Remarks on the OECD/G20 program of work: Profit allocation and minimum taxation

The OECD proposes new nexus rules and formula-based allocation of large digital and consumer-oriented MNE’s residual profits to market states where the respective MNEs serve their customers (Pillar One Proposal, POP) combined with a worldwide minimum taxation regime (Pillar Two Proposal, PTP). POP creates a hybrid system of international profit allocation because it comes on top of the traditional arm’s length principle (ALP). The new hybrid system causes the risk of double taxation due to overlapping tax bases. In addition, MNEs have new tax planning opportunities when determining the amount of residual profits in the market states. PTP suggests an internationally agreed effective minimum tax rate combined with a (residence-based) income inclusion rule and a (source-based) undertaxed payment rule. In principle, the income inclusion rule would be sufficient and avoid an otherwise necessary priority rule. Without setting a minimum tax rate, the allocation of MNEs’ profits to market states in effect also establishes a minimum taxation regime. Therefore, waiving POP as well as PTP in favor of a full-fledged formula-based profit allocation scheme is a valid tax policy option. POP and PTP call for an unprecedented level of international tax cooperation. States have to agree on the details of the tax base as well as on the tax rate. Credibility is paramount for such far-reaching international cooperation. Up to now, the OECD has not envisaged an international tax agency, which has the power to establish an effective enforcement procedure. If the OECD fails to establish a long-term international tax agreement, ongoing tax competition may convert the corporate income tax into a pure benefit tax. National tax policy could adapt by placing a higher personal income tax burden on corporate profit distributions to resident shareholders as well as on resident shareholders’ gains from the sale of corporate shares