On October 13, 2021, the G20 Finance Ministers and Central Bank Governors issued a Communiqué formally endorsing the political agreement reached by 136 countries of the OECD/G20 Inclusive Framework on Base Erosion and Profit Shifting (IF) on a two-pillar framework to dramatically change the taxation of multinational enterprises (MNEs). The  Communiqué calls on the IF “to swiftly develop the model rules and multilateral instruments. . .with a view to ensure that the new rules will come into effect at global level in 2023.” The Finance Ministers’ endorsement is an intermediate step concluded in anticipation of the G20’s full approval of the agreement to be considered at the next G20 meeting in Rome at the end of October.

As discussed in our recent Legal Update, the IF had announced the landmark 136-country agreement just five days earlier on October 8, 2021. Importantly, the agreement would reallocate $125 billion of annual profit to countries that would not otherwise tax such profits under current international tax norms and require that all profits be subject to a global minimum tax rate of 15%. To reallocate such profits, the agreement relies in large part on a new formulary taxing right called “Amount A.” Specifically, Amount A reallocates 25% of the residual profits (i.e., profits in excess of a 10% margin) of approximately 100 of the world’s largest and most profitable MNEs from the jurisdictions that currently earn the residual profits to the MNE’s market jurisdictions. While Amount A is an explicitly non-arm’s length allocation, it operates as an overlay rather than an override to the existing transfer pricing rules. This will likely create complex interactions between the new and existing rules that will put additional pressure on existing transfer pricing methodologies and create the potential for double taxation. This in turn will put added pressure on the new multilateral mandatory dispute resolution mechanism that the agreement contemplates will be put in place to resolve Amount A-related disputes.

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On August 13, 2021, the IRS released a Chief Counsel Advice (“CCA”) (CCA 202132009) addressing the tax treatment of intercompany reimbursements of the Branded Prescription Drug (“BPD”) fee, a non-deductible excise tax imposed by the Patient Protection and Affordable Care Act on entities that manufacture or import branded prescription drugs for sale to specified government programs. The CCA concludes that intercompany reimbursements of the BPD fee are not per se excludable from gross income, but rather, the inclusion or exclusion of the reimbursement depends on whether the entity paying the fee was the beneficiary of the payment under the facts and circumstances. For pharmaceutical companies subject to the BPD fee, the CCA stops short of providing certainty that reimbursements of the fee are per se excludable, but nevertheless, offers useful guidance on how the reimbursements might be structured to support exclusion in many cases. Outside of the pharmaceutical industry, companies in other industries that pay and receive intercompany reimbursements of other material non-deductible costs may also find the CCA’s guidance to be instructive by analogy.

Continue Reading IRS CCA Addresses Intercompany Reimbursements of Branded Prescription Drug Fee: Guidance May be Relevant to Taxpayers Across Industries with Material Non-Deductible Expenses

On September 9, 2021, the Treasury Department and the Internal Revenue Service (“IRS”) issued its Priority Guidance Plan for 2021-2022. The Priority Guidance Plan gives the public a sense of what regulations and other guidance the Treasury Department and the IRS might develop over the following 12 months. Among dozens of other pending and potential guidance projects, the Priority Guidance Plan lists the following two new potential section 482 regulations projects:

  • Regulations under §482 clarifying the effects of group membership (e.g., passive association) in determining arm’s length pricing, including specifically with respect to financial transactions.
  • Regulations under §482 further clarifying certain aspects of the arm’s length standard, including (1) coordination of the best method rule with guidance on specified methods for different categories of transactions, (2) discretion to determine the allocation of risk based on the facts and circumstances of transactions and arrangements, and (3) periodic adjustments.

Continue Reading Priority Guidance Plan Portends New Transfer Pricing Guidance

A recent Tax Notes article analyzes the “standard of review” that the Tax Court will apply to the IRS’s transfer pricing adjustments. In transfer pricing cases, the Tax Court determines whether the IRS has abused its discretion by proposing an adjustment that is “arbitrary, capricious, or unreasonable.” Although courts often describe this standard as a “heavy” burden for the taxpayer to prove, the Tax Notes article concludes that “recent experience suggest[s] that taxpayers and the IRS are on mostly even ground in transfer pricing litigation.”

