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US drops ‘safe harbor’ demand in digital tax talks

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Tax Hot Topics newsletter Treasury Secretary Janet Yellen announced at a virtual meeting of the Group of 20 finance ministers on Feb. 26 that the United States is no longer demanding inclusion of a “safe harbor” rule that would allow U.S. companies to opt-in or out of Pillar One of the proposed two-pillar tax regime being discussed to address the tax challenges of digitalization. This announcement removes a major, but far from the only, obstacle to a consensus agreement among the 137 countries of the Organisation for Economic Cooperation and Development (OECD) “inclusive framework” (IF) addressing the tax challenges of digitalization.

The OECD has been attempting to address the impact of digitalization on the global economy since the issue was first discussed in Action 1 of the OECD’s Base Erosion and Profit Shifting (BEPS) report in 2015. The ability of large, profitable multinational enterprises (MNEs) to use internet-based business models to engage in transactions with consumers in a country – the “market” country – without triggering the traditional taxing nexus in that market country has been identified as a tax challenge of digitalization. Since January 2019, the OECD discussion has centered on a two-pillar approach to address those tax challenges. Pillar One proposes to expand taxing jurisdiction of “market countries” and allocate some profits to those market countries. Pillar Two focuses on tax rules that would allow jurisdictions to tax profits in other jurisdictions that have a low effective tax rate or have not exercised their taxing right.

The discussions of the 137-country IF intensified in 2019, with discussions about the scope of proposed rules, the amount of profit to be reallocated, enforcement and dispute resolution. In October 2019, the OECD issued a “unified approach” paper which attempted to develop a consensus around the two-pillar approach, but the November 2019 consultation meeting regarding Pillar One failed to develop consensus support. In December 2019, former Treasury Secretary Steven Mnuchin dealt a blow to discussions with sent a letter to the OECD expressing misgivings about the unified approach’s departures from established tax principles and demanding a “safe harbor” approach that would make Pillar One rules elective. Discussions continued in 2020, but deadlines for consensus resolution were missed and rescheduled.

The current anticipated deadline for resolution is mid- 2021. Although many commenters acknowledge that Yellen’s withdrawal of the safe harbor demand is helpful, many substantive issues remain regarding scope, computations, enforcement and dispute resolution. Given the number of countries in the IF and the number of detailed issues for resolution, some are pessimistic about the ability to reach consensus in the current year. In the meantime, the unilateral enactment of digital services taxes by individual nations is expected to continue.

Contact:
Steven C. Wrappe
Partner
Washington National Tax Office
T +1 202 861 4104

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