Paul L. Caron

Friday, July 3, 2020

Weekly SSRN Tax Article Review And Roundup: Kim Reviews Rethinking Tax For The Digital Economy After COVID-19 By Magalhães & Christians

This week, Young Ran (Christine) Kim (Utah) reviews a new work by Tarcísio Diniz Magalhães (McGill) & Allison Christians (McGill), Rethinking Tax for the Digital Economy After COVID-19 (June 2020).

6a00d8341c4eab53ef022ad3a74c80200d-300wi (1)The coronavirus recession has brought many challenges, including economic and fiscal crisis. Still, there are winners during this difficult time. As the COVID-19 pandemic hit the United States in full scale leading to a nationwide lockdown starting in March, stock prices plummeted sharply for all but a handful of companies. Compare the year-to-date chart of the S&P 500 with that of Zoom, Netflix, and Amazon—companies that are thriving despite the pandemic. The exceptional performance of these companies is seemingly a “windfall” arising from the extreme restrictive measures governments had to impose on other sectors of the economy. As one possible solution for the fiscal crisis, prominent scholars, such as Reuven Avi-Yonah, Emmanuel Saez and Gabriel Zucman, as well as Melani Cammett and Evan Lieberman, have proposed to revive excess profits taxes. In Rethinking Tax for the Digital Economy After COVID-19, co-authors Tarcísio Diniz Magalhães and Allison Christians extend the excess profits tax proposal to the international domain and argue that the world needs to adopt a "Global Excess Profits Tax” (GEP Tax). Magalhães and Christians' paper was presented yesterday at the Indiana/Leeds Summer Tax Workshop Series (the Workshop), hosted by Leandra Lederman (Indiana – Maurer) and Leopoldo Parada (Leeds).

Excess profits taxes are not a new idea or practice. Many countries have widely used it as a temporary response to economic and social consequences of wartime. The United States deployed the excess profits tax in World War I and World War II to prevent some fortunate companies from unjustly achieving opportunistic enrichment. Similar to the economic reality of the companies subject to the excess profits tax during World War I and World War II, certain companies have experienced excessively high profits resulting from certain aspects of today’s pandemic crisis. This comparison has revived the idea of imposing higher rates of tax on a portion of such profits. 

Excess profits taxes are not without challenges. One challenging part of excess profits taxes is defining the tax base or "excess profits." Noting the resemblance between the concept of "excess profits" of excess profits taxes and "residual profit” (or non-routine profit) in the global discussion for taxing the digital economy, the authors propose to implement a GEP Tax built upon mechanisms and tools that the OECD has been developing in the Base Erosion and Profit Shifting (BEPS) Projects 1.0 and a two-pillar approach for the taxation of the digital economy (so-called BEPS 2.0).

The kernel of the authors’ proposal is as follows. First, use the country-by-country reporting (CbCR) of BEPS 1.0 to provide a base of information to identify the average earnings of multinationals in previous years or to establish a uniform threshold for normal profits, thus making it possible to calculate how much is to be considered excess. Second, apply Pillar One of the OECD's digitalization proposal to distinguish residual profit (non-routine profit) from routine profit. In combining the information available at CbCR in the first step, the second step may isolate the above-normal returns of firms subject to the GEP Tax. The authors explain that nonroutine profits are distinct from abnormal and unpredictable profits that justify imposing excess profits taxes. However, both concepts are roughly overlapping, so that at least the concept of residual profits may be used as a baseline of defining excess profits subject to GEP Tax. Third, apply Pillar Two of the OECD digitalization proposal which guarantees that the consolidated profits of multinationals would be subject to a global minimum rate, such that if one country fails to impose the GEP Tax on what is defined as excessive, other countries can step in to fill the fiscal void.

The authors' proposal underscores the fact that, because we live in a world where capital is fully mobile and firms are able to shift their profits into low tax jurisdictions, domestic excess profits taxes unilaterally adopted by some countries may initiate another round of aggressive international tax planning. However, the proposed GEP Tax may not be politically popular because it inherently involves allocating profits, and the resulting revenue, among relevant countries. What country would want to share revenue generated by excess profits taxes with other countries? As excess profits taxes are an extreme measure usually deployed during wartime, this similarly devastating time of the coronavirus recession makes a globally harmonious GEP Tax sound too idealistic for policymakers.

In addition, the GEP Tax proposal tries to resolve both the "under taxation issue" and "allocating taxing rights" at the same time. This ambitious goal may have overly complicated the analytical framework. Allocating taxing rights among countries has been one of the most challenging international tax issues to solve. As a result, its reform failed to gain true momentum until the recent BEPS 2.0's digitalization proposal. Attempting to add the concept of excess profits or windfall of the GEP Tax to the BEPS 2.0 may divert focus from the legitimate issues related to profit allocation. Stephen Shay (Harvard), Ruth Mason (Virginia), Werner Haslehner (Luxembourg), and many others gave similar comments during the Workshop. 

During the Workshop, Stephen Shay and Mindy Herzfeld (Florida) made another interesting observation. According to Amazon's recent 10-Ks, the operating profit margin on its North American sales is about 4~5%, and its consolidated operating profit margin is about 5%. Amazon even said it could report operating losses for the second quarter of 2020. If Amazon's normal or routine operating margin were even as low as 5%, it would not be considered to have excess profits—at least on a book basis. This observation demonstrates an issue related to excess profits taxes in general, rather than specifically the authors’ proposal of a GEP Tax. However, it implies that policymakers should consider a robust revenue analysis and detailed tax and accounting rules if they were to propose excess profits taxes.   

This timely paper provides plenty of issues to ponder upon. Despite the potential political pushback, the urge for a GEP Tax is worth giving attention to as COVID-19 has spread around the world and is not simply one country’s problem. The paper is also brilliant and practical by combining its proposal seamlessly with other major international tax projects such as CbC reporting and the two pillars of BEPS 2.0. For these reasons yesterday’s Workshop discussion was so lively. For those who missed the Workshop, the presentation video is available here, and the slides are available here. I highly recommend reading, watching, and enjoying the fascinating Venn diagrams and charts presented at the Workshop.  

Here’s the rest of this week’s SSRN Tax Roundup:

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