We won’t comment on that conclusion in this blog post, although we encourage anyone interested in the intersection between transfer pricing and court procedure to read the article.

We do, however, want to point out that there is at least one area where our experience tells us that the standard of review really might matter: in dealings with IRS personnel. While the IRS has indeed lost many transfer pricing cases, the IRS has always had considerable leverage at administrative levels (e.g., in audit or before Appeals) and in settlement discussions in litigation. No matter whether a court practically puts the IRS and taxpayers “on mostly even ground,” the IRS continues to believe (or at least argue) that the abuse-of-discretion standard of review gives the government the advantage. This could in some cases make IRS agents, Appeals officers, and IRS trial counsel less willing to resolve transfer pricing controversies on terms that are favorable to the taxpayer. It could also mean that IRS personnel will make arguments about the standard of review, which the taxpayer will need to address. Even if IRS personnel are not justified in their thinking, the standard of review does have practical significance in that sense, at least in our experience.

On August 5, 2021, the OECD released updated Peer Review Results for preferential tax regimes reviewed by the OECD Forum on Harmful Tax Practices (“FHTP”) in connection with BEPS Action 5. Of particular interest to Multinational Enterprises (“MNEs”), the Peer Review Results report that the Foreign-Derived Intangible Income (“FDII”) regime is already “in the process of being eliminated” and that “the United States has committed to abolish this regime.”

The possibility that FDII might be repealed should come as no surprise given the Biden Administration’s Green Book proposal to eliminate FDII. And in any event, the repeal cannot actually take effect until and unless FDII is repealed by legislation. Nevertheless, for MNEs that would be adversely affected by the possible repeal, the references in the Peer Review Results send a strong signal that FDII repeal may be a key priority in future tax reform negotiations.

Continue Reading Whither FDII — OECD Discusses FDII in Harmful Tax Practices Update

Many taxpayers are familiar with information document requests where taxpayers are notified that taxing authorities are inquiring into certain transactions based on their receipt of the request. But today, many types of foreign tax information exchanges occur without the taxpayer’s knowledge. Moreover, tax administrations around the world are expanding tax information exchange programs. For example, on May 19, 2021, the European Union (“EU”) approved a measure to spend an additional € 270 million to improve national information exchange programs with a particular emphasis on upgrading information technology systems and financing joint audits.

Taxpayers should: 1) refresh themselves on the major types of tax information exchanges, 2) know how that information is used, and 3) be prepared that anything they provide to one tax administration could likely end up in the hands of another. Continue Reading No Secrets are Safe in an Era of Global Tax Information Exchange

On April 15, 2020, OECD released the report titled “Tax and Fiscal Policy in Response to the Coronavirus Crisis: Strengthening Confidence and Resilience” (the “COVID-19 Response”). The COVID-19 Response discussed the decisive action many governments have taken to contain and mitigate the spread of the virus and to limit the adverse impacts on their citizens and their economies, and outlined various tax policy options as available tools. Included in the tax policy discussion is the commitment to stay the course in response to the tax challenges of the digitalisation of the economy and ensuring that MNEs pay a minimum level of tax. (p.6)  In the COVID-19 environment, the new impetus to efforts to reach agreement on Pillar One issues internationally can now stem not only from “[t]he increased use of digital services” but also from “the need to collect more revenues” which can be achieved, in part, by “strengthening the taxation of economic rents” (p.6) particularly of the companies which perform relatively well during the crisis.

The intent to focus the “taxation of economic rents” on better-performing enterprises has been reinforced in the OECD’s “Statement on a Two-Pillar Solution to Address the Tax Challenges Arising From the Digitalisation of the Economy” published on July 1, 2021 which proposes that in-scope companies be defined as the MNEs with global turnover above 20 billion euros and profitability above 10%. While the profit margin cut-off may seem reasonable, the one-size-fits-all approach is disheartening.

A quick review of the top 100 brands valued by BrandFinance[1] illustrates the point:  while for the companies with operating margins under 10% the ratios of brand value to revenue cluster between about 15% and 40%, for companies with operating margins in excess of 10% – which companies would be in-scope as proposed by the Statement – the ratios of brand value to revenue are spread widely between 20% and over 100%. Thus, if the 10% profitability were to be accepted as a simple mechanical threshold, the residual profits that would be subject to allocation as Amount A could include, in part, the return on the MNE’s brands. One can question whether this is OECD’s intention.

