1. Top
  2. Policy Proposals
  3. Business Law
  4. Tax Challenges Arising from Digitalization Comments on the Public Consultation Document concerning the Pillar One and Pillar Two Blueprints

Policy Proposals  Business Law Tax Challenges Arising from Digitalization
Comments on the Public Consultation Document concerning the Pillar One and Pillar Two Blueprints

December 14, 2020
Subcommittee on Taxation


Keidanren welcomes the progress of work examining the tax challenges arising from the digitalization of the economy under the Inclusive Framework (IF) on Base Erosion and Profit Shifting (BEPS) and the presentation of the Reports on the Pillar One and Pillar Two Blueprints.

It is of paramount importance for jurisdictions to establish a stable and predictable investment environment for businesses by jointly agreeing and presenting long-term solutions. Unilateral digital services taxes should be definitely abolished.

The scope of both Pillar One and Pillar Two should be narrow to respect the principle of proportionality, and the rules should be simple to minimize compliance burdens. It is critical to ensure tax certainty through dispute prevention and resolution and to ensure that individual jurisdiction implement rules consistently. Pillar One and Pillar Two should be agreed as a package.

Japanese businesses consider the following matters particularly important:

[Pillar 1 / Amount A]

  • Simplification of revenue sourcing rules for transactions through independent parties
  • Utilization of existing disclosed segments
  • Identification of paying entities in a formulaic way

[Pillar 2]

  • Introduction of effective simplification options in GloBE
  • Withdrawal of split-ownership rule

I. Pillar One

To ensure smooth implementation of new rules, we agree on the overall direction of the Pillar One Blueprint to set higher thresholds for several years after enforcement of the rules to narrow down in-scope businesses. The scope should be further clarified, with segmentation, revenue sourcing, identification of paying entities, and other rules kept as simple as possible. We expect effective dispute prevention and resolution mechanisms to be established.

1. Amount A

(1) Scope
(i) Activities test

Clear guidance is required for in-scope businesses, namely automated digital services (ADS) and consumer-facing businesses (CFB), so that no divergence in views may arise among tax administrations and businesses, and to ensure that individual jurisdictions apply the rules consistently.

For the Internet of Things (IoT), we agree to exclude certain types of machinery and industrial products that may contain a digital component from the scope of ADS. Meanwhile, it should be clarified what cases the statement "revenue streams are separately identifiable" (Box 2.28) is intended to cover. We would also like to clarify whether the sale of data collected from automobiles, which are CFB products, falls within ADS.

While some examples have been provided for dual category ADS and bundled packages (paragraph 50), the criteria to determine whether the overall services should be considered as ADS should be clarified.

For CFB, it would be preferable to specify that original equipment manufacturer (OEM) products (e.g., car navigation systems) do not fall within CFB as intermediate products. Additionally, the definition of "CFB" (Box 2.32) should be clearer. For example, the definition should clarify whether a multinational enterprise (MNE) engaged in the sale of products in a market jurisdiction would be out-of-scope of Amount A if the MNE sells a product of a third party CFB merely using the trade name of the CFB, provided that while the MNE owns the product (as its inventory), it does not own intangibles related to the product and does not pay any brand royalty or other fees to the CFB.

Natural resources, banking, insurance, asset management, infrastructure, real estate, international air and shipping, and other businesses that are currently regarded as out-of-scope in the Pillar One Blueprint should continue to be treated as out-of-scope. Although the paragraphs concerning insurance make no reference to reinsurance (paragraphs 132 through 134), we would like to confirm that reinsurance is also an out-of-scope activity. It would also be preferable that sales finance businesses related to CFB products, which are usually subject to regulations similar to other financial sectors such as banking, are out-of-scope.

Prescription drugs should be out-of-scope. Besides the reasons mentioned in the Pillar One Blueprint (paragraph 71), prescription drugs are subject to regulations in market jurisdictions, as with financial services, and certain levels of taxes are invariably imposed on subsidiaries and other entities in these market jurisdictions. The introduction of Amount A would likely result in double taxation. As prescription drugs and over-the-counter (OTC) drugs are already managed separately by many companies, treating the two differently would cause no problems in practice.

(ii) De minimis foreign in-scope revenue test

A de minimis foreign in-scope revenue test would be useful to exclude from the scope of Amount A the MNEs that mainly operate in the jurisdiction where their ultimate parent entity is located. However, domestic and international services are sometimes provided as a package and existing accounting data do not distinguish between the domestic and international revenue streams. For this reason, as mentioned in (3) below, to make revenue sourcing unnecessary, the test should be voluntary and operate as simply as possible. The threshold for de minimis foreign in-scope revenue should be set based on a percentage of global revenue, rather than an absolute number. Nevertheless, if the threshold is set at a specific amount, it should be at least 100 million euros.

(iii) Other

The process of applying Amount A begins with identifying in-scope businesses and determining the revenue attributable to these businesses. Where an MNE is engaged in many different businesses, the identification step of in-scope businesses would itself create a substantial compliance burden. When the profit margin of the entire group, or a particular segment, is equivalent to or less than the agreed profitability threshold, there would be no residual profit, and accordingly Amount A would be zero. In this case, the MNE should be exempted from identifying in-scope businesses and the amount of in-scope revenue for the group or the relevant segment. Provided that tax base of Amount A is determined based on disclosed segments, as MNEs are able to foresee whether their profitability would exceed the agreed threshold in advance, it is unlikely that our suggested rule would hinder an MNE from filing in time. The benefits of simplification are more significant.

