SOME THOUGHTS ABOUT THE PAST AND FUTURE OF INTERNATIONAL TAX LAW

Prof. dr. Kasper Dziurdź1

1. Introduction

Moving to a different country is an adventure, which is connected with many challenges of smaller and bigger nature. For such an adventure to succeed and to enjoy life in a new country, connecting with locals is particularly important. Although I met Hans Arts only two years ago after moving to Maastricht, knowing him has been enriching. On many different occasions, whether at the EATLP congresses in Luxembourg and Antwerp, at a movie screening at Lumière cinema, or at the jubilee celebration of Raymond Luja, I had the pleasure to learn from Hans about Maastricht, the university, the Dutch people, and all the small things that matter in life. Hans was also the first who started to speak to me in Dutch on a regular basis, and I appreciate this a lot. Thank you!

Very quickly, I also learnt from others about the great dedication and achievements of Hans Arts. He has been a pillar of our tax law programmes for many years. His expertise in the field of income and corporate taxation inspired many students, scholars and future generations. It is therefore a great honour to contribute to this Liber Amicorum for Hans Arts.

Fifteen years ago, few would have believed that a multilateral instrument revising almost 2,000 double taxation conventions would ever become a reality, that a global minimum tax would put a floor on tax competition, and that the OECD’s leading role in setting the agenda in the area of international tax law would be fundamentally questioned in favour of the UN. Similarly today, many doubt that there will be a fundamental shift of taxing rights to market jurisdictions through Amount A of the two-pillar approach, that the Under-Taxed Payments (or Profits) Rule (UTPR) will ensure minimum taxation of extraterritorial profits, including US profits, or that there will be a global minimum tax for (rich) individuals. However, considering the dynamics we are now facing in international tax law, even the impossible seems possible and one thing is for sure: international tax law will not get less interesting and complicated anytime soon. We already face a myriad of challenges implementing the existing measures. Unfortunately (or perhaps fortunately for the tax profession and scholarly discourse), many more legal and practical challenges await us.

In this contribution, I intend to outline some thoughts about the past and future developments in international tax law related to three connected areas:

the trend towards multilateralism to solve global tax issues;
the shift of taxing rights to market jurisdictions; and,
the global minimum taxation initiative.

I should note that this contribution does not aim to achieve scientific accuracy or completeness. Still, I hope that it will inspire some controversial discussions, which is the purpose of this contribution.

2. Multilateralism

Multilateralism is the process of organizing relations between groups of three or more jurisdictions. Besides this quantitative aspect an ideal type of multilateralism arguably involves an indivisibility of interests, diffuse reciprocity due to expectations that do not lie in immediate and equivalent exchanges, and a dispute settlement system to ensure compliance.2

Since countries have different domestic tax laws, economies, views and interests, they negotiate and conclude double taxation conventions mostly on a bilateral basis. Some states favour source taxation over residence taxation. Others favour residence taxation over source taxation. Some states maintain borders between each other and want to address the taxation of frontier workers in particular by deviating from the place-of-work principle. Others fear people leaving their jurisdiction after retirement in favour of sunnier states and are thus opposed to exclusive residence taxation of pensions. This leads to fragmentation of international tax law through bilateralism. On an abstract level, all states intend to eliminate international juridical double taxation to stimulate cross-border investment, trade and exchange. On a more technical level, due to their different systems and interests, it seems impossible to achieve this common goal through a single multilateral convention that goes beyond a regional level.

These differences in systems and interests are reflected in the BEPS Multilateral Instrument.3 Although the BEPS Multilateral Instrument pursues a common and arguably indivisible interest of preventing base erosion and profit shifting, the contracting jurisdictions share different views about the extent and way of achieving this multilateral goal. In addition, the BEPS Multilateral Instrument modifies bilateral conventions, which may differ significantly in wording, or may already include anti-BEPS measures. This explains the flexibility inherent in the BEPS Multilateral Instrument, achieved through various options and reservations that the contracting jurisdictions may exercise.4

Despite this continued fragmentation, the BEPS Multilateral Instrument is a success. Its purpose is not to harmonize all anti-BEPS measures in tax treaty law. It is rather a showcase that a vast number of double taxation conventions can be modified through a multilateral convention in a short time. It is an inspiration for future multilateral agreements addressing specific goals that require modification of tax treaties. Some of these kinds of agreements have already been developed and proposed: the STTR Multilateral Instrument5 and the Amount A Multilateral Convention.6 This means that the future of international tax treaty law will continue to be bilateral and multilateral at the same time. On the one hand, double taxation conventions will remain mostly bilateral to consider the different interests and views of the two contracting jurisdictions. On the other hand, where a need to swiftly amend a vast number of double taxation convention arises, or where a certain allocation of taxing rights can be better regulated through a multilateral convention rather than through bilateral agreements,7 multilateral conventions will apply on top of existing and/or newer double taxation conventions.

