Risks and possibility of litigation


Decision-makers often suffer from partial analysis. They look at a problem and come up with a solution that they believe would meet the initial challenge. But what is often overlooked is the answer to the solution. People are creative, and they can often see opportunities to react when governments design policies.

Recent analysis by Texas A&M professor Lorraine Eden highlights the complexity of current international tax proposals and the potential for corporate and government backlash that could lead to unexpected outcomes and new tax litigation.

Currently, countries around the world are negotiating tax rules so that companies pay more taxes in the jurisdictions where their customers are located. In theory, it is easier to tax companies where their customers are located than where the head office, employees or factories are. Companies can choose where they operate and can reduce their tax burden by strategically choosing to invest in lower tax jurisdictions while selling products to customers in higher tax countries.

Since companies that sell to customers around the world don’t really have a choice of where their customers are located, the rules that tax companies where they make their sales should be less subject to manipulation by businesses.

But what if countries have a mix of rules with companies paying partly where their headquarters are, partly in the countries where they operate, and partly where their customers are?

This will be the state of the world if nearly 140 countries reach agreement on an Organization for Economic Co-operation and Development (OECD) proposal called Pillar 1 Amount A, which introduces an element of destination-based taxation in corporate tax rules while leaving most of the other rules unchanged.

In tax parlance, this would be a system in which companies are subject to tax in the countries of residence, origin and market. The proposal is not yet final and the Biden administration has just weighed in on its preferred approach to limit the application of the proposal to the 100 largest multinational companies in the world.

To understand the potential impacts of this policy, it is good to understand how things work under the existing rules.

Right now, a US company with overseas operations in France would likely face corporate taxes in the US (based on its US profits) and France (based on its profits French). This company likely has customers in the United States, France, and dozens of other countries. Other countries where the business has customers but no business do not have “taxing rights” on the business’s profits. Only the United States and France would be able to tax the company because it operates in those jurisdictions.

However, the OECD Pillar 1 A amount would change this so that the US company would have to pay taxes in the US, France and the dozens of other countries where it has sales. The plan is to divide the company’s profits into a part taxed by the countries where the company has its headquarters and operations and another part that would be taxed in the countries where the company has its sales.

While the current rules require the US company to pay taxes on its profits in the US and France, the A amount would give other countries the right to tax the profits. This would force the United States or France (or both) to forgo part of their tax base; otherwise, there would be double taxation.

The United States and France should cooperate with other countries to ensure that the company is not overtaxed. For example, if Germany taxes the US company based on its share of the company’s sales, the US or France might need to give a tax credit or new exclusion to ensure that no more than 100 % of the company’s profits are not taxed. all over.

However, if neither France nor the United States believe they are responsible for giving tax breaks, the company could be overtaxed. The two countries could simply choose not to give tax relief because they do not want to have lower tax revenues.

Businesses could also change their organization to minimize the complexity of determining where they owe taxes. Instead of having to seek tax relief from both France and the United States, a company could sell its French operations and simply deal with the U.S. Treasury when it comes to requesting tax relief for news. foreign tax charges in respect of amount A.

These and other scenarios are explored in Professor Eden’s recent analysis. She suggests that countries that will have to forgo part of their income to make Amount A work will be prompted not to give tax relief or to suggest that another jurisdiction be responsible for granting the tax relief. US multinational companies are likely to be caught between the US Treasury which wants to tax them more heavily and countries which get a new tranche of taxable profits under Amount A.

In addition, it highlights the complexity for companies that operate in multiple jurisdictions. One possibility, she concludes, is that companies try to limit their exposure to amount A either by selling through unrelated parties or by shifting profits to less taxed locations.

Eden concludes that businesses that need local entities with employees and assets in many countries and businesses that are fully digital and do their sales remotely will find themselves facing more difficult compliance issues.

In other analysis, Eden examines where the most serious impacts of these policies could lie. She expects the biggest story for the United States on the A-amount to be with Europe, which accounts for about two-thirds of the overseas sales and profits of US foreign affiliates; The European subsidiaries hold similar shares of the American market.

In recent years, tax disputes between the United States and Europe have turned into trade disputes, with the United States threatening the tariffs of European countries that have adopted digital services taxes that unfairly target American businesses.

Amount A is intended to ease these disputes and introduce a mutually acceptable regime that requires companies to pay more taxes in the countries where they make their sales. However, Eden is concerned that a tax dispute for the A amount could arise between the United States and Europe, as the two increase the corporate tax of the foreign affiliates of the other.

Amount A will require a dispute resolution process for it to work effectively. This is something the OECD recognizes and strives to design. Eden’s analysis shows the need for an effective mechanism to resolve disputes because Amount A, itself, would invite such disputes.

While it is possible for countries to adopt the A amount and give appropriate tax breaks and not tax more than their share of the profits, Eden ends her argument in one of her articles with the caveat Hic Sunt Dracones! —A warning that the unexplored impacts of this policy can be host to dangerous distortions.

As countries move closer to agreement on how the OECD Pillar 1 A-amount works and which companies will be affected by it, it is critically important that policymakers continue to assess not only the intended effects, but also the potential unintended consequences.

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