(2) Nexus rules

Nexus rules should be basically simple. Meanwhile, given that a CFB may not straightforwardly meet the criterion of "scale without mass," a key characteristic of ADS, establishing plus factors would be sensible.

In principle, the plus factors should capture a physical presence that exists in a market jurisdiction such as a subsidiary or a permanent establishment (PE). The Pillar One Blueprint suggests that a stand-alone "group-PE" definition could be specified in tax treaties (paragraph 207). Any definition should be clear and unambiguous, preventing varied interpretation so far as possible with reference to the OECD Model Tax Convention.

For CFB, there is room for further discussion on whether a nexus should be determined based solely on the monetary amount of revenue. Meanwhile, CFBs with a certain amount of sales usually need physical facilities to manage their sales. Criteria based solely on the amount of revenue would require tests for each fiscal year especially where amount of revenue is close to the threshold. If the amount of revenue is used, a substantially high threshold, such as 100 million euros, should be applied.

It is not advisable to determine a nexus based on advertising activities and other criteria that are difficult to measure, irrespective of whether applying them as a standalone test or applying them as a factor for a group PE test.

With respect to a temporal requirement, nexus test should be applied basically every year to ensure simplification, but in order to deal with a business with large fluctuations in revenue from year to year, when a threshold is exceeded in a single year, taxpayers should be allowed to apply the test on an average of multi-year basis by their own choice. This reduces the number of cases where Amount A is applied solely due to unconventional transaction and ensures tax certainty.

(3) Revenue sourcing rules

With respect to revenue sourcing rules, the Blueprint's proposal is overly prescriptive and difficult for companies to implement, and it is imperative that the following revisions be made for the sake of simplicity. In particular, the revenue sourcing rules for transactions through third parties are fraught with challenges.

(i) Narrowing down MNEs required to apply revenue sourcing

The scope of MNEs required to apply the revenue sourcing rules should be narrowed. According to the Pillar One Blueprint, MNEs may be required to determine the amount of revenue for each jurisdiction at the stage of de minimis foreign in-scope revenue test (Step 2). However, taxpayers should be allowed to calculate numbers for each step as they choose regardless of the listed order in the process map for Amount A. Where the profit before tax of the relevant group or segment is less than the amount based on an internationally agreed routine profit margin, which can be determined at Steps 3 through 5, any revenue sourcing exercise should be made unnecessary. This would greatly contribute to reducing the administrative burden. Requiring MNEs with zero Amount A allocation to apply the current revenue sourcing rules would create an administrative burden disproportionate to the purpose of the regime.

(ii) A hierarchical approach
  1. 1) General Comment
    In the revenue sourcing rules, the priorities of relevant indicators are designated under a hierarchical approach (Paragraph 289-295). However, rather than applying indicators in a hierarchical manner, each MNE should be permitted to determine indicators that it considers appropriate. Depending on the availability of information and the characteristics of transactions and markets, indicators that most accurately reflect the commercial reality vary among MNEs and their businesses.

    For example, for goods sold by a CFB through an independent distributor, information reported by the independent distributor is prioritized, and if it is unavailable, other information would be used according to the Pillar One Blueprint. As discussed below, simply obtaining information about independent distributor sales would create a significant administrative burden. The Pillar One Blueprint states the MNE would use other information that is already available (paragraph 379) "only if the MNE can demonstrate that it has taken reasonable steps to change the contract ... but has been unsuccessful in doing so". However, it is not clear what should be the basis to determine that such information is unavailable. For the preparation of documents for tax administrations (paragraph 393), it is not uncommon for a single MNE to do business with hundreds of independent distributors (wholesalers and retailers). Explaining the negotiation process with every independent distributor would impose an undue administrative burden on MNEs.

    If a hierarchical approach is maintained, unduly strict rules should not be imposed regarding "reasonable steps" to obtain information (paragraph 402). At a minimum MNEs should be able to determine the applicability of an indicator as a whole instead of testing the indicator for each distributor. For the documents proving that a revenue sourcing indicator cannot be adopted, if there are a large number of customers, creating a document for all the customers will be an excessive compliance burden. Therefore, it should be permitted to adopt other indicator with only one document stating for example "It is difficult to adopt the indicator because many customers refuse to provide information and the data are unreliable.". In addition, the guidance should clearly state the criteria for judging the unavailability of information, and each country should follow the guidance. The documentation should be kept simple, for example by incorporating a checkbox type format.

    For ADS, the billing address, which is used for VAT rules for electronically supplied services (ESS) and introduced in many countries such as those within the European Union, is an available and reliable indicator. If the billing address is used as an indicator in its own system, this should be respected, not just in cases where Geolocation and IP address are unavailable. Credit card information is also a viable indicator. Companies are equipped with systems to determine the country and region where their customers are located using reasonably available customer information for indirect tax purpose. Thus, revenue sourcing rules should make use of these existing systems.

  2. 2) Revenue sourcing indicators for CFB (especially sales through independent distributors)
    The indicators presented in the current Pillar One Blueprint for the sale of tangible goods (CFB) through independent distributors are inappropriate due to challenges in acquiring the information and its accuracy.