Whether negotiated at OECD or UN level, multilateral solutions must bring the diverging interests of jurisdictions closer together in order to address global tax problems and implement common approaches. As a result, they will constitute a compromise rather than a perfect solution. This may affect the design of the convention itself to allow for enough flexibility so that the required consensus for approval can be reached. This may further affect the design of the implemented solutions. Just like the BEPS Multilateral Instrument, conventions may leave the jurisdictions with choices and have an impact only to the extent there is a “match” between the jurisdictions.8 This gives a lot of freedom to the contracting jurisdictions. However, this approach may not be suitable to address all tax issues. For example, a completely new and complex system for the (re)allocation of taxing rights, notably, Amount A of Pillar One, would not be manageable in practice if jurisdictions could individually redesign and fragment this system through reservations. The adoption of uniform rules may be an objective in itself.9 Thus, conventions may also leave little to no choices, except for the choice to join or not.10 To ensure broad participation, however, the proposed solutions may be watered down, not rely on clear principles, introduce arbitrary thresholds and formulas, try to navigate between conflicting purposes at the same time, or be phrased in an ambiguous way to allow everyone identifying with the chosen wording. Arguably, many of the design choices of Amount A of Pillar One and the Global anti-Base Erosion (GloBE) rules of Pillar Two (the latter being implemented through a common approach11 and not through a multilateral treaty) can be explained by such a need for a compromise.

3. Amount A

Amount A of Pillar One, a new taxing right for market jurisdictions, would represent a fundamental shift of how taxing rights are allocated between jurisdictions. It would not only rely on consolidated financial statements and formulary calculations, but would also establish new and quite complex nexus rules. Thus, it needs to be implemented in a multilateral framework so it can succeed. While the current framework relies on principles developed more than hundred years ago and, thus, heavily relies on physical presence, under Amount A, market jurisdictions would have a taxing right even without such physical presence. Although taxation without physical presence is familiar when it comes to dividends, interests, royalties or technical services, Amount A would constitute a deviation from the well-established permanent establishment principle. In some cases, even the mere delivery of goods to a business customer in another jurisdiction may trigger a reallocation of taxing rights to that jurisdiction, notably where this customer is the final customer.12

Amount A is a compromise. What began with BEPS Action 1 and the tax challenges of the digital economy ended with a suggestion for a fundamental tax reform for all kinds of businesses, either digital or not. It seems impossible to ringfence the digital economy, as the whole economy is becoming more and more digital.13 From a legal perspective, it is not impossible to do so. Various tax measures such as digital services taxes (DSTs) do exactly this. They ringfence a certain type of business. Rather than impossible, it seems not desirable to ringfence the digital economy. Both in the traditional economy and in the digital economy there is no strict need to maintain a fixed place of business in another jurisdiction to do business. In fact, the concept of the dependent agency permanent establishment already recognized this a century ago. It deems another person to constitute a permanent establishment if that person meets certain conditions of dependency. There is still a physical link caused by the physical presence of that person. Some kind of physical presence is (almost) always relevant, whether it is the presence of the taxpayer, the agent, the customer, the consumer or the product. Shifting the taxing rights to market jurisdictions under Amount A means that the physical presence of the taxpayer would lose significance, while the physical presence of customers, consumers, users and goods would become more important.

Amount A would apply to (almost) all kinds of businesses, but it would only apply to approximately 100 multinationals worldwide due to the choice of arbitrary thresholds, namely, the revenue threshold of EUR 20 billion and the profitability threshold of 10% of the revenues. If market jurisdictions are justified in having a right to tax independently of physical presence in the form of a fixed place of business, this should be true in all situations, not only with the largest and most profitable multinationals. Any justification for a new taxing right should be valid for all multinationals, all corporations and all individuals doing business cross-borderly. The limited scope of Amount A can be explained from a practical standpoint and by the fact that the multinationals actually covered are profitable enough to have a substantial impact on the reallocated tax revenues. The complexity of Amount A, its reliance on consolidated financial statements and the administrative burdens associated with Amount A prevent a wide application of the suggested regime. The amount of potentially reallocated tax revenues seems sufficiently high to bring the conflicting views of winning and losing jurisdictions closer together and to reach a compromise under a multilateral agreement.

