Michael J. Graetz (Columbia), A Major Simplification of the OECD’s Pillar 1 Proposal, 170 Tax Notes Fed. 213 (Jan. 11, 2021):
In this report, Graetz suggests major modifications to the OECD’s pillar 1 blueprint proposal to create a new taxing right for multinational digital income and some product sales that would greatly simplify the proposal. The modifications rely on readily available existing financial information and would achieve certainty in the application of pillar 1, while adhering to its fundamental structure and policies.
No one seems happy with the OECD’s pillar 1 blueprint. Borrowing from Tolstoy, much unhappiness is being expressed in its own way. Some simply want to torpedo the project. The position of the United States, expressed in Treasury Secretary Steven Mnuchin’s insistence that the pillar 1 allocation to market countries not be mandatory, but instead some sort of a safe-harbor regime, seems to fall into that category.62 The secretary’s position, however, did not halt the project, and it allowed Treasury representatives to participate in OECD discussions of the technical issues. But Mnuchin might just as well have said that the United States opposes the pillar 1 effort.
Many other objections to the pillar 1 blueprint, however, are well justified. Businesses that will have to comply with pillar 1 are properly concerned with its complexities and attendant compliance costs; the ambiguities in its application, which threaten multiple and overlapping claims to revenue; and the practical challenges of achieving the level of certainty in its application that the blueprint promises. Many countries rightly worry about their ability to administer the rules described in the blueprint.
The incoming Biden administration will no doubt reevaluate the U.S. position because, as I have said, it is foolish to think that the status quo predating these OECD efforts is an appropriate baseline for comparison. Instead, market/user jurisdictions will continue to develop and impose new and varying taxes based on the use of digital services and sales of goods and services in their jurisdictions. Pillar 1 is intended to substitute a multilateral agreement on the allocation of some profits to those jurisdictions for the many different unilateral regimes that are emerging and will emerge — and for the retaliatory tariffs and other trade measures that have been promised and seem likely to occur in response.
The 230 pages of details in the pillar 1 blueprint obscure its underlying principles. Of course, it is difficult to discern clear principles in a structure that uses arm’s-length transfer pricing to allocate the great majority of profits and a formulary method of apportionment to allocate a limited portion of residual profits to market/user countries. Nor is there an obvious principle that yields clear answers to the question of where the offsets to the reallocation of amount A to eliminate double taxation should come from. The mechanisms in the OECD’s pillar 1 blueprint to allocate some relatively small portion of residual profits to user countries produce great complexity without eliminating transfer pricing disputes or concerns with income shifting of proponents of allocating all residual profits based on sales and digital services.63 Nevertheless, success of the OECD’s effort is important.
In my view, the best path forward lies in a dramatic simplification of the pillar 1 proposal. While working within the OECD’s basic framework, I have demonstrated how substituting formulary apportionment of a smaller percentage of all profits, rather than attempting to allocate an arbitrary percentage of residual profits to market/user jurisdictions, and requiring MNE entities to share in that allocation based on their pro rata shares of residual profits offer the potential for a major simplification of pillar 1 that also avoids double taxation. The proposal here is based on readily available financial information and avoids debatable segmentations, with inevitably controversial revenue and cost allocations, as well as contestable efforts to link an MNE’s particular entities to specific market jurisdictions that would benefit from the reallocations of amount A. All of these inevitably will create controversies that undermine the OECD’s quest for certainty, despite its efforts to institute new mandatory dispute resolution arrangements.
Architects of the OECD pillar 1 blueprint may complain that the pro rata allocations urged here sacrifice the blueprint’s fidelity to greater precision for unscientific outcomes. But, in my view, the blueprint’s veneer of preciseness sows seeds for pillar 1’s downfall, and its promise of certain outcomes is a chimera.