    Where a CFB sells products through third parties (multiple independent distributors are often involved in sale) with no obligation for the distributors to report the sales destination, it is usually impossible to obtain information on how many units of products were ultimately sold in which jurisdictions, and it does not work effectively as an indicator. This is because information on sales destinations (sales information including the aggregate number and type of products sold) is sensitive commercial information (know-how) for the distributors. Disclosure of the information would threaten the independence of the third party distributors and change the balance of power with the supplier. Moreover, the hurdles to change contracts are extremely high. For some products (e.g., household appliances), a single entity in an MNE group is engaged in transactions with hundreds of independent distributors, and the independent distributors range in size from large corporations to small and medium-sized companies. Accordingly, just seeking a change in the contract would cause a significant compliance burden for both parties. If independent distributors do not have such data, a question would arise about who should bear the IT system development, personnel, and other costs to be incurred to collect and provide the data. Even if independent distributors have the data, additional expenses may be charged as information provision fees at the time of contract renewal. Seeking additional negotiations on commercial contracts based on tax requirements would be inappropriate in light of the freedom of contract principle. We cannot support an approach that seeks to change the contract. Requesting independent distributors to provide information should be sufficient.

    Regarding market research for the purpose of management reporting, which serves as an alternative to the provision of information from independent distributors, the ultimate parent entity does not necessarily collect information on market research when business is conducted on the initiative of local entities. If it were explicitly stated that specific market research information can be used, this might contribute to simplification. However, information captured for some products may be limited to data from large distributors. Accordingly, the data may not be reliable enough for tax return filings. Thus, as an alternative approach to revenue sourcing for CFB, the jurisdictions where independent distributors are located should be accepted as an indicator. At the very least, if an MNE has an agreement with an independent distributor to grant distribution rights in only one jurisdiction, the collection of information from that independent distributor should not be necessary and the revenue to the independent distributor should be used. For licensing and franchising, it is desirable to regard the jurisdiction in which the licensee or franchisee is located as an indicator.

    For the calculation of the amount of revenue, the Pillar One Blueprint does not require sensitive commercial information such as pricing information or specific customer addresses from independent dealers, and information on the aggregated number and type of products sold to each jurisdiction is deemed sufficient (paragraph 378). It needs to be clarified whether revenue in each market jurisdiction will be calculated on a pro-rata basis by dividing sales to an independent distributor by the number of products sold in each market jurisdiction through the distributor.

  3. 3) Revenue sourcing indicators for ADS
    Revenue sourcing indicators for ADS also requires more consideration. For example, in business models involving contracts to produce digital content for which the license is owned by a digital service provider (DSP), the DSP is not obligated to provide information about market jurisdictions which makes it difficult for the content producer to obtain information. Even if the content producer holds the license, some DSP/platformer may offer to customers bundled, flat- rate content service made up of multiple contents whose owners are different. In such a case, the price for customers is flat regardless of which product is viewed and how many times. As a result, the calculation of royalties paid to content holders from the DSP/platformer is not independently linked to data on the amount paid by customers and the number of views in market jurisdictions. If a DSP offers set services at the same price in all market jurisdictions, and if the DSP provides the information, revenue sourcing is possible. However, the reality is that information on market jurisdictions may not be provided and the set services varies by market jurisdiction. Therefore, an MNE should be allowed to use a reasonably prorated amount based on internal estimates. Cloud computing services may go through multiple independent corporate entities to reach final consumers (B to B to C), and the indicator for personal cloud services, "where the individual purchased" would not be identifiable. Information that the companies already have or can obtain without additional work should be used. As noted in the Pillar One Blueprint (paragraphs 305-309), as IP addresses can be changed with virtual private network (VPN), the identification of locations using IP addresses may be inaccurate. In the context of ADS, another point in question is whether requesting the consumer information itself would be acceptable based on information protection laws, including the EU's General Data Protection Regulation (GDPR).

    Finally, if the rules require that MNEs obtain sales and other information from third parties, it would be necessary to mandate information provision from distributors and DSPs with legal and other arrangements in individual jurisdictions.

(4) Segmentation
(i) Utilizing of existing disclosed segments

For segmentation, additional compliance administrative burdens need to be minimized.

The segments currently disclosed in MNEs' financial statements should be respected. The disclosed segments are continually applied based on the same reasonable criteria every fiscal year and accordingly are reliable. The disclosed segments represent how an MNE regards its business and corresponds to the requirements of its shareholders. Requiring MNEs to rearrange or subdivide the segments for the purposes of Amount A would cause deviation from actual corporate management. Hence, it would be difficult for many of MNEs to do so. In addition, cases where the use of disclosed segments can be rebutted by tax administrations should be narrowly defined, by such means as limiting to the cases specified in guidelines.

Segmentation hallmarks currently seem to be complex, ambiguous, and adding an unnecessary hierarchy. To respect the segmentation currently implemented by companies for financial reporting purposes, it is basically appropriate to base segmentation hallmarks on International Financial Reporting Standard (IFRS) 8, rather than International Accounting Standard (IAS) 14, which preceded IFRS 8. Requiring MNEs to apply detailed and subdivided segments by product would generate burdensome work. Therefore, a broader segmentation should be accepted.

(ii) Allocating costs and intersegmental transactions

It would be preferable to allocate central and unallocated costs to individual segments based on the amount of revenue to ensure simplicity.

