going to be a time to ensure that revenue is raised in the least economically damaging way possible, that time is now,” said Miller.

This week in ITR

This week in ITR, readers got a detailed breakdown of the views and tax strategies being used by tax directors across the Asia Pacific region.

Following on from the ITR Asia Tax Forum 2020, tax directors said there will be national divisions over group credit ratings versus stand-alone ratings in regards to the OECD transfer pricing guidance on financial transactions.

Countries like Singapore could chart a different path to the OECD guidance on group credit ratings and this will lead to more problems for businesses in the future.

“The guidance is definitely useful and welcome, but the issue is that it can cause additional issues and disputes because of how countries interact with the guidance,” said one transfer pricing director. Many others explained how they are dealing with the “black spot” created by the guidance, but taxpayers are hoping for further clarity soon.

While taxpayers wait for further TP guidance, some businesses are investing in their operational TP (OTP) systems to pre-empt difficult questions from tax authorities.

“People focus on the OECD guidelines, but without a strong OTP execution you can forget your documents and OECD guidelines. It’s the key function in the tax department,” said the head of TP at a manufacturing company based in Singapore.

Optimised OTP systems may also help tax departments with the high burden of compliance and administration expected from the pillar one proposals on taxing the digitalisation of the economy.

“There is a mountain of work ahead on compliance and administration under pillar one,” said one vice president of tax at a large consumer goods company.

With the OECD trying to gain political agreement on the digital tax proposals by the end of 2020, tax directors are worried that the blueprint is raising more questions over how to comply than it answers.

Gaining clarity is still a long way away because the OECD is still trying to work out the scope of Amount A and Amount B in pillar one and appears to have many questions to answer for itself before it can issue guidance to tax professionals.

Other ITR stories from the week that you might like to read include:

Next week in ITR

Next week in ITR, we will bring you initial coverage of the Brazil Tax Forum. Register now for this two-day event.

We will also be releasing articles on the economics and politics of Brazil in 2020, providing detailed coverage of the pillar one and pillar two blueprints, and explain how COVID-19 is continuing to raise the profile of tax functions when company make important business decisions.

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