[1]              brandirectory.com/global  Brand Finance Global 500 January 2020

After Altera’s victory in Tax Court in 2015,[1] many companies with cost sharing arrangements (“CSA”) ceased sharing stock-based compensation (“SBC”) costs. To address the possibility of a reversal on appeal, many of these companies added reverse claw-back provisions to their CSAs. Under these provisions, in the year a reversal of Altera becomes final, the US participant typically “claws back” from the foreign participants the amount of SBC costs not shared in prior years (the “claw-back true-up”). The effect is a large inclusion of SBC costs into the US participant’s income in the year the reversal becomes final.

These reverse claw-back provisions were revisited by companies in 2019, when the Ninth Circuit reversed the Tax Court, and in 2020, when the U.S. Supreme Court declined to hear Altera’s appeal.[2] Companies were concerned about whether the IRS would respect the provisions or insist that adjustments be made year-by-year. Should taxpayers report the claw-back amount in 2020, or amend prior year returns to include the SBC costs in the cost pool for each open year, or modify the CSA to defer or cancel the payment pending IRS guidance? On July 13, 2021, the IRS provided guidance on these questions, in the form of a Chief Counsel Memorandum, AM-2021-004 (the “CCM”).

Continue Reading IRS Memo on 482 Adjustments for CSAs with Reverse Claw-Back Provisions

On July 10, 2021, the G20 endorsed a broad framework to advance Pillars One and Two, which includes an aggressive timetable for bringing the new rules into force in 2023. The endorsement came in a Communiqué, which approved the July 1 statement by the 139-country Inclusive Framework. The G20 agreement represents a political consensus on a substantial revision to global tax policy.

As discussed in our recent article, there is still much work to do to flesh out the details of the framework. Moreover, there is considerable skepticism as to whether a final agreement can be reached, whether it can be implemented legislatively in the United States and abroad, and whether countries that have enacted (or are considering enacting) digital services taxes (DSTs) and similar unilateral measures will find the proposed framework sufficiently revenue-generating to repeal their DSTs.

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On July 15, we will be hosting a webinar to discuss these important developments, together with an analysis of the US President Biden administration’s international tax proposals that complement the G20 agreement.

For over a decade, countries have been looking for ways to tax the digital economy. On July 1, 130 countries announced an agreement that would provide a new taxing right to enable a country to tax a portion of digital profits even in the absence of traditional taxable nexus with the country. This new taxing right is known as “Amount A”. The quantum of Amount A remained a mystery until the publication of the OECD’s “Statement on a Two-Pillar Solution to Address the Tax Challenges Arising From the Digitalisation of the Economy” on July 1, 2021 (the “Statement”) which quantified Amount A to be “between 20-30% of residual profit defined as profit in excess of 10% of revenue” for in-scope enterprises. Although this quantum of Amount A represents a political compromise, a solid theoretical basis underlying that compromise is essential to sustaining consensus.

The early proposals to modify profit allocation and nexus rules for the digital economy enterprises, which ultimately produced Amount A, strived to be based on certain subjective criteria, including the concepts of user participation, marketing intangibles and/or the concept of significant economic presence. The contemplated methods for profit allocation were the Modified Residual Profit Split method, Fractional Apportionment method, and Distribution-based approaches, along with the options for business line and regional segmentation. However, the criteria and methods of the early proposals are nowhere to be found to found in the OECD July 2021 Statement, leaving many questions about Amount A still unanswered. While the final compromise on Pillar One eliminates the focus on digital economy and shifts instead to high profitability when defining in-scope MNEs, the “digital essence” still surrounds Amount A. For one thing, the introduction to the Statement continues to refer to the “two-pillar solution to address the tax challenges arising from the digitalisation of the economy.” Moreover, a widely accepted assumption in the final Pillar One negotiations is that high profits are generated by intangibles and those are increasingly concentrated with digital businesses. Therefore, an analysis of Amount A cannot be divorced from the analysis of the factors that contribute to the digital economy.

Continue Reading The Elusive “Amount A”