The treatment of intersegmental transactions remains to be determined (paragraph 466), but given the heavy administrative burden of identifying profit from intersegmental transactions, where the scale of intersegmental transactions is below a certain level, adjustments should be made unnecessary.

(iii) Regional segmentation

Regional segmentation should not be mandatory as it does not correspond to the management unit and many MNEs do not report regional segmentation in their current financial statements. Very careful consideration is needed to avoid imposing unreasonable compliance burdens on MNEs.

(5) Loss carry-forward
(i) Losses

It is appropriate for losses to be reported and administered through a single account for the relevant group or segment and carried forward to subsequent years through an "earn-out" mechanism.

It would be advisable to take account of losses incurred before the introduction of the Amount A as some businesses may have investments preceding returns where excess profits may arise in the future. Considering the potential compliance and administrative burdens associated with retroactive calculation, consideration should be made to design a regime that allows taxpayers to use only losses incurred for the ten years before its introduction.

(ii) Profit shortfalls

It is inappropriate for the application of profit shortfalls to cause the profitability threshold to be lowered. Based on this premise, consideration should be given to introducing a simple regime that would not give rise to additional compliance burdens and adjustments.

(6) Profitability threshold and allocation percentage on residual profits

The profitability threshold should be the group's profit before tax to revenue ratio from its consolidated financial statements (or segment data) and be set well over 10% (e.g., 15% or 20%). Additionally, the portion of deemed residual profit to be allocated to market jurisdictions should be limited to levels below 10%.

According to the Pillar One Blueprint, consideration has been given to whether the Amount A formula could be weighted to allocate more profits to more profitable market jurisdictions (paragraph 526). However, this may increase complexity and should not be implemented. Applying differentiation based on the level of profitability for each sector should also be avoided.

To ensure simplicity, we support a throwback system (paragraph 517) to allocate residual profit to eligible market jurisdictions where a nexus has been established.

(7) The issue of double counting
(i) Marketing and distribution profits safe harbour

The Amount A rules allocate taxing rights over a portion of residual profit to market jurisdictions. Double counting in the same market jurisdiction should be unacceptable. When substantial profits are already attributable to a market jurisdiction, it would be reasonable to consider the allocation of Amount A unnecessary. The policy objective of marketing and distribution profits safe harbour is understandable.

However, to make the rules useful, further work and clarification are necessary. For example, clarification is needed regarding how a fixed return and Amount B currently interact and whether it would be necessary to top up until the profit reaches the fixed return if the marketing and distribution profit calculated based on the existing arm's length principle (ALP) is lower than the fixed return. Considering the purpose of Amount A, top-ups should be considered unnecessary. The purpose of Amount A is to allocate residual profit to market jurisdictions based on their contribution and it should not aim to guarantee a minimum profit.

In the Pillar One Blueprint, the fixed return is set at a return on sales (ROS) of 4% for illustrative purposes (paragraph 543), but the number of entities regularly earning more than 4% ROS is limited and 4% appears too high compared to general levels based on the ALP. If a high ROS is used and a top-up allocation is required, the M&D safe harbor will not function as intended. The level of the fixed return may also affect existing transfer pricing practices. Furthermore, it may take significantly more time to achieve consensus on the concept of different fixed return for each industry and region. To ensure simplicity a single fixed return would be preferable.

Essentially, measures that can address the issue of double counting without relying on setting a fixed return would be useful, if possible. Rules to determine whether Amount A should be allocated would be simpler than making adjustments to reduce Amount A.

(ii) Interaction with withholding taxes

The interaction between Amount A and withholding taxes on royalties and other payments from market jurisdictions may give rise to double taxation. We support refunds or deduction for withholding taxes that can be effected in a simple way, but such measures may unavoidably complicate the regime. Besides adjustments to Amount A, another option may be to reduce withholding taxes through future treaty negotiations and similar opportunities.

(iii) The domestic business exemption

Where it is obvious that a business is carried on solely in a single jurisdiction, it would be appropriate to apply a domestic business exemption. In other cases, however, administrative burdens may increase, and domestic businesses may not always easily be distinguished from other businesses. An exemption should be considered only to the extent that it would not add complexity.

(8) Identification of paying entities and elimination of double taxation

The determination of paying entities should ensure simplicity and contribute to tax certainty for both tax administrations and taxpayers. We support a formulaic allocation (Steps 2 and 4) rather than a qualitative test. Even when a qualitative judgment is required, a market connection priority test (Step 3) would cause concern due to the potential compliance burden.

(i) Activities test (Step 1)

It would be preferable that the determination of paying entities adopt a formulaic allocation rather than qualitative tests because qualitative tests undermine tax certainty. If activities tests are introduced, the determination would be based on master file information, from which it may be difficult to clearly identify entities with important functions, assets, and risks. Descriptions concerning activities tests will inevitably become qualitative explanations. To eliminate arbitrariness and save time for preparation, the IF should provide clear guidelines on elements to be described or documentation in checkbox format.

(ii) Profitability test (Step 2)

It is important to design the profitability test to enable simple determination. One option may be to focus on a certain percentage of payroll and depreciation expenses for tangible assets, but the calculation may be complicated. Consideration should also be given to using of the profit before tax to revenue ratio of each entity, or adopting a mechanism that allows taxpayers to take account of payroll and depreciation expenses for tangible assets of their own choice. While the Pillar One Blueprint states that the use of a profit before tax to revenue ratio is considered inappropriate because entity-level accounts include intragroup transactions and they can be easily manipulated (paragraph 558), it is more important to emphasize simplicity when designing the regime. When defining profit before tax, specific adjustments such as the exclusion of dividends should be avoided as much as possible.

