Podcast: An Update on the Digital Economy and DSTs

Nasim Fussell: Welcome back, everybody, to our second podcast on the digital economy and tax. I am Nasim Fussell. I'm a partner in the trade group at Holland & Knight, and I am joined once again today by two of our Holland & Knight tax gurus, Josh Odintz and Alan Granwell. We hope you had the opportunity to listen to our last podcast, essentially laying the framework for you on what is going on with digital services taxes. What are these taxes? Why the proliferation of these taxes around the world? And what is the United States and its trading partners doing to address these taxes and find an agreement on the global stage? So, with that, today we are going to just spend some time updating you on what has happened since we were last all together, talking about this very interesting topic.

An Update on USTR and DSTs

Nasim Fussell: On the trade front, when we got together last time, I gave you a brief overview of the latest actions taken by the Biden Administration. If you go back to last year when the last USTR started a number of investigations under the auspices of Section 301 of the Trade Act of 1974, essentially they started these investigations and concluded before leaving office that these taxes were, in fact, discriminatory and unfairly targeting U.S. companies. However, they didn't take action. There was a lot of anticipation that they would take action on their way out the door and impose tariffs, but they did not do so and they left that for the Biden Administration. At the end of March, the Biden Administration, through USTR, announced that it was going to seek comment from the public on a potential trade action against a number of the countries that USTR had investigated. That includes Austria, India, Italy, Spain, Turkey and the United Kingdom. USTR asked for public comment and also announced multijurisdictional as well as individual hearings on these various investigations that will be happening in the beginning of May. So if you are interested in commenting, we encourage you to get your comments in. If we can be of assistance, we would be very happy to and please feel free to reach out. The comments are due by April 30, and USTR is also asking if companies or organizations would like to appear at the hearing, that they submit their request for appearance by April 21, along with testimony. Again, these hearings will be held in early May, ranging from May 4 through May 11. Now another interesting development, at the end of March USTR announced that it would not be proceeding with investigations. At the last, USTR had begun on the DSTs that had been proposed by the European Union, the Czech Republic, Brazil and Indonesia. USTR indicated that these jurisdictions had not adopted or implemented the taxes, that it would be terminating the investigation. So that's where we are now on the trade front. Notably, USTR also said that it was going to continue to remain focused on the OECD process and committed to finding a solution there, but that it wanted to maintain its options, including tariffs in the meantime. With that, I want to hand it over to Alan to talk to us about what is going on in the tax universe. There's just been a flurry of activity and it all may very well determine what happens when it comes to the trade actions or not. So, Alan, over to you. Maybe you can clear some of this up for us.

USTR also said that it was going to continue to remain focused on the OECD process and committed to finding a solution there, but that it wanted to maintain its options, including tariffs in the meantime.

An Update on Taxes in the U.S. and Abroad

Alan Granwell: Thank you so much and welcome, everybody. There, as Nasim has mentioned, really been a frenetic force of activities in the last week or so, every day something else comes out. Let me summarize it and then Josh and I will sort of chat about this in high-level terms. As you are undoubtedly aware, last week, the president announced his jobs plan, this major initiative to invest in American infrastructure, research, technology, green energy, which is more than the hard type of infrastructure, roads, airports and other types of facilities. This plan is proposed to be funded primarily by increases in corporate taxation, which we'll describe, and it's summarized in another document the administration released called the Made in America Tax Plan. Under this particular plan, the U.S. corporate income tax rate would be increased from 21 to 28 percent. There would be an adoption of a 21 percent global minimum tax on foreign profits of U.S. multinational corporations. There would be incentivization for U.S. corporates to invest in the U.S. and in jobs, and a disincentive of the U.S. corporates to invest abroad and jobs, and also a disincentive in terms of profit shifting. All of this would be monitored by increases in the IRS budget on the compliance front. Well, the reaction to the infrastructure is one thing. I think the parties agree that infrastructure should be improved, but there has been a significant counter reaction to the increase in corporate rates to fund this particular plan. At the same time, while all of this is going on, as Nasim had mentioned and as we discussed in our first podcast, there are the imposition of the unilateral digital services taxes by countries around the world and how the U.S. reacts against those. As we mentioned, there is this project going on at the OECD to resolve these issues, which is the Pillar One and Pillar Two, to deal with profit allocation and nexus initiatives and also a global minimum taxation. What is so interesting in terms of what the Biden Administration did is they tied their corporate tax increases to what is going on in the OECD. In other words, to maintain U.S. competitiveness in view of the proposed increase of the corporate tax rate to 28 percent, the U.S. has actively engaged with the OECD Inclusive Framework dealing with this Pillar One and Pillar Two, and in the Pillar Two context has urged countries around the world to adopt a robust minimum taxes and to provide for disincentives. And if they don't adopt these minimum taxes, these countries would be subject to disincentives, potentially the denial of deduction of payments to these low tax countries. Likewise, in terms of how to address digital service taxes and the proliferation of those types of taxes worldwide, the United States is mentioning to the U.S. that that type of issue has to be resolved in order to really create a uniform international tax structure. The proposals being made currently by the U.S. would provide a simpler method to deal with the process, allocation and nexus, as opposed to the complex ways that previously had been proposed. Simpler ways would reduce compliance, administrative burdens, provide certainty in principle and not be discriminatory against large U.S. companies. If this all works, the idea would be that there would be a resolution of this DST problem and concomitantly an increase in the global minimum tax, so countries then would not be racing to the bottom. Josh, am I getting this right? What do you think the takeaways of this unusual initiative are?

