By David Morse, Tax Policy Associate Director
Law 360 reported this week that US Treasury officials believe multinational companies should anticipate new formulas as a part of future taxation. This is good news for companies producing in America who are tired of paying higher tax rates than many multinational enterprises (MNE). The Organization for Economic Cooperation and Development’s (OECD) recently approved “Programme of Work” also indicates that formulas will be a significant part of taxing MNEs in the future. One reason fo the change could be comments by Pascal Saint-Amans, OECD Director of the Center for Tax Policy and Administration. He believes that the old system of transfer pricing aspects for “Base Erosion and Profit Shifting” (BEPS) has failed.
The OECD will explore three options to modernize the global tax system in the coming months. Concerns include: which countries should be able to tax; what fraction of corporate profits should be taxable; and, what “bright line” rule establishes the right to tax at all. The OECD will also consider minimum taxes that create an effective throwback rule. An overriding concern, however, is a global desire to develop clear new rules allowing countries to tax a multinational company beyond its physical presence in a particular country. But this has not yet been defined.
The first option, the “Modified Residual Profit Split” method, prefers to split profits into routine and non-routine profits. The old system would tax “Routine” profits. However, “non-routine” profits would now be taxed under a new formula instead. “Non-routine” profits are poorly defined, but for now, they are best described as risky and associated with intangibles. However, the definition must be refined as part of the OECD work project.
Fractional Apportionment, the second option, contains the Sales-Factor Apportionment (SFA) approach promoted by the Coalition for a Prosperous America (CPA). However, Sales-factor is only one version of this option. Fractional Apportionment doesn’t bother with creating a special label for types of profit, but instead assesses overall profitability, applies an allocation key (such as sales factor only), and applies a tax formula. Sales Factor Apportionment remains the easiest and most reliable tax mechanism to understand.
The third option, a “Distributional-based approach,” follows the first option above and attaches other types of profits to the term “non-routine”—all to establish a different base subject for the formula. This method is very open-ended and can be as complicated or straightforward as future definitions will allow. Some suggest treating each type of profit differently, with different tax rates, and could exist inside or outside of current rules. The last method appears to be closest to the original proposals from the US Treasury.
However, US Deputy Assistant Treasury Secretary of International Tax Affairs Chip Harter recently said that profit allocation rules should ideally be simple and formulaic: “something that can be administered by countries that don’t have Ph.D. economists in their internal revenue service staffs.” The need for simplicity and reliability conflicts with the US Treasury’s desire to restrict these new formulas to “above-normal” returns. Such restrictions are in the interest of those supporting the 2017 Tax Cuts and Jobs Act (TCJA). However, domestic manufacturers and producers remain concerned about multinational companies paying far lower tax rates. To date, targeting “above-normal” returns in the TCJA has yielded poor results so far.
Recent reports indicate that the TCJA failed to hold both foreign and American multinational corporations accountable. And it did not induce serious investment in the US by. Companies that produce in the US should have been prioritized—and should be now. OECD Tax Reform holds significant promise, even as CPA advocates for improvements in the TCJA before Congress.
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