Amount A is, in principle, not about increasing tax revenues, but about reallocating tax revenues. In order to prevent double taxation, the tax paid in the market jurisdiction should trigger some form of relief in another jurisdiction. While market jurisdictions would receive a new taxing right, they would also have to give up their DSTs in return. This is the still existing connection to the digital economy. Many US multinationals of the digital economy avoided (or had no need for) physical presence in market jurisdictions. As a result, and due to some clever forms of tax planning, they paid little to no corporate income taxes. If others do not tax, why should market jurisdictions not tax instead? Thus, market jurisdictions started introducing different forms of DSTs. In reality, those jurisdictions do not want to tax digital services. They want to tax the US multinationals providing those services because those multinationals do (or did) not pay any substantial corporate income tax. Since DSTs arguably fall outside of the existing tax treaty network, it is possible to levy them without physical presence as a compensation for a low level of corporate taxation.

Here Amount A comes into play. Amount A will not become a reality without the US14 (but the same is arguably true for Article 12B of the UN Model). While the market jurisdictions would gain a new taxing right, they would also lose their DSTs. While the US would have to give up taxing rights (to some extent: it is also a large market), it would avoid a proliferation of unilateral DSTs. Thus, the removal of DSTs is an integral part of the multilateral agreement to implement Amount A.

Should all DSTs be abolished? No, market jurisdictions may benefit from both Amount A and DSTs at the same time. This is the case as long as DSTs are not designed in a discriminatory manner15 or, in short, as long as they do not predominantly target US multinationals. Austria, for example, has had an advertising tax for many years. Its scope covers various forms of advertising, except digital advertising. If Austria would extend this advertising tax to digital services (and abolish its current separate DST), this would not constitute a problem from the perspective of the Amount A framework. This is true as long as the revised advertising tax applies to all kinds of enterprises, large and small, carried on by individuals and by corporations and without discrimination.

4. GloBE

A third trend to discuss relates to the GloBE rules. The GloBE rules of Pillar Two arguably pursue two different objectives at the same time:

Setting a floor to tax competition; and,
Tackling remaining BEPS issues.

There is a certain conflict between these two objectives. If limiting tax competition is at the forefront, there is no need to exclude (or limit the impact on) substance-based activities through a substance-based carve-out, or to restrict the relevant substance to tangible assets and payroll. Despite that, the GloBE rules permit tax competition without limitations as long as the profits are supported by sufficient substance, and exclude intangible assets from the definition of substance. If tackling remaining BEPS issues is the priority, minimum taxation should only apply if there is an indication of abuse or missing economic substance and business reason. However, the GloBE rules apply and may impose additional taxes even if no abuse or base erosion and profit shifting is involved.

The fact that the GloBE rules do not specifically look at the existence of either abuse or base erosion and profit shifting does not necessarily mean that they give up on their purpose of addressing such situations. Indirectly, the GloBE rules will change (or have already changed) the behaviour of both taxpayers and jurisdictions, and that is their primary objective. Some tax havens without a corporate income tax system will introduce a corporate income tax because of the GloBE rules. Some jurisdictions with a nominal corporate income tax rate below 15% may consider increasing it. Many jurisdictions will review their tax incentives to align them better with the GloBE rules. Many will also introduce a Qualified Domestic Minimum Top-up Tax (QDMTT). If they consider the GloBE rules and the QDMTT too complex, they may reform their domestic corporate income tax system to avoid reaching an effective tax rate of less than 15%. All this – and the GloBE rules themselves – will affect how taxpayers will behave. If tax planning is not able to lower the effective tax rate below 15% due to the GloBE rules, there will be less incentives for the taxpayers to get involved in what may be a BEPS practice.

While the GloBE rules are expected to significantly increase tax revenues,16 this is not their ultimate objective. Rather, if the GloBE rules would never apply and would therefore only cause administrative burdens without raising any tax revenues, they would still fulfil their objectives. In such a situation, for the GloBE rules not to apply, all in-scope MNEs would have to be subject to an effective tax rate of at least 15% in every jurisdiction. If that is the case, there is no need to apply the GloBE rules. Nevertheless, the existence of the GloBE rules remains crucial, as they guard over the behaviour of taxpayers and jurisdictions, similarly as anti-hybrid mismatch rules de-incentivize taxpayers getting involved in hybrid mismatch arrangements and still would fulfil their goal if taxpayers would not enter into hybrid mismatch arrangements. On the one hand, taxpayers know that their involvement in BEPS will not be fruitful as long as the GloBE rules exist. On the other hand, jurisdictions will ensure that they raise the tax revenue up to the minimum level of 15% to prevent the application of the GloBE rules in another jurisdiction. Jurisdictions will still compete between each other, but through “GloBE-compliant” measures, such as by switching from non-qualified refundable tax credits to qualified credits, replacing income-based incentives with expenditure-based incentives, granting non-tax subsidies, or granting incentives in other areas of taxation, such as in the area of labour taxation or value added tax.

