The safe harbour provided by Pillar One falls short of industry expectations

Sources say they are dissatisfied with the marketing and distribution safe harbor's pillar one safeguards, despite the fact that it was supposed to provide firms with greater tax certainty.

According to tax directors, the marketing and distribution safe harbour is unfit for purpose in preventing double taxation and may result in discriminatory outcomes under the OECD's profit allocation mechanism in pillar one.

The marketing and distribution safe harbour (MDSH) calculation, according to Thomas Roesser, a Microsoft tax policy expert in Washington DC, can bias Amount A adjustments in markets that already tax a group's residual profits.

“We were surprised to see complex limitations to the MDSH in the progress report,” says Roesser, about how the safe harbour treats withholding taxes on deductible payments in Amount A adjustments.

“We recommended the limitations to be deleted to ensure there is no double counting,” he adds.

According to Roesser, pillar one should also prevent market countries from imposing "additional withholding taxes or severe transfer pricing changes" where Amount A already offers an internationally agreed share of residual earnings.

“Amount A should be reduced to the extent countries are already taxing residual profits through transfer pricing, withholding taxes, and other taxes too,” says Roesser.

Amount A was initially specified by the OECD as the share of residual profits to be allocated to market countries. The MDSH restricts how much residual profit can be allocated.

However, the MDSH establishes an unnecessarily high residual profit barrier, which can produce unexpected effects.

“We recommend a total system profits cap at 25% including withholding taxes to reduce Amount A,” adds Roesser, on setting a ceiling on residual profit.

On September 12, the OECD held a consultation on the safe harbour, which raised various difficulties, including the treatment of withholding taxes, undefined elements of the formula, and other solutions for tax certainty.

Alan McLean, Chair of the OECD's Business and Industry Advisory Committee (BIAC), advises that the OECD tax unit rewrite the September progress report on the safe harbour for simplicity and clarity.

“This is one of the more confusing documents released by the working party to date,” says McLean.

The industry believes that the MDSH does not go far enough to address the issue of double counting, which occurs when a country taxes a company's residual profit more than once using profit allocation regulations and Amount A.

Microsoft's Point of View

Microsoft's tax team is concerned that the procedures in pillar one, such as the MDSH, produce unpredictable formulaic results for how much Amount A is owing in different market regions.

Taxpayers may see that the safe harbour formula favours larger markets, implying that pillar one would not provide a stable international tax climate. Microsoft and other large firms subject to the requirements of Pillar One are asking the OECD to amend the MDSH because the criteria to avoid double taxation are ineffective for companies operating in many regions.

The Microsoft team suggests that the OECD remove components of the MDSH calculation, such as the arbitrary 'Y' limitation, the utilisation of return on depreciation, and the unexplained 40% barrier.

“We believe it is important to provide an explanation of how the proposed multiplier shall be deducted from the profit... such a multiplier appears theoretically to only change the complex tiering requirement without reducing Amount A,” says Roesser.

According to paragraph six of Article Six of the MDSH draught legislation, when an Amount A adjustment is implemented in a market country, an equal amount is deducted from group profit reports submitted to the local tax authority.

Pillar one would impose a three-tier profit allocation method - Amounts A, B, and C - each of which would have ramifications for how earnings are divided between jurisdictions.

According to Roesser, keeping the MDSH in its current form may create administrative difficulties for groups because the safe harbour calculations require taxpayers to do all Amount A computations as well. This means that complying with pillar one comes at a substantial expense, despite the fact that the final tax amount is little.

Countries in Development

While industry wants clearer and simpler pillar one processes, Pascal Saint-Amans, Director of the OECD Centre for Tax Policy and Administration, says contradictory perspectives from developing-country governments make it difficult to find an elegant solution that can assist all stakeholders.

“Developing countries do not want withholding taxes as part of the safe harbour,” says Saint-Amans.

Belema Obuoforibo, director of the non-profit International Bureau of Fiscal Documentation in Amsterdam, criticised the OECD's two-pillar strategy for developing countries' policy planning. Developing countries want a policy solution with a broader scope to collect more tax income.

According to Obuoforibo, there is a sensitive dialogue between leaders in poor nations to support the UN Model Convention's Article 12B rather than Amount A in the OECD model. Article 12B would subject any business, regardless of size, to an automated digital services tax.

Many African countries believe the UN version provides a simpler and easier policy for tax administrations and taxpayers, but officials warn that this may lead to more unilateral DSTs.

Amount A's next steps

Amount A is designed to address the criticism that under international norms, market countries do not have enough taxing rights. Revenue is only generated by groups in markets where they have a taxable presence.

The MDSH will cap the residual profit that will be allocated to markets. When a country already has residual profit taxing rights, this gives guardrail relief on Amount A costs.

At the OECD's September consultation, industry groups unanimously agreed that failing to address withholding taxes would be counter to the MDSH's policy aim. It may encourage governments to levy additional withholding taxes to compensate for revenue lost by eschewing DSTs under Article 12B in favour of Amount A's top up tax.

At the same time, because the Inclusive Framework negotiations are still ongoing, the OECD report does not go into detail on withholding taxes. The MDSH's conclusions are influenced by differing perspectives from the government and industry on whether withholding taxes should be treated under Amount A protections.

At the September consultation, French Ministry of Finance official Gal Perraud and other political leaders proposed that the OECD's tax team begin developing the international treaty for pillar one. The signing ceremony is scheduled at the end of the first half of 2023.

The OECD's tax unit will now begin a public consultation to update pillar one's tax certainty guidelines and offer alternatives to unilateral measures. Delegates at the consultation reaffirmed their commitment to reaching an agreement on pillar one's building blocks by mid-2023 and signing a global treaty to include Amount A in tax treaties.

By fLEXI tEAM