J. Scott Wilkie
48 Riverview Gardens
Toronto, ON Canada M6S 4E5
scottwilkie@rogers.com

 

OECD
Tax Policy and Statistics Division
and
International Co-operation and Tax Administration Division
Centre for Tax Policy and Administration
2, rue André Pascal
75775 Paris Cedex 16
France

TFDE@oecd.org
taxpublicconsultation@oecd.org

Dear OECD Colleagues:

Re: Secretariat Proposal for a “Unified Approach”
Under Pillar One; and Global Anti-Base Erosion
Proposal (“GloBE”) Proposal under Pillar Two

 

I would like to join others in thanking the OECD for its contribution to the ongoing international conversation most recently arising from the “Base Erosion and Profit Shifting” project undertaken with the G 20, and for broadly soliciting interventions in that conversation from the many constituencies affected by reconsideration about how countries should configure and share taxing rights more effectively.

My comments are entirely personal and should not be attributed to any organization or firm of or with which, as the case may be, I am or have been a member or otherwise affiliated. They are submitted in the spirit of my long-standing commitment to, admiration for and participation formally and informally in the valuable, leading work of the OECD on fiscal and tax policy. They are informed by practicing tax law for over thirty-five years, and by teaching international tax law and publishing on matters of international tax law and policy, and on taxation more generally for almost the same period. Deliberately, these comments concerning the above-referenced Proposals are not “technical”. No doubt many commentators will provide comments of this nature which, I predict, in many cases may be quite similar. The Proposals are likely to be perceived to be far-reaching and indeed somewhat iconoclastic considering commonly held perceptions of the internationally “agreed” parameters establishing the boundaries of shared taxing rights among countries.

My comments are more in the nature of a plea for the infusion of more thoughtful perspective and informed reflection in the ongoing discussion, as the current preoccupation with all things “digital” illuminates latent meanings and implications of markers of relative tax jurisdiction and the allocation of taxing rights among countries, which may have been obscured by practical circumstances or simply taken for granted to have shallower significance than a thorough understanding would illuminate. It may be, indeed it is probably likely that the ongoing consideration of the Proposals will not slow from the evident momentum, though interestingly not consensus, propelling the seemingly urgent impression that those markers are irretrievably deficient. However, even an inquiry so directed would, in my view, by improved by due attention to what these markers mean given the inescapable inter-nation taxation interests that justify any measures to allocate and share taxing rights, aside from what it has become customary to conclude they mean because of what they “say”.

Indeed, one of my concerns prompting these comments is the all too common tendency to
subject proposals like the Proposals to the kind of scrutiny associated with the study of religious texts, without due attention to the resilience of familiar markers of inter-nation tax jurisdiction understood with reference to their origins and applied constructively with reference to the business and commercial contexts that now, necessarily, host them.

The current storm of competing proposals and commentary concerning all matters “digital” is susceptible to just this sort of vulnerability, abetted by continual assertions by the OECD and others that “digital” modalities of conducting business and “digital products” are responsible for a failure of those familiar markers of inter-nation tax jurisdiction, occasioning an as yet unfilled void and, potentially, resurgent tax chaos – or unlimited “freedom” - that law, generally, exists to discipline in the interest of civil and predictable interactions. In other words, the common perception, fed by much of the ongoing commentary about “digital”, is that there are no longer any coherent limits establishing the boundaries of tax jurisdiction in, at least, a number of key and pervasive contexts, because many business activities – customer facing and others – can be conducted without an animate or otherwise more or less physical presence in “source” countries whose tax claims necessarily depend, it is usually thought, on the existence of such a presence.

I do not think this is correct. My comments are meant to encourage others to reflect on whether the international tax environment is as unstable as may seem from the current discussion and indeed from the BEPS project more generally to be the case.

In making these comments, I am reminded of a famous, even apocryphal scene in the Victorian novelist Thomas Hardy’s Far from the Madding Crowd, in which a shepherd’s dog proudly drives a herd of sheep off a precipice to their profound demise – because that is what the dog knows and knows how to do unconstrained by limits informed by experience and perspective. (see footnote 1*)

Without meaning any disrespect or belabouring the allusion to this remarkable Hardy scene, the present “digital” debate seems to me a lot like this – with many like-minded herders of international fiscal and tax policy single-mindedly driving the herd of all of this, as single mindedly as the dog in Hardy’s story, to what for the sheep and us, in both cases, is an unnecessary and not inevitable outcome.