What is so interesting in terms of what the Biden Administration did is they tied their corporate tax increases to what is going on in the OECD … to maintain U.S. competitiveness in view of the proposed increase of the corporate tax rate to 28 percent, the U.S. has actively engaged with the OECD Inclusive Framework dealing with this Pillar One and Pillar Two.

Josh Odintz: Alan, you absolutely nailed it, and there's a lot to unpack. I think it's interesting, looking at the OECD and Inclusive Framework process, just reminding everyone that back in 2020 the last administration created a new hurdle for Pillar One and said that Pillar One would be a safe harbor for Amount A. Amount A, once again, is the IP return that would be ceded to the market jurisdiction. Secretary Yellen noted that the U.S. changed its negotiation position and that Pillar One, Amount A would no longer be a safe harbor and the U.S. would change its negotiating position. So that led to, I think, some very positive developments and showed the U.S.' willingness to move in a direction to reach agreement at the Inclusive Framework. It's clear that the Biden infrastructure proposals are fairly similar to what is under discussion at the OECD on Pillar Two. What we have not seen is how Pillar One would operate in the U.S. system, but perhaps the U.S. will move forward on changes to guilty and changes to the BEAT, or the base erosion and anti-abuse tax, and will then make further revisions to align us with Pillar One if an agreement is reached.

Nasim Fussell: Does this mean we're going to end up with tariffs? Because what you guys just described sounds incredibly ambitious, but there also seems to be this great deal of ambition backing the goals. So are we going to get there? Are we going to avoid tariffs? Where do you see this going?

Josh Odintz: So I think there are different pieces of what's in the Biden tax proposal. It's possible that we end up with multiple rounds of corporate tax and international tax changes. I think raising the rate, for example, is fairly easy. If one looks at the polling, it's a fairly popular message to increase corporate taxes in exchange for paying for better infrastructure - that even polls well among Republicans. So I think it's possible we could see a corporate tax increase, and then on the OECD Inclusive Framework and guilty BEAT side, we need to see more details to see the advanced thinking of Treasury. We will see that when the Treasury releases its full budget and green book, and we'll get a sense of what the connections are between the different provisions. It's possible that may not be ready for passage in the near term and it might be a Fall exercise. At the same time, what we've seen at the OECD so far, the two public documents, Pillar One and Two, contain detail, but not sufficient detail for implementation. So we don't really know the timeframe for implementing Pillars One and Two, they will require uniform legislation and a multilateral instrument. Both of those could take years once a deal is reached, to flesh out the details. I'd say we're in this period of flux. Alan, there is some cryptic messaging about unilateral measures. What do you think? Where are we on the path for agreement?

If one looks at the polling, it's a fairly popular message to increase corporate taxes in exchange for paying for better infrastructure - that even polls well among Republicans.

Alan Granwell: Thanks, Josh. I mean, interestingly, I think the idea is to sidestep all the trade issues by having countries adopt a uniform and robust global minimum tax. By happenstance, I was speaking to various colleagues today in Switzerland and Ireland, and the U.S. is proposing a 21 percent rate, in certain instances in Switzerland, under the various cantonal tax regimes, the rate is 13 percent, and the rate that is sort of the headline rate in Ireland is 12.5 percent. So in terms of reaching agreement on a 21 percent rate of corporate minimum tax, you will have countries such as Switzerland, Ireland and Hungary, which has a 9 percent rate, not much in favor of it, but subject to the unilateral approach the U.S. might take at denying deductions and applying then to parties in those other countries. So I think all of this has a long way to go to get resolved, but I think the underlying premise now of the administration is to reduce the race to the bottom. It's important for countries around the world to agree to a uniform rate, but that whole arrangement will not get that far through the continuation of the imposition of unilateral taxation through these DSTs or other types of crawlspaces taxation. Therefore, it's necessary to have a stable system. As Josh was mentioning, you have to resolve who's within scope, how does this all work, can you achieve certainty, and from the U.S. point of view that it doesn't discriminate against the large U.S. taxpayer. So I think, Josh, this is a huge challenge, not only in terms of doing all of that, but also maybe equally challenging in relation to how all of this is going to be passed by the U.S. Congress, which is probably a topic for another day.

 It's important for countries around the world to agree to a uniform rate, but that whole arrangement will not get that far through the continuation of the imposition of unilateral taxation through these DSTs or other types of crawlspaces taxation.

Nasim Fussell: Indeed. Well, thank you both. I find that I learn so much from both of you about everything that is happening in parallel in the tax and trade world right now, and really, one is so dependent on the other in terms of outcome. At the end of the day, whether it's taxes or tariffs, it's all taxes in the end. So please do reach out if you would like to talk to us more about any of this, and we are going to continue coming together to bring you more content.