If any correction is made to the income of an entity, it may become necessary not only to identify paying entities again but also to reperform the process to calculate Amount A. Some measures to restrict the impact of corrections should be considered. In addition, as noted in step 4 (paragraphs 608-610), there needs to be some limit on the profit to be allocated.

(iii) Market connection priority test (Step 3)

Among the proposed processes, the market connection priority test in particular would require detailed transaction analysis, and accordingly may become extremely complicated and result in a heavy compliance and administrative burden. There appear to be many cases where entities with a market connection do not necessarily earn profit enough to allocate Amount A. Moreover, in the manufacturing industry, paying entities are expected to be limited to the ultimate parent entities engaged in research and development. This test should be avoided to limit unreasonable documentation burdens.

To ensure simplicity, it would be preferable to allocate the Amount A tax liability on a formulaic basis, basically without needing to apply the market connection test. As a result, it is possible that Amount A may be allocated to unconnected markets, but a certain pragmatic approach is necessary.

Even if a market connection priority test is adopted, consideration should be given to ensure further simplification. For example, when the parent entity owns all intangible assets related to product manufacturing, the parent entity should be deemed to be connected with all market jurisdictions.

(iv) Elimination of double taxation

With regard to the elimination of double taxation, we strongly recommend that individual jurisdictions uniformly adopt the exemption method. With the credit method, the limit on the available credit could make full deduction impossible, and compliance burdens may increase dramatically when a broad range of jurisdictions are in scope.

Furthermore, the Pillar One Blueprint presents a possible approach of setting the filing deadline for Amount A up to 12 months after the end of the relevant fiscal year (paragraph 717). Meanwhile, the tax return filing deadlines in jurisdictions are generally set at a shorter period than 12 months. The elimination of double taxation in the same fiscal year may therefore be difficult.

2. Amount B

(1) General comments

We understand that Amount B is intended to simplify the transfer pricing rules and enhance tax certainty. However, the transactional net margin method and other one-sided transfer pricing methods have generally worked well to date for cross-border controlled transactions involving limited risk distributors. There is no compelling reason to change the existing approach unless it is replaced with a method that will lead to further simplification. If Amount B is to be implemented, the scope should first be narrowed then clear criteria should be established. Exploring the feasibility of implementing Amount B through a pilot program may also be prudent. The risk of double taxation may increase if tax administrations insist on an application of the ALP that prioritizes their rights to tax profits other than Amount A and B. Thus, it is necessary to ensure implementation based on international cooperation with a view to securing tax certainty.

(2) Scope of Amount B

Regarding the scope of Amount B, service providers should be excluded in addition to commissionaires and sales agents, as stated in the Pillar One Blueprint (paragraph 666).

The direction underlying the positive and negative lists of baseline marketing and distribution activities proposed in the Pillar One Blueprint is generally appropriate but requires further clarification. We request that the following matters be considered:

  • Based on the requirements for application of Berry ratios in the OECD Transfer Pricing Guidelines 2017 (paragraph 2.107), the baseline marketing and distribution activities should be subject to Amount B only if the value of the functions performed by an entity engaged in these activities is materially affected by the value of the products distributed, i.e., the value of the former is proportional to sales.

  • If a distributor is not operating at its own expense and is outsourced by the owner of intangibles, the activity should be excluded from the scope of Amount B. For instance, outsourced activities such as brand promotion or the detection and reporting of counterfeit goods to customs should not be subject to Amount B.

  • A distributor may purchase products designed and manufactured by a third party and sell these products with a trademark owned by the group's parent company, in addition to those designed by a group's parent company and manufactured by a group's manufacturing company. Provided, however, that the distributor's sales derive primarily from selling the products bearing the trademark owned by the group's parent company, the distributor as a whole should be allowed to be treated as a limited-risk distributor.

  • Consideration should be given to the allocation of Amount B when some of the functions specified in the positive list are performed by multiple entities in multiple jurisdictions. If multiple companies performing distribution and marketing functions exist in a single distribution channel, i.e., selling products through a regional distribution headquarters (RDHQ), there should be no double counting of Amount B between the limited risk distributors that perform distribution and marketing activities and the RDHQ that controls these activities. The total profits to be earned by those functions should be equal to the quantum of Amount B that would be earned by a single distributor that performs those functions in a single jurisdiction. The functions belonging to the same supply chain should not each individually earn Amount B.

  • The meaning of "limited market risks" (paragraph 672) should be explored further in light of real-world practices.

In determining whether a distributor is in-scope of Amount B, there is space for using quantitative indicators and thresholds to the extent that they do not overcomplicate the rules. Multifunctional entities should be out-of-scope of Amount B to prevent the rules from becoming too complex.

(3) Quantum

For the profit level indicator, a return on sales needs to be used. The numerator of the return on sales should be operating profit, which is approximately equal to earnings before interest and taxes minus extraordinary profits and losses. In view of limited risks, the level of the return on sales should be set sufficiently low, with an upper limit imposed on the profits allocated to market jurisdictions. Furthermore, as it is impracticable for entities to deliver a return on sales that exactly matches a set percentage, a range should be provided.

