The OECD tax reform could be seen as the final act of efforts to harmonize international corporate taxation. Just a few years ago, there was a consensus that key challenges such as the taxation of digital companies with no presence in a country should be addressed within the existing system. Now the OECD, with the cooperation of the G20, is preparing to create an entirely new tax code. This restructuring primarily favors large countries, for example by classifying tax competition between countries as fundamentally harmful. Nevertheless, the initiators of the tax reform have succeeded in rallying the community of states behind the reform ‒ a coup that until recently not many thought possible up.
Little progress on the taxation of digital business models
However, the agreement reached by nearly 140 states in July 2021 disguises numerous practical problems that are already creating uncertainty, even before it enters into force. For example, the implementation of the so-called Pillar One has stalled seriously. Under this pillar, profits are to be redistributed to countries that don’t have the right to tax these profits under current tax standards. In other words, under the new arrangements, profits wouldn’t just be taxed in the country in which they originated, where development, production, and marketing took place, but also in the target country, i.e. the main place where a company generates sales. The purpose of this regulation would be to ensure taxation of corporations without a physical market presence and thus prevent unilateral digital taxes.
The reallocation of profits pursued under Pillar 1 is challenging, and numerous questions remain unanswered. For example, which states must grant relief on profit tax to prevent double taxation? Or how should the mechanism for dispute settlement between states be designed? The signing of the multilateral agreement needed for implementation was recently postponed by one year to mid-2023. This is a strong indication that agreement hasn’t been reached on weighty issues.
More than 135 countries have agreed to implement this tax reform. (Jason Leung, Unsplash)
Behind closed doors, there is already speculation about whether Pillar 1 will ever be implemented ‒ not least because the fate of the multilateral agreement in the USA is uncertain. An agreement without the US, the most important country of domicile for large digital companies, is pointless. If the reallocation of taxation rights were to fail, this would likely revive the appetite for digital taxes, especially in the EU. A scenario thus becomes conceivable in which nobody has any interest ‒ a scenario which Pillar 1 is actually supposed to prevent: new trade distortions due to unilateral digital taxes imposed by European countries and US punitive tariffs on, for example, French luxury products or German cars. Incidentally, there are also calls in Switzerland for a digital tax. A motion to this effect is pending in parliament.
Minimum tax faces further political hurdles
Although numerous technical aspects have been fleshed out in recent months, Pillar Two, the minimum tax rate of 15% for multinational corporations, hasn’t yet been wrapped up. For the OECD, the technical work has been completed and nothing seems to stand in the way of implementation at the beginning of 2024. However, these new rules are being met with resistance in individual countries. In the US, for example, politicians and business leaders are concerned that the agreement will also influence the design of tax incentives to promote investment. As a result, Washington is delaying the necessary adjustment of the existing US system ‒ the US has levied a 10.5% surtax on the profits of subsidiaries of US companies since 2017 ‒ to the OECD agreement. Even before the mid-term elections in November, in which the Democrats, who are more inclined toward the agreement, fear for their majority in the House of Representatives, US approval is hanging in the balance.
Moreover, in the EU, individual member states ‒ currently Hungary ‒ are blocking the corresponding guideline for EU-wide implementation. Unanimity is important for the EU, as an early supporter, primarily for political reasons. And if the US stays out, the agreement would hardly be salvageable without the EU’s support…
Don’t try to be more Catholic than the pope
In this context, the Swiss Parliament is currently discussing the Federal Council’s implementation bill. In addition, the consultation on the transitional provisions in the constitution will be running until November. In view of the considerable uncertainty, politicians would be well advised to push ahead with a lean implementation. Instead, the Federal Council is threatening to overshoot the mark. Both the proposed constitutional amendment and the temporary ordinance give the impression that they don’t even want to raise suspicions that Switzerland wouldn’t implement the reform in a bulletproof manner. In the eleven articles of the temporary regulation, reference is made at least ten times to the OECD model rules.
Apparently, the Federal Council ‒ and with it the Council of States Economic Affairs and Taxation Committee ‒ believes that the reform can only be implemented if existing taxation principles are violated. Thus, a provision in the new constitutional article (Art. 129a para. 3 E of the Federal Constitution) allows the federal government to evade guiding principles of tax law which are also laid down in the Constitution (Art. 127 para. 2 of the Federal Constitution). This is despite the fact that alternatives to this fiscal wording were already pointed out in the consultation on the constitutional provision in spring and also more recently in the Neue Zürcher Zeitung.
Last but not least, the federal government is extending its profit tax competence by designing the necessary supplementary tax as a federal tax. In doing so, it is breaking with the principle that federal taxes are limited and capped, thus opening the door to redistributive mechanisms that are alien to the system. As justified as the concern for legally secure and internationally accepted implementation of the tax reform may be, in view of these shortcomings the implementation bill is immature from a national policy perspective.
Further information on this topic can be found in the Avenir Suisse analysis: “Brave New World of Tax”.