COVID-19 May Slow Or Weaken Deal On Global Tax Rules

Negotiations on a rewrite of the global tax rules in light of digitalization may need to be extended due to complications stemming from COVID-19 — and even if the current deadline is met, the agreement would be weak.

Even before the novel coronavirus pandemic, it was clear that the timeline was rushed and positions have varied widely. Major players remain at odds over how a global tax deal should be structured. The U.S. wants a deal on tax reallocation to be optional, a position that has ruffled feathers internationally. Moreover, some smaller, rich investment hubs, such as Switzerland, object to an international minimum tax.

Now the economic chaos spawned by the pandemic could allow countries to pause fraught negotiations that have gone on in various forms for the last three years.

"COVID is the perfect cover. It's the perfect excuse," said Hosuk Lee-Makiyama, director of the Brussels-based European Center for International Political Economy, who doubts an agreement can be reached on time. 

Failure to agree would come with costs. The Paris-based Organization for Economic Cooperation and Development has estimated that an international agreement would raise corporate tax revenue by about $100 billion. But while most countries would be better off, investment hubs that attract a lot of foreign investment would lose out.

The OECD is currently working with nearly 140 countries and territories to try to find a deal by the end of the year on two key changes to international corporate tax law. The changes are prompted by international concern that increasing digitalization allows companies to engage in commercial activity in a jurisdiction without having a physical presence there, which would generally be required to assess corporate tax.

The first pillar would see the reallocation of some taxing rights to countries that have a large number of digital customers, but in which companies lack a taxable physical presence. The second pillar would establish a global effective minimum corporate tax. The two pillars have emerged as public officials have had to answer protests from civil society organizations that large corporations, especially technology companies, don't pay enough tax.

So far the OECD has insisted that the program will go ahead as planned, with the expectation that the political parameters for a deal can be worked out in early July in Berlin and that a final deal can be reached at the end of the year.

But the question for many in the international tax community is whether these negotiations will be the Tokyo Olympics of international negotiations: Will leaders insist on sticking to the pre-pandemic timetable until they succumb to the inevitable and delay?

One reason the OECD has stuck to this outline is that a trade war looms if the deadline fails. The U.S. has already threatened to charge tariffs on a slew of French goods in retaliation against the latter's digital services tax, which the U.S. says unfairly burdens American corporations.

The two sides agreed early this year on an effective cease-fire in which France agreed not to collect the digital tax until the end of the year, with the hope that an international deal could be reached in the meantime.

To delay the process would require getting everybody on board.

"The U.S. and countries with unilateral digital taxes would have to lay down arms," said Daniel Bunn of the Tax Foundation, a think tank in Washington, D.C.

Bunn believes COVID-19 has made it more challenging to reach an international agreement on corporate tax reform as currently envisaged by the OECD.

"I always thought there was a non-zero risk of failure, maybe even 30-40% depending on where the U.S. was, and that has increased due to COVID," he told Law360.

In December, U.S. Treasury Secretary Steven Mnuchin sent a letter to the OECD suggesting the U.S. wanted to make any agreement under pillar one optional for American companies. This plan seemed to be getting very little support internationally before COVID-19 took over policymakers' attention.

But Mnuchin was simply reflecting a reality in the U.S. His proposal was based on his "reading of the political temperature and from the U.S. multinational community," Bunn said.

Business groups in both the U.S. and Germany have recently said that the timeline for finding a deal on international digital tax changes should be extended due to COVID-19.

Not having physical meetings will also make it harder to find a deal that includes much detail, according to one tax official who spoke to Law360 on the condition of anonymity. The official said the most likely outcome is an agreement that is reached by the deadline, but thin on detail.

The OECD had no specific comment on how it could enable such informal interactions amid pandemic-imposed travel restrictions.

The lack of a deal, or a very weak one, would potentially bolster the case for countries wanting their own digital taxes. This could raise the risk of retaliatory measures, such as tariffs, meaning that delicate diplomacy will be required whatever the outcome.

Some policymakers have started to think about how countries can raise proceeds to pay for expenses taken on in the crisis — for example, by taxes on digital technology.

Digital companies are expected to do relatively well in the COVID-19 crisis as many consumers are forced to stay at home and thus are in a position to use digital conferencing applications, download films or order items for home delivery.

The European Union's tax commissioner, Paolo Gentiloni, said this month there was a growing case for a digital tax.

Last week, Mohammed al-Jadaan, the finance minister of Saudi Arabia, which is chairing the Group of 20 leading industrial and developing nations, said that work with the OECD is ongoing to move forward on digital taxation.

He added, "I believe it is actually more relevant today than before as countries start to recover from the crisis and start to think about means to ensure that they repay their debt."

--Editing by Robert Rudinger and Neil Cohen.

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