Economic fallout from the coronavirus pandemic has created a dilemma for the OECD-led effort to overhaul global tax rules: How will negotiators deal with massive global losses.
The Organization for Economic Cooperation and Development has been trying to get nearly 140 countries to rewrite how the digital economy is taxed. The effort is driven by concerns that multinationals, especially tech giants like Facebook Inc. and Amazon.com Inc., aren’t paying taxes in the countries where they have customers and users.
Before the Covid-19 outbreak, negotiators were mainly focused on how to reallocate part of multinational companies’ taxable profits among those countries as part of a broader plan that included a global minimum tax.
But the pandemic’s unprecedented economic upheaval means the question of how to deal with corporate losses could be a point of contention for negotiators. For countries, how the plan handles the issue could mean revenue losses for some jurisdictions. Multinationals hit hard by the economic crisis will want reassurances they’ll be able to offset some of their future taxes with losses from this year.
“Nobody has done anywhere near enough thinking about losses,” said Barbara Mantegani, a tax attorney and the founder of Mantegani Tax PLLC in Washington. “This is a big sticking point that’s going to come home to roost sooner rather than later, because everybody’s going to lose money.”
A Jan. 31 proposal, approved by 137 countries, listed losses among the OECD’s remaining work. The proposal called for looking at how to define and calculate losses along with how to design carry-forward rules.
“This is probably taking on more importance now when we’re in the middle of this crisis and so many companies will have losses,” said Carol Doran Klein, vice president and international tax counsel at the U.S. Council for International Business.
The project’s work is ongoing, said Pascal Saint-Amans, director of the OECD’s Center for Tax Policy and Administration. He declined to comment on specific discussions.
The organization said in March that the work will continue on schedule despite the pandemic, with meetings between government officials held virtually as they try to reach consensus by July.
One key question for negotiators is how companies would use losses or expenses they accrue now against future years’ tax burdens.
If the OECD is successful and a deal is reached by the end of the year, it could still take several years before countries change their tax laws and implement new rules. Depending on the design of the loss carry-forward or carry-back provisions in the OECD rules, losses companies incur in 2020 could still be used to offset profits by the time the OECD rules are implemented, practitioners said.
“Until now, that was a theoretical discussion,” said Bart Le Blanc, a partner at Norton Rose Fulbright LLP in Amsterdam. “Now it’s a reality,” as most multinationals will incur losses in 2020.
A key part of the plan, known as Amount A, would reallocate some of multinationals’ profits to market jurisdictions, where they have customers. As proposed, it would only apply to large, consumer-facing companies making above a certain profit margin. Companies may worry that they’d face increased disputes with tax authorities or additional tax liabilities under a system so different from current tax rules.
Falling under the to-be-determined profit threshold—for example, a profit margin of 10% or 20%—means a multinational wouldn’t be subject to Amount A rules that reallocate a portion of its income.
Companies could avoid Amount A in future years by applying losses or expenses to reduce profitability, Le Blanc said. If the new rules don’t allow losses to be applied to other years, they’ll pay higher taxes.
And 2020 will likely generate significant losses.
“In many cases this year, there won’t be excess profits for many companies,” said Tommaso Faccio, head of secretariat at the Independent Commission for the Reform of International Corporate Taxation.
Multilateral negotiations have been contentious over how to split profits in good years. Deciding whose coffers will take a hit in bad years may not be any easier.
Under the current proposal, some countries would gain tax revenue, while those that give up revenue under one part of the plan might gain revenue elsewhere. Or they could see greater tax certainty for their companies through stronger dispute resolution.
If headquarter countries give up some of their profits to market countries under Amount A, they’ll likely want those jurisdictions to shoulder some burden of losses, too. Amount A could be designed to allocate losses in the same way as profit.
For example, the rules could move a portion of a company’s deductions to the market jurisdiction when its losses exceed a certain threshold, said Jeff VanderWolk, a partner at Squire Patton Boggs in Washington and a former OECD official.
But the current economic situation might make that prospect less attractive for the market jurisdictions.
“It puts a different color on the picture if they’re thinking: Our tax base is not going to be enlarged, it might be shrunk,” VanderWolk said. “And the enthusiasm for doing Amount A with a loss-allocating formula might significantly reduce.”
Companies are concerned that the rules could limit how they apply losses to past or future years, such as by defining accounting periods in such a way that the company would appear loss-making one year and profitable another, said Doran Klein. USCIB’s members include about 300 multinational companies, law firms, and business associations.
And companies are growing worried that the political difficulties of getting countries to agree when it means taking on losses will jeopardize the chances of loss carry-forward provisions being included in the Amount A rules at all.
“Nobody wants the losses, and nobody wants somebody else’s losses,” Doran Klein said. “If you’re going to get to some unified method, you have to get past that.”
“The convention of how losses get used may result in an inability to use those losses,” she added. “That’s true without having a multinational argument about it, but it gets worse if the countries are saying: No, that’s not my loss, that’s your loss.”
Developing countries—some of which would see some additional revenue under Amount A—would fare better with a different approach altogether to profit allocation, advocates say.
“In principle, profits and losses should equally be shared among the jurisdictions in which a given multinational operates,” Alex Cobham, chief executive at the Tax Justice Network, said in an email. But the current approach isn’t the way to go, he added.
Earlier in the project, a group of 24 developing countries, led by India, proposed a “unitary” approach that considers a multinational’s overall profits globally, then allocates them among the jurisdictions where it has business. The proposal would have brought more revenue to developing countries, and would have been easier to administer, he said.
“What is needed in the face of the crisis are simple measures that will allow affected countries directly to increase their revenues, from those who can shoulder additional costs at this time,” Cobham said. Under a unitary approach, multinationals would pay tax where they have economic activity, he said, which would bring governments revenue they need in the coronavirus crisis.
Developing countries should be more concerned about the treatment of losses under the plan’s Amount B, Faccio said. Amount B would replace subjective calculations with formulas to determine how multinationals compensate their distributors—entities that take on limited risk because their functions are limited to distribution or sales, for example.
Developing countries like Amount B because it would provide a guarantee of how much profit is attributed to the distributor entity in their jurisdiction—and therefore taxable.
That’s why developing countries are hoping that losses don’t become allocable to distributors, which could erase some companies’ profits from those jurisdictions, Faccio said.