Under exceptional circumstances such as the current coronavirus pandemic and large natural disasters, the Amount B mechanism should not be mandatory; instead, losses should be shared by market jurisdictions.

We support the proposal that the fixed return rule should operate under a rebuttable presumption. Each taxpayer should be given the opportunity to rebut the application of Amount B.

3. Tax certainty

(1) Early tax certainty process for Amount A

The tax certainty process for Amount A is an essential prerequisite for implementing Pillar One. We support the two-panel process proposed in the Pillar One Blueprint, which is a mandatory and binding multilateral process to provide early tax certainty. Relevant tax administrations should confer and agree, in advance, on the allocation of their taxing rights. It is imperative for them to reach a conclusion as early and with as much certainty as possible. We are concerned that tax administrations could take time to reach a conclusion, resulting in corrections to taxpayers' tax returns for prior years.

In principle, an MNE group's coordinating entity should be its ultimate parent entity. However, some MNE groups have business segments that are headquartered in different jurisdictions. In such cases, it is desirable that an entity serving as the headquarters of a business segment be allowed to become the segment's coordinating entity.

When determining whether MNE groups have in-scope businesses for Amount A, a mechanism needs to be established that provides early certainty, as mentioned in the Pillar One Blueprint. Particularly in the first year of applying Amount A, MNEs may face unanticipated problems and tax administrations may encounter cases not originally expected. If difficulties arise in the first year, the reliability of the regime may be affected. Accordingly, securing a sufficient preparatory and test period is of vital importance.

In addition to a multilateral early certainty process, it is desirable that the following two mechanisms be created: a mechanism whereby an MNE group can have a prior consultation with the tax administration of the parent entity's jurisdiction to determine whether the MNE group has in-scope businesses of Amount A; and a system that enables an MNE group to consult, from an early stage, with the tax administration of the parent entity's jurisdiction to identify issues it is expected to face at the time of filing by referring to the prior year's financial statements and other materials.

From the perspective of tax certainty, we consider it beneficial to develop and publish guidelines based on the shared knowledge resulting from, to the extent possible, the agreements reached by the review panel in order to contribute to the proper filing of Amount A.

(2) Beyond Amount A

We strongly support the application of a mandatory and binding dispute resolution process for any dispute over the transfer pricing and PEs of in-scope taxpayers relating to Amount A as well as any dispute over Amount B (e.g., whether certain operations correspond to the defined baseline marketing and distribution activities). It is also hoped that existing dispute prevention and resolution mechanisms such as the mutual agreement procedure and corresponding adjustments will be enhanced. To the extent possible, a binding dispute prevention and resolution mechanism should also be introduced for other transactions.

It is desirable to create a framework that prevent a jurisdiction from imposing taxes unilaterally, where tax administrations cannot agree on the allocation of their taxing rights. More specifically, it is worth considering allowing MNEs to apply for mutual agreement procedures in the relevant jurisdictions in their value chain at the point where a tax authority suggested additional taxation, and establishing a mandatory framework to halt the ongoing tax audits until a conclusion is reached in the mutual agreement procedures. Continued efforts also need to be made to increase the adoption of arbitration. It is crucial for the OECD to keep monitoring the status of implementation of dispute prevention and resolution mechanisms in each jurisdiction and to help advance this initiative. Further, the OECD should consider improving capabilities for dispute resolution procedures of each tax administration including in developing countries, to help resolve disputes as early as possible.

II. Pillar Two

We understand that Pillar Two is aimed at addressing remaining BEPS challenges and ensuring an international level playing field in relation to corporate taxes.

However, we strongly feel that the Pillar Two proposals overlap the existing BEPS recommendations. We appreciate the OECD considering the top-down approach and the carve-out as part of the income inclusion rule (IIR). But if jurisdictional blending will be adopted, further simplification is essential to avoid overly burdensome compliance obligations.

Additionally, the minimum tax rate should be set as low as possible to limit in-scope entities.

1. Coexistence with the global intangible low-taxed income (GILTI) regime

In cases where an MNE's ultimate parent entity is domiciled outside the US and owns, indirectly through its US subsidiary, another subsidiary in a low-tax jurisdiction outside the US, the application of GILTI should be deactivated in accordance with the top-down approach. If deactivating the application of GILTI proves difficult, consideration should be given to at least reflecting the amount of taxes imposed by GILTI in the calculation of the effective tax rate (ETR), with attention paid to the MNE's administrative burden. While we understand the purpose of ensuring that GloBE and GILTI co-exist, in consideration of the administrative burden on companies, it is desirable to design a system in which MNEs need to calculate either GloBE and GILTI, but not both.

The base erosion and anti-abuse tax (BEAT) is not necessarily limited to payments to low-tax jurisdictions. However, if an ultimate parent entity applies the IIR, consideration should be given to deactivating BEAT with regard to its US subsidiaries.

2. Scope of the global anti-base erosion (GloBE) rules

The Pillar Two Blueprint states that subsidiaries excluded from the consolidated financial statements on the grounds of materiality are in-scope of the IIR. However, obtaining the information that goes beyond the purpose of country-by-country reporting (CbCR) from such nonconsolidated subsidiaries would entail a substantial administrative burden. While respecting the threshold of more than 750 million euros for CbCR, it is not necessary to make the scope of the IIR strictly similar to the CbCR. As any entity's determination of materiality is subject to rigorous verification by the accounting auditor, there is little possibility for high-risk subsidiaries to be excluded from the consolidated financial statements.

