Last August, Angel Gurría, right, secretary-general of the Organization for Economic Cooperation and Development, met with French Finance Minister Bruno Le Maire in Paris to discuss digital taxation. France has said it will move ahead with its digital services tax if the OECD cannot secure an agreement on an alternative. (AP)
The OECD is working with 137 countries and territories to develop a taxing approach that will attribute more revenue to countries where companies have customers but lack the physical presence that generates taxable income under current rules. Along with that reallocation approach, the OECD is working on a global minimum tax. The question of competent authority involvement arises under the reallocation approach, known as Pillar One of the OECD's global tax redesign, rather than Pillar Two, the minimum tax.
MAP and Unilateral Taxes
While most countries are waiting to adopt the OECD's global tax regime, several have implemented their own digital services taxes or are considering them, and it isn't entirely clear whether these would be eligible for competent authority involvement under the mutual agreement procedures of most tax treaties.
The various digital services taxes countries have imposed are different from each other, noted Jefferson VanderWolk, a partner at Squire Patton Boggs and a former tax official at the OECD. But the countries imposing them are all likely to argue they are outside the scope of MAP.
"My sense is that the treaty scope question is unclear in the case of every DST, so in practice the competent authority of the country with the DST will be able to take the position that the DST is not within scope," he said.
In the same vein, Monique van Herksen, a partner with Simmons & Simmons in the Netherlands, said that because treaties cover mainly corporate income taxes, when a new tax such as a digital services tax is imposed, "it's not a given" that the treaty will cover it. Unless a country were to change its tax code, something considered a digital levy would not be eligible for MAP under most treaties, she said.
Ramon Camacho, an international tax principal at RSM, also agreed that digital services taxes probably don't fall within the scope of tax treaties — a fact that he said would make a significant amount of income ineligible for MAP.
The treaties "don't cover what is probably the largest revenue stream for European countries right now, which is gross basis, non-income-tax-based charges like the [value-added tax]," Camacho said. The French digital tax is a tax on revenue, he added, and that tax and similar taxes in Europe "are not considered income taxes but maybe sales taxes."
Camacho also said he saw little motivation for countries to amend their treaties to consider offering MAP for taxes that are not income taxes. The Internal Revenue Service, he said, has been reluctant to entertain anything having to do with sales taxes or revenue-based taxes in its programs.
While he agreed that digital services taxes aren't income taxes, Steven Wrappe of Grant Thornton LLP said companies might still be able to obtain a measure of relief because of the way the taxes would "feed into transfer pricing" — that is, as a cost.
"It's still not the total resolution," he said. "The cost itself is not appealable under competent authority, but the impact of it from an income tax angle can be discussed."
Another practitioner, meanwhile, saw no reason for digital tax cases to be exempt from the MAP process.
"People are overthinking it," said Barbara Mantegani of Mantegani Tax PLLC. Referring to France's digital services tax, she asked, "How is it not an income tax?"
If France unilaterally imposes a digital services tax on a U.S. company and the U.S. won't give a deduction, the company could be taxed on the same amount twice, Mantegani said.
"This is really no different from your standard MAP case, where one country increases the amount of income that it thinks should have been generated in its borders," she said.
MAP Under an OECD Approach
For tax disputes arising under the OECD's still-to-be-determined approach, one thing is clear — they are sure to involve more than just two countries.
A problem that could arise in such a case is that some countries might not have treaties with, for example, the U.S., which means there would be no route to MAP, according to Peter Barnes, of counsel with Caplin & Drysdale Chtd. and a tax professor at Duke University School of Law.
A separate issue is that even if MAP is available everywhere, the deadline for bringing a dispute may have lapsed in some countries by the time another jurisdiction makes an adjustment, Barnes said.
Say a multinational company that has allocated expenses among 20 affiliates is audited in Japan in 2023, he said. The National Tax Agency determines the Japanese entity was entitled to claim only $700,000 in expenses rather than $1 million for 2020.
"You don't have any place to reallocate a 2020 expense in 2023," Barnes said. "If Japan gets less in the way of expenses, other countries should pick up more, but it's too late. … That $300,000 would have no place to go because the years could be closed by the time you raise it."
Along with involving multiple countries, future disputes will require computing multiple amounts under the approach the OECD has currently proposed.
What the OECD is calling its "unified approach" describes three amounts that must be calculated in the reallocation exercise. But those don't include the amount of routine profit, which is something governments are assumed to agree on, said Lilian Faulhaber, a professor at Georgetown University Law Center.
Routine profit is an "unspoken amount" under the OECD's approach, she said.
"For reasons that continue to be opaque to me, it's basically assumed that everybody understands what that is and it's never mentioned in the OECD literature," Faulhaber said. "But what the routine profit is, is actually fundamental to this entire calculation. If it's 2% or 10% or 15%, that matters a lot."
The OECD didn't respond to multiple requests to comment for this article.
Once the routine profit is determined, it is then possible to calculate the other three amounts. Amount A is a share of deemed residual profits allocated to a market jurisdiction using a formulaic approach. Amount B is profit related to activities in market jurisdictions, such as distribution, which would remain taxable under existing rules. Amount C would include any additional profits where functions in a market jurisdiction exceed the baseline activity compensated under Amount B and could be adjusted through dispute prevention and resolution mechanisms.
While the OECD's publication doesn't seem to envision much need for dispute resolution around Amount B, Faulhaber said, "there's still a question of how much the cost was."
Amount C raises even more questions, she said.
"It's really just saying, here you have this mechanical calculation of Amount B, and now we're trying to argue that it's a different amount," Faulhaber said. "And if one country argues it's a different amount, that has ramifications for all the other countries that would otherwise be claiming that amount."
She added that while the OECD seems to contemplate dispute resolution for Amount A, "it seems as if all three of them highlight the need for a multilateral dispute resolution mechanism."
As envisioned in the OECD's latest proposal, a company would submit financial filings supporting its calculation of Amount A and its allocation across countries, according to Elizabeth Stevens, a member of Caplin & Drysdale.
Included in the documentation would be the "surrender jurisdictions" — those giving up the revenue allocated to the market countries. The package of supporting documentation would be given to an "early determination panel," where, at least in theory, representatives from surrender countries and beneficiary countries would review and come to an agreement about Amount A, Stevens said.
One problem, however, is that companies won't have the information needed for these calculations during the current year, she said.
"You will be a few months into the next taxable year before you have complete audited financials," Stevens said. "I think most taxpayers would want to wait until they had their audited financial statements in case there are any changes."
Perhaps the OECD will come up with a solution for the timing issue, she added.
Once the OECD finalizes its approach, government officials who are used to handling two-sided cases will be tasked with resolving a whole new category of disputes under the new allocation regime, Camacho noted. This may be unsettling for those used to working in a program that has always achieved a high degree of success, he said.
"If you look at the U.S. competent authority program, they're probably the highest customer satisfaction program at the IRS," Camacho said. Taxpayers like the U.S. competent authority office because it allows them to avoid disputes in court and double taxation, and the program has long enjoyed support from the IRS commissioner, he added.
Some government negotiators might not be ready to have their role expanded so far beyond traditional transfer pricing disputes, Camacho said.
"I can see them running for the hills," he joked. "There's a lot of open issues, and it would take them down a whole new path."
--Additional reporting by Natalie Olivo and Alex M. Parker. Editing by Robert Rudinger and Neil Cohen.
For a reprint of this article, please contact firstname.lastname@example.org.