What can you say about the OECD/G-20 global tax reform proposal that hasn’t already been said? Assuming the megadeal comes to fruition, it will represent the biggest change in international corporation taxation in almost 100 years.
If you’ve been paying attention, you know the plan consists of two distinct pillars. Pillar 1 seeks to reallocate jurisdictional taxing rights over a prescribed portion of multinational profits. The good thing about pillar 1 is that it allows market jurisdiction to access a segment of the corporate tax base that has proven difficult to reach under the current international tax regime.
Pillar 2 would introduce a global minimum tax. The good thing about pillar 2 is that it responds to the race to the bottom that facilitates corporate profit shifting. Tax competition would still exist under pillar 2, but tax havens would have little incentive to set their domestic corporate tax rate under the agreed threshold rate of 15 percent.
In Washington, people are asking whether those global reforms — especially those under pillar 1 — advance U.S. national interests. By now, there’s a familiar elevator speech on why the answer is yes. It relies on recognizing that pillar 1 reflects a pragmatic compromise that ultimately benefits the United States in important ways.
Arguably, the greatest benefit of the OECD tax deal is that it significantly strengthens the overall stability of the international tax system by eliminating the dozens of digital services taxes the U.S. government finds problematic.
The U.S. Trade Representative strongly opposes foreign DSTs and has threatened retaliatory tariffs against countries that enact them. Without pillar 1 to defuse the tension, there could be a disruptive trade war that both harms the appetite for U.S. exports and drives up the retail cost of U.S. imports. Not a great outcome when inflationary pressures are already a major problem for the economy at large. A trade war would make it far worse.
The gain in stability is worth the hassle and sacrifice of pillar 1, but there’s one thing that continues to trouble me about the compromise. Participating market jurisdictions are supposed to abandon their DSTs in full — that is, on all relevant profits of all affected companies. In exchange, they obtain expanded taxing rights over a narrow range of corporate profits. That’s a classic mismatch.
Pillar 1 doesn’t apply across the board. It affects in-scope multinationals, defined as having global turnover of at least €20 billion and profitability exceeding 10 percent. That translates to about the 100 biggest and most profitable corporate groups. Computationally, the new taxing rights will extend to 25 percent of an in-scope company’s residual profits, to the exclusion of routine profits — a calculation referred to as amount A.
It’s a mistake to regard amount A as representing a slice of multinational profits. It’s more like a slice-of-a-slice of those profits, and only for a cluster of in-scope companies. A better trade-off would be based on proportionality. That would address the underlying mismatch by requiring that market jurisdictions give up only a slice-of-a-slice of their DST tax bases.
As things stand, you could be forgiven for thinking the “A” stands for asymmetrical.
Consider Kenya, which is one of the four countries in the OECD inclusive framework that declined to embrace the global tax reform package announced last October. (The other three holdouts are Nigeria, Pakistan, and Sri Lanka.)
Kenya’s DST reaches 89 companies whose combined profits reflect a sizable tax base — which the country is asked to forfeit in exchange for pillar 1. Yet pillar 1 grants Kenya new taxing rights over just 11 in-scope companies.
Map of Republic of Kenya through magnifying glass
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Looking at those numbers, you can see how the mismatch in scope operates to the disadvantage of market jurisdictions. They stand to lose more than they’d gain.
That observation is not new. Civil society organizations have been pointing it out for months.
The modification proposed here would leave amount A untouched. Far too many resources and political capital went in to cobbling pillar 1 together for stakeholders to be tinkering with the details at this late stage. Pillar 2 would also be left alone. The rethink is limited to the accompanying rollback of DSTs — the proverbial carrot for the United States to accept the deal.
Here’s the change: Market jurisdictions should be allowed to retain their DSTs for out-of-scope taxpayers. That’s a straightforward application of the matching principle, which is common in international tax policy. A lot of high-level diplomacy went into the scoping concept that supports pillar 1; it should serve double duty as the scoping rule for DST relief.
The U.S. Treasury Department played a key role in establishing the pillar 1 approach, known as comprehensive scoping. Readers may recall how the OECD’s original scoping proposal fixated on a company’s characterization as either an automated digital business or a consumer-facing business. About a year ago, in the spring of 2021, U.S. negotiators reinvigorated the OECD inclusive framework by calling out the original scoping criteria as overly subjective and fundamentally flawed. Scoping based on objectively verifiable measurements of a company’s size and profitability proved a major design enhancement.
The matching principle now demands that those same quantitative metrics serve as the determining considerations for whether a company should be off the hook for DSTs. The matching would apply universally — that is, for economically advanced nations with DSTs (think France and the United Kingdom), as well as less developed countries (like Kenya).
If a U.S.-based company was keen to remain outside pillar 1 (let’s say it actively lobbied the U.S. government and the OECD to that end), then there’s no natural reason why it should partake in the corresponding benefit of DST relief. If a company wants to be liberated from the indignity of DSTs, then it must be in on pillar 1. Think of it as having skin in the game.
For U.S. businesses that dread the thought of foreign DSTs (which are not creditable for foreign tax credit purposes), the matching principle creates an incentive to lobby the U.S. government and the OECD for a strategic lowering of the pillar 1 thresholds. There’s already a nonbinding option for the global turnover threshold to be reduced from €20 billion to €10 billion after the reforms have been operational for seven years, which would extend the reach of pillar 1 beyond the current pool of roughly 100 multinationals. With matching, the move would similarly expand the pool of U.S. companies no longer subject to foreign DSTs. That could be done on an expedited basis — perhaps after just three years — if enough U.S. companies were to request it.
It seems to me that the ideal state of affairs for ensuring the durability of pillar 1 is for influential U.S. multinationals to be vested in the project’s success and eventual expansion, rather than to oppose that. What better way to achieve that than by conjoining favorable DST treatment to the pillar 1 scoping rules? Besides, it’s hard to argue with the idea that benefits should be proportional to burdens.