For the international shipping industry, individual jurisdictions have introduced tonnage taxes and other alternative or supplementary taxation regimes that reflect the industry's nature (paragraph 111). Applying the GloBE rules to this industry might cause problems relating to these frameworks for international shipping and national policy decisions. This industry should be out-of-scope.

3. Calculating the ETR under the GloBE rules

(1) Dividends, and gains or losses from the disposition of stock

Excluding from the GloBE tax base dividends as well as gains or losses from the disposition of stock is appropriate from the perspective of enabling financial accounting figures to approximate tax accounting ones. Consideration should also be given to the exclusion of portfolio investments from the tax base, to reduce MNEs' burden to confirm the holding period and percentage for each investment. If excluding portfolio investments proves to be difficult, the ownership threshold should be set low.

(2) Reorganization

In jurisdictions that allow for tax deferral in connection with reorganizations, it is appropriate to ensure similar treatment under the GloBE rules (paragraph 212).

(3) Accelerated depreciation

Deferred tax accounting is useful in reducing ETR fluctuations resulting from accelerated depreciation. However, applying deferred tax accounting solely to accelerated depreciation would make the process even more complicated. To simplify the rules, one solution may be to simply apply deferred tax accounting to ETR calculations. It would then be conceivable to exclude the impact of valuation allowances based on estimates of future performance, simplifying the rules and eliminating arbitrariness.

(4) Treatment of cross-jurisdictional taxes

As a means of dealing with overlap between the controlled foreign company (CFC) rules and the IIR, it would be logical to include the aggregate of CFC taxes in the numerator of the ETR calculation for the CFC jurisdiction. In cases where the parent entity subject to the CFC rules recognizes a net loss, CFC taxes are not actually levied. Even in such cases, however, reflecting the amount corresponding to the aggregate of CFC taxes in the ETR calculation for the CFC jurisdiction should be considered.

The Pillar Two Blueprint mentions the possibility of adding anti-avoidance rules when implementing the IIR, taking into account the risk of passive income being shifted to CFCs (paragraph 284). However, making the rules more complex should be avoided.

(5) Relationships with Pillar One

Although the Pillar Two Blueprint states that Pillar One outcomes should be reflected in Pillar Two (paragraph 219), ignoring Pillar One outcomes might make the rules much simpler in practice. We are concerned that re-calculation of Amount A required under the Pillar One tax certainty process might result in the MNE refiling the tax return in relation to Pillar Two.

(6) Intragroup transactions

The Blueprint states that the elimination of transactions between constituent entities resident in the same jurisdiction may be required (paragraph 261). However, as this may result in a considerable administrative burden, elimination should be entirely optional. There is also concern about the requirement to record intra-group transactions in accordance with ALP, which may also increase administrative burdens.

4. Carry-forwards and carve-out

(1) Carry-forwards

In cases where the deferred tax accounting approach is not adopted, the loss carry-forward mechanism needs to be implemented to distribute the tax burden across fiscal years. We appreciate the approach proposed by the Pillar Two Blueprints. The carry forward of pre-regime losses should also be permitted, although certain restrictions are conceivable, such as period-related ones. Alternatively, deferred tax accounting may be used to estimate the amount corresponding to pre-regime losses.

Both local tax carry-forwards and IIR tax credits can be beneficial systems. Desirably, the carry-forward period should exceed at least seven years and be made as long as possible. This is because the differences between accounting and taxable income can arise over a long period of time due to impairment of losses and other items.

(2) Carve-out

We appreciate the proposed carve-out based on payroll and tangible assets (including the deemed depreciation of land), which is an essential measure for excluding a return for substantive activities from the tax base.

For the payroll component, as eligible employees and eligible payroll costs are defined broadly, detailed guidance is needed on the examples provided in the Pillar Two Blueprint. One case concerns payroll costs for employees of a foreign branch. Within the EU and other jurisdictions where the movement of people is relatively free, it is sometimes difficult for an MNE to match the jurisdiction where the employee's activities are performed to the jurisdiction where the constituent entity pays the employee's salary, or a dispute concerning the location of the employee may arise. In that case, it is desirable that the MNE be allowed to use the figures obtainable from the branch's financial statements. For the tangible asset component, the scope of assets that are recognized as depreciable property may vary from one accounting standard to another, a notable example being leased assets. Verification therefore needs to be conducted to ensure that no material differences arise between the calculation outcomes in individual jurisdictions. For the percentage of carve-outs, consideration should be given to setting a number higher than 10% set out in GILTI (for example, 20% or 30%).

5. Simplification options

Simplification measures are extremely important to reduce the administrative burden resulting from Pillar Two. A combination of measures is better than relying on a single method. Simplification options should not be complicated. The measure that we believe is most conducive to simplification is tax administrative guidance (i.e. the white list).

(1) CbCR ETR safe harbor

If adjustments to CbCR are kept to a minimum, this measure will greatly contribute to simplification. Conversely, if such adjustments are highly detailed, the measure will unduly increase MNEs' compliance costs. We are also concerned that this may lead to an excessive expansion of CbCR contents.