It would be hoped that the origin of the jurisdictional “norms” captured by “permanent
establishment” and “attributed” income and similarly directed “transfer pricing” profit allocation, framed respectively by Articles 5, 7 and 9 of the OECD Model Tax Convention and most model or bilateral tax treaties since the earliest modern drafts arising from the work of the League of Nations, is well understood. However, given the present discussion, I doubt it. The early treaties and their progeny, which are largely unchanged in the relevant respects bearing on the current “digital” conversation, sought to allocate taxing rights according to a very simple premise, maybe not articulated quite this way but nevertheless intrinsic to the above jurisdictional and income attribution notions mentioned above. Namely, taking account of the nature of a business and in that light its essential productive and market-related elements and, as well, how a business of that nature typically because of that nature is (and only needs to be) conducted, non-residents should be taxable by a “source” country as and to the same extent as similarly situated residents of that country carrying on the same kind of business in more or less the same relevant conditions.

It is in the nature of the subjects of international taxation and how they are typically discussed that we get caught up in and even distracted by questions concerning what “permanent” means, what is an “establishment”, what “dependency” means in relation to a representative presence, that activities and connections that are not core, i.e., in themselves profit generating, business activities should be seen as benign “auxiliary” or “preparatory” activities to which little tax significance should be attached, and others, almost as if we were parsing a religious text. But the essence of the notion of a sustainable jurisdiction to tax, as a careful study of and reflection on the earliest formulations of the familiar jurisdictional notions shows, is as I have just put it: income earned by similarly situated residents and non-residents carrying on business “in” (including via controlled intermediaries) a “source” country should face equivalent if not mostly the same tax claims by that country. In effect, it is in the nature of the familiar jurisdictional parameters to treat the non-resident as a constructive resident in the circumstances; the same effect is achieved if the non-resident acts in the guise of separate entity by evaluating the commerciality of profit allocations to commonly controlled (non-arm’s length) entities transacting with each other to ensure that the common control is not exercised chauvinistically and only because it can be so exercised, to misshape commercial outcome.

A thorough study of the origin of the parameters of jurisdiction to tax with which we think we are familiar reveals two seminal observations.

First, the jurisdictional “rules” framed by “permanent establishment” and income “attribution” are and always have been descriptive, not prescriptive. They originated from observing and reacting to how business activities of the day took place and, pertinent to the present discussion needed to take place considering prevailing business modalities and limitations. In the current discussions, far too much effort has gone into validating and reinforcing the perception that the “rules” are prescriptive and accordingly securely attached to outmoded ways of conducting business. Not only is this not correct (or an advisable perception given the reasons for and goals of inter-nation tax accommodations), taking account of how and why the jurisdictional notions arose, it is unnecessary as a matter of legal construction. Even taking account of judicial pronouncements concerning these notions, about for example the kind of self-interested “control” that must be exercised over premises to constitute them a taxpayer’s “permanent establishment”, it is possible to construe these notions constructively in relation to the modalities of business which now host them, in much the same manner as was the case when they were devised. In other words, it is possible to regard these jurisdictional notions as descriptive and indicative, and suitably elastic to apply to detect now as they existed to do in the 1920s and 1930s when a non-resident similarly situated to a resident should be treated as what amounts to a constructive resident. Adopting this tack, in the present “digital” discussion might not change the discussion about the degree of elasticity required to adapt prevailing jurisdictional notions to evolved business modalities, but it would suggest some reservation on the conclusion that directionally, if not more, the long-standing jurisdictional parameters are irretrievably broken.

Second, the early modern students of tax jurisdiction, including wise contributors to an earlier era’s equivalent-to-“digital” concerns about allocating taxing rights, were prepared and in some cases even attracted to adopting “fractional apportionment” as an objective and more rather than less predictable and readily applicable means, at least in the first instance, to associate income with countries whose tax claims might be competing. Both the International Chamber of Commerce and the League of Nations, and for that matter working groups of the Organisation for European Economic Cooperation concerned in the late 1950s with base erosion occasioned by transactions entailing deductible charges, not only did not dismiss such an approach but indeed recognized its benefits. Among other notable parallels, as the work of Mitchell B. Carroll in the 1930s records, the frailty of reliable international income allocation was in significant measure associated with the unreliability or non-existence of entity level accounts (a current preoccupation and concern of the second of the two present OECD Secretariat proposals) and, in the day, the implications of business value being intangible and therefore not easily associated with any particular taxing jurisdiction but that of the parent or home establishment, the second main preoccupation, analytically, of “digital”. In other words, much less has changed, and much less is new, than the present tax policy race for Hardy’s precipice seems to presume.

