The Don and The International Tax System

It would seem to follow that the position underlying the Trump Presidential Action referred to above must be that the existing rules of the international tax system that govern the allocation of taxing rights – being chiefly those rules that deal with transfer pricing and permanent establishment issues – are generally suitable and appropriate for the taxation of international business. (Of course, it is alternatively possible that the Trump administration has an entirely novel vision for the future direction of the international tax system but as things stand this seems somewhat fanciful). It is therefore concluded that the position of the Trump administration is that no reform of the international tax system along the lines that had been proposed by the OECD is required. Presumably, the US administration believe this to be a sustainable position. 

However, many states – including the US – have for some time voiced concerns about the existing rules dealing with the allocation of taxing rights and in particular their ability to operate in circumstances where cross-border business is conducted digitally – that is remotely from the market in which the associated revenues are generated (as in the case where a digital service is provided from operations in one state to users/consumers in another). These concerns are grounded on the point that the existing transfer pricing and permanent establishment rules are engaged by the physical presence of business operations, meaning that remote or digital business conducted in the state of users/ consumers cannot be taxed in that state. There is a widespread view on the part of states that this situation is highly problematic because such digital business represents a clear participation in the economy of the user/consumer state and should be taxed in that state. These concerns first emerged in the mid to late 1990s and ultimately led to an overwhelming consensus of states (including the US) that reforms to the existing international tax system were needed. 

A significant process of reform responding to these issues has been pursued globally since 2017. That process, which has been led by the OECD, has by no means been perfect and it has certainly had its critics, but it is very hard to find any state that has not signed up to the notion that reform of the existing system is required. It is also true that the US has played a central role in the development of thinking and that it has been the most influential state in steering the shape of the final global reform package that emerged in 2021. That package of reform was supported by no less than 135 states, and it was premised on the notion that key elements of the international tax system are no longer fit for purpose. It is also notable that the backdrop to the policy discussion was the widely recognised need to get away from not just the policy inadequacies of the current rules on the allocation of taxing rights but also the day-on-day chaos (reflected in the nature and scale of inter-governmental disputes on taxing rights in individual cases) of the current international tax system.

In the context of all the above matters, the Presidential Action earlier this week may be seen as tantamount to “asking” states (or making them an offer that is not to be refused) to sign up in perpetuity to an international tax system that all parties have agreed is not fit for purpose and in need of reform. 

At this early stage, the global response of states can only be predicted. It seems obvious that, given the scale of the commitment to and investment in the reform process, states are unlikely to accept this position and will probably want to preserve as much of the existing package of global reform measures as possible (particularly as many states – around 30 in number – have already enacted measures to implement elements of the global reform package). This would suggest some significant compromises are required to accommodate the US position. 

In theory, there are more aggressive options available to states to respond to the new US position (such as proceeding with the reform package and ignoring or overriding the US position) but these would seem less likely as presumably states will be reluctant to start a tax-trade war with the US.

However, in the absence of a pervasive and profound collective amnesia on the part of the governments of the world, there seems little prospect of states backing off entirely and jettisoning all that they agreed and signed up to in 2021about the need to reform the current tax system. There is also the small matter that states may have pencilled in expected revenues from this reform – at a time when many states are in desperate need of additional money. This means that the response of states might well be to pursue options to tax cross-border business where those options do not create overt policy changes that might trigger a tax-trade war with the US, but which might in practice be effective in raising revenues. An obvious early option for states would be to focus on those parts of the current international tax system that are the weakest and most open to “flexible” interpretation, where inflated tax demands might have the greatest cover - namely the transfer pricing rules and the rules on permanent establishments. Ironically, these are of course the rules which created the need for the global reform in the first place, as explained above. 

Dispute resolution practitioners may well be sharpening their pencils in anticipation of what is to come but for the rest of us the wider point is that surely the process of international tax policy and reform could – and should - be conducted in a better way.