Some of the adjustments given as examples in paragraphs 385 and 386 of the Pillar Two Blueprint would undermine the usefulness of the measure as a safe harbor. For example, adjusting the jurisdiction to which withholding taxes paid in respect of dividends from a group member are attributed; removing withholding taxes paid in respect of dividends received from equity-method entities; and removing from income the profit or loss of non-group members reported in profit or loss before income tax under the equity method. These adjustments require ETR calculations for individual jurisdictions in accordance with the GloBE rules. Adding and adjusting items should be made unnecessary in principle.

To improve the accuracy of ETRs, it may be possible to consider the utilization of deferred tax accounting. In this case the impact of valuation allowances based on estimates of future performance should be excluded to simplify the rules and eliminate arbitrariness.

(2) De minimis profit exclusion

The Pillar Two Blueprint provides 2.5% of the group's pre-tax profit as an example (paragraph 394). If the de minimis threshold is set at 2.5% or higher, a considerable number of subsidiaries will be out-of-scope of ETR calculations, rendering this measure a viable option. Setting a percentage threshold is generally preferable, provided that any extra compliance burden is small, for example by allowing the use of CbCR pre-tax profit data with no adjustments.

When calculating the percentage threshold, the treatment of losses needs to be determined (paragraph 397). We believe the denominator of the percentage should be global pre-tax profit, although the total of global pre-tax profits for multiple fiscal years might need to be considered in order to accommodate temporary performance fluctuations.

Alternatively, setting a monetary threshold instead of a percentage is worth considering. In this case, however, the 100,000 euros given as an example in paragraph 398 of the Blueprint is too low. The threshold should be set at one million euros or higher.

(3) Single jurisdictional ETR calculation to cover several years

As this measure requires the jurisdictional ETR calculation for every jurisdiction in the base year, it would impose a significant compliance burden on MNEs that have many subsidiaries. To implement this measure, this problem would have to be resolved first, for example by narrowing the jurisdictions down through the measures outlined in (2) above and/or (4) below. On top of that, it is also conceivable to require an MNE to calculate the average ETR for multiple fiscal years, instead of the single-year ETR, for each of the narrowed-down jurisdictions; and that, if the average ETR of a particular jurisdiction exceeds a certain threshold, the MNE should be exempted from calculating the ETR for that jurisdiction for the next several years. In any event, making anti-abuse rules overcomplicated to prevent taxpayers from manipulating the base-year ETR should be avoided.

(4) Tax administrative guidance

Tax administrative guidance (or the white list) is the most straightforward measure and will contribute greatly to reducing compliance burdens. This measure should be widely employed while referring to the statutory tax rate and existence of a harmful preferential tax regime in each jurisdiction. At the same time, to minimize uncertainty, the white-listed low-risk jurisdictions should be specified by the IF in guidance to taxpayers.

The Pillar Two Blueprint implies that, even if a jurisdiction has been deemed to be low risk, a tax administration could specifically request an MNE to perform the ETR calculation for that jurisdiction (paragraph 406). If such requests were to be made frequently, the benefit of this simplification measure would be undermined. This request should only be permitted in highly exceptional circumstances, for example on the condition that the tax administration explains to the taxpayer the reason why the ETR calculation is necessary based on reasonable grounds.

If a jurisdiction's tax rate change or other material revision to its national law is likely to affect its white-listed status, it is desirable for the jurisdiction to notify other jurisdictions.

(5) Other simplification options

In jurisdictions that have strict CFC rules in place as recommended by the BEPS Action 3 Final Report, there is not much room for tax avoidance. For those jurisdictions, therefore, consideration should be given to allowing MNEs to apply the tax burden ratio calculated under the CFC rules to the IIR, in the interest of reducing compliance burdens. We propose two specific measures for consideration: first, recognize, as the ETR for the IIR, the tax burden ratio that is calculated under the CFC rules and adjusted to a certain degree; second, exempt from the GloBE rules the in-jurisdiction entities whose tax burden ratio under the CFC rules exceeds a certain threshold.

6. Split-ownership rule

We do not support the split-ownership rule, since this rule is overly complicated. Only in limited cases would IIR without split-ownership rule be exploited for tax avoidance purpose. It should be reconsidered whether implementing this rule is truly necessary to achieving the policy objectives of the GloBE rules.

The top-down approach enables an MNE to calculate and file IIR tax solely in the country of its ultimate parent company's residence, which contributes to simplicity. However, the split-ownership rule would undermine the efficacy of the top-down approach, imposing considerable compliance burdens on MNEs that have hundreds of subsidiaries. This is because, under this rule, MNEs are required to confirm the detail of the investment structure of every subsidiary, the status of the implementation of the IIR in each jurisdiction, and to decide which entity applies the IIR. The Pillar Two Blueprint mentions the risk of tax avoidance by means of the ultimate parent entity spinning off a minority interest in its subsidiary to its existing shareholder. However, in cases where the ultimate parent entity is a publicly traded company (and it is safe to assume it normally is, given that the IIR applies to an MNE with consolidated revenue of 750 million euros or more), it would be utterly irrational for the entity to transfer a part of its stake in a subsidiary to another shareholder solely for the purpose of reducing the tax burden. Even if problems arise, it will be sufficient to address only exceptional cases, such as those in which the ultimate parent entity is controlled by a few individuals. This rule should not apply broadly.

Assume that, as in paragraph 437, the ultimate