There are, to my mind, four notable features of or associated with the not-so-new jurisdictional markers and an evaluation of their constructive and verifiable application to contemporary business modalities that do to reflect, because they do not need, arcane forms of business presence (apart, perhaps, from the presence occasioned by being “invited” into a “source” country – many, many times a day in fact – in the form of a consumer’s electronic device, and essentially taking over that device to consummate the full metamorphosis of a “transaction” via that quite physical device in the quite physical place in which it is used, relying on the consumer – retail or business – to act in the dual roles of supplier representative and self-interested customer).

1. The notions of “carrying on” business and carrying it on “in” a place are more evidently conflated, as “digital” business modalities reveal. This, however, has been an ever present situation from the earliest modern draft income tax treaties and was never really a dichotomy except because observably and hence descriptively business was necessarily conducted in a more cumbersome and physically iterative way and communications technology, which still in some ways marginalized the significance of political boundaries, was relatively undeveloped. But what this suggests is that the connotations of the jurisdictional parameters we take for granted were, in fact, a necessary default position of the time and always were taken for granted – descriptively. Their indicative significance, however, to treat similarly situated nonresidents and residents in an equivalent fashion given the nature and exigencies of a kind of business, is enduring.
2. The challenge of “fractional apportionment” – which the OECD seemingly in the “Unified Approach” Proposal and its precursors in the January 23, 2019 Policy Note on Addressing the Tax Challenges of the Digitalisation of the Economy and the ensuing Plan of Work, is at least willing to entertain (possibly as long as it is not labeled “formulary” apportionment)  - needs to be faced and given a more refined voice, and, at least, not dismissed out of hand because of incipient design challenges. In fact, all of the elements of fractional apportionment are embedded in the longstanding notions of “permanent establishment” and “attribution of profits” we take for granted, i.e., where physical and human capital is located and measures of sales revenue and relevant expenses, some or all of which are the main possible elements of a typical formula. This is hardly surprising because these are encapsulations of business inputs and market-oriented outcomes – in other words how business is conducted -- which after all is the full compass of business operations and necessarily, then, the contributions that generate profits. In other words, we are familiar with fractional apportionment, and have been for a very long time, even though we called its elements Articles 5, 7 and 9. And, whatever its merits or drawbacks, in the absence of common or harmonized “source rules” – which are products of and necessarily influenced countries’ legal regimes to which tax law is accessory and are not to be assumed to be common among countries or their legal (including tax) regimes – fractional apportionment offers an objective, conceptually familiar way at least to gauge the limits of “being wrong” and therefore the ways in which refinement of the apportionment criteria, even bilaterally, could be achieved.
3. Countries are right to insist on some measure of taxation if they via their resident consumers account for the consummation of activities directed to earning income and, indeed, without which there would be no income. Productive activities are like one hand clapping, to borrow a familiar adage, unless there is revenue – without which undeniably there is no income. A minimum tax is not out of order; its rate could be derived to be equivalent to applying a normative income tax rate to a projected measure of net income assuming certain kinds and degrees of deductible charges, complemented by a taxpayer’s opportunity to elect be fully accountable as a tax filer in the source jurisdiction and compute its income as the constructive resident, in the circumstances, it may be seen to be. None of this is unusual and many countries have this kind of approach built into how certain categories of income are taxed.
4. The critical issue, for developed and less developed countries alike, is tax administration. This is where the most urgent attention is required. How is tax associated with “digital” business modalities to be levied and collected, and verified? The most serious “opportunity” offered by “digital” when seen according to ossified notions of tax jurisdiction, i.e., perceptions that the jurisdictional parameters are prescriptive with the specific connotations they had many years ago when originally conceived, is to be “everywhere” and “nowhere” at the same time. There are lessons to be learned from withholding tax and destination-based consumption tax regimes about the efficient, reliable and verifiable administration of taxation of “remote”, i.e., non-resident, taxpayers, with or without the co-opted engagement of intermediaries, i.e., payment intermediaries including financial institutions. All of this is familiar ground; little is new in a revolutionary sense. In so observing I am reminded of the admonition of one of Canada’s, and I would say the world’s, most distinguished public and development economists Richard Bird: to paraphrase him, we do well to remember that taxation is practical and the circumstances in which taxation occurs imperfect, and therefore to be effective taxation fundamentally and foremost has to be administrable even if in result also imperfect, and it needs to take account of circumstances that will host its particular kind and degree - the elasticity of potential avoidance measured with reference to the reasonable “reach” of the jurisdiction – nation or sub-nation – seeking to impose the tax. This multi-faceted realization may entail departures from what otherwise would be the ideal tax world and ideal tax outcome, but the world is not ideal and despite clear aspirations on the OECD’s part countries’ legal systems, fiscal priorities, and economic resources are not the same and are unlikely to be sufficiently harmonized or uniform anytime soon to permit the “common consolidated commercial tax base” – like goal of the OECD, with all the necessary legal changes by countries to effect it, to be a likely possibility rather than a directional discipline. The kind of complexity that the Proposals would entail to parse jurisdiction to tax and assign taxing rights to income, and even to determine what “income” is, seems almost to be a restatement of the limitations of transfer pricing guidance.

There is one other concern about the present debate. We are encouraged to believe that at least in certain contexts, the familiar jurisdictional parameters are not merely unreliable but irrelevant. We have nothing yet to replace them, and even with conjoined international sentiments and effort it is anticipated that affected countries would have to change their domestic laws in a coordinated or similarly directed fashion to achieve the objectives sought by the Proposals. Does this mean, then, that businesses that operate without the need for the “old” connotations of presence or connection to a “source” jurisdiction because of their nature, are unbounded? (see footnote 2*)

The enthusiasm for change of this order in a world without common legal or tax systems needs to be tempered without diluting the worthy goal of enhanced and more transparent economic fairness. But, more seriously perhaps, international agreement that the jurisdictional rules do not any longer “work” in certain commercial and business settings could operate as a kind of admission against countries’ interests, leaving them without effective remedies to the BEPS ostensibly underlying the Proposals.

I offer these comments respectfully and with my continuing commitment to the goals and aspirations of the OECD in tax matters. I do not want to detract from the excitement that embarking on “new” ventures with alluring horizons often entails, but I would observe that there is less rather than more newness in the Proposals and this should in my view moderate the drama, urgency and direction of those Proposals and the degree to which “digital” is seen, for purposes of gauging tax jurisdiction, as something more than a mere business modality not unlike business modalities of earlier times that for the same purposes as the present the jurisdictional parameters reflected and accommodated.

Yours very truly,

J. Scott Wilkie

 

Footnotes:

1*:  From Thomas Hardy, Far From the Madding Crowd, (Harmondsworth, Middlesex, England: Penguin Books Ltd., (1894) 1982), Ch. V, at 83 and 87: “Gabriel had two dogs. George, the elder, … [was wise and experienced from attentive learning and working] … The young dog, George’s son, …was learning the sheep-keeping business … but had got no further than the rudiments as yet – still finding an insuperable difficulty in distinguishing between doing a thing well enough and doing it too well. So earnest and yet so wrong-headed was this young dog … that if sent behind the flock to help them on he did it so thoroughly that he would have chased them across the whole county with the greatest pleasure if not called off, or reminded when to stop y the example of old George. … As far as could be learnt it appeared that the poor young dog, still under the impression that since he was kept for running after sheep, the more he ran after them the better had …. collected all the ewes into a corner, driven the timid creatures through the hedge, across the upper field, and by main force of worrying had given them momentum enough to break down a portion of the rotten railing, and so hurled them over the edge. George’s son had done his work so thoroughly that he was considered too good a workman to live, and was, in fact, taken and tragically shot at twelve o’clock that same day – another instance of the untoward fate which so often attends dogs and other philosophers who follow out a train of reasoning to its logical conclusion, and attempt perfectly consistent conduct in a world made up so largely of compromise.” 

 

2*: I have the same kind of question about the implications of the Action 11 BEPS Report, which has from its initial draft seemed to me to be an admission of sorts that we do not really know what BEPS is but even if we did we don’t really know how to measure it. This essentially is because “base erosion” and “shifting” are necessarily informed by particular countries economic, fiscal and tax perspectives in relation to others but which cannot be expected to be the same as others – loosely, their distinct sovereign characters and interests. Accordingly, it is difficult to establish irrefutably what is impugnable “base erosion and profit shifting” and even so how to measure it. I have wondered about the practical impact of these undercurrents of the Action 11 Report in defending against assertions of unwarranted avoided tax.