While the GloBE rules raise many legal and practical challenges, they are here to stay. Many design choices of the GloBE rules can be seen as a compromise that do not rely on clear principles. Why is 15% the minimum rate and not 10% or 20%? Why is the substance-based carve-out restricted to 5% of the tangible assets and payroll and not higher or broader? Why are only multinationals with at least € 750 million revenues within the scope of the GloBE rules and not their smaller competitors (this threshold may lead to situations in which large multinationals have a competitive disadvantage in low-tax jurisdictions compared to their local and/or smaller competitors)? The fact that so many jurisdictions have been able to agree on a common approach is a respectable achievement of the OECD and the Inclusive Framework. Is a similar compromise possible in the future at OECD or UN level to revise and improve the GloBE rules, for example by extending or removing the substance-based carve-out? It seems more likely that the GloBE framework will continue to exist as already agreed rather than that we will see an agreement for any kind of major revision of the GloBE rules.

On a technical level, the GloBE rules achieve their goals by encouraging (or some would say: forcing) all jurisdictions, even those that decided not to implement the GloBE rules, to revise their domestic tax law systems in order to be “GloBE-compliant”. This is achieved through the interaction of the Income Inclusion Rule (IIR) and the UTPR, ensuring that if one jurisdiction does not levy at least 15% corporate income tax, another jurisdiction will tax the income instead. The IIR is to some extent comparable to CFC rules, the most significant difference being that the IIR does not require any particular form of (presumed) avoidance or abuse, whereas most CFC rules do so. CFC rules are arguably compatible with tax treaty law because they tax the shareholder as a resident and not the CFC.17

This rather formal argument of taxing only a resident could theoretically also justify the application of the UTPR without any limits. However, the UTPR is a somewhat different method, and a cleverly designed mechanism. It ensures minimum taxation of profits regardless of where those profits have been earned within the structure of a multinational group. The UTPR’s compatibility with double taxation conventions can be doubted. It taxes extraterritorial profits of another person that are protected under tax treaty law without relying on a shareholder connection like CFC rules.

From a practical perspective, however, any incompatibility of the UTPR (or IIR) with a tax treaty may not have much effect on the whole GloBE system. If the UTPR is successfully challenged in one jurisdiction, the UTPR of another jurisdiction might apply instead, and that jurisdiction may have no tax treaty in force that could potentially limit the UTPR’s application. This means that a taxpayer may win the battle, but not the war. If the UTPR is incompatible with a tax treaty, the issue can be solved by amending (or overriding) the treaty. Perhaps in a few years we will therefore see a multilateral instrument ensuring the compatibility of the GloBE rules with the existing tax treaty network.

5. Conclusions

The future of international tax law is hard to predict, but it will be full of fascinating developments and challenges. The nexus for the allocation of taxing rights seems to move away from the traditional understanding of physical presence. It puts a stronger focus on consumers, users and markets. It remains to be seen to what extent this new understanding of nexus will not only affect the largest multinationals, but all businesses, large and small, regardless of their legal form.

There also seems to emerge a revised understanding of how far jurisdictions can go to compensate for untaxed profits. Taxation of extraterritorial but undertaxed profits due to group membership might soon become an accepted practice under international tax law, even if there is no shareholder relationship and/or predominant anti-abuse purpose. This could be achieved through the conclusion of a new multilateral instrument to ensure the compatibility of the GloBE rules with tax treaties.

So much has been done in the area of corporate taxation that the focus is shifting to the taxation of individuals. The increased mobility of individuals as well as different forms of tax incentives and opportunities to minimize taxes lead to issues similar to those in the corporate tax world. Thus, some of the existing rules and multilateral approaches might serve as an inspiration for new initiatives.

I am very much looking forward to discuss these developments with Hans Arts and to learn from his experience and expertise (and hopefully soon I will be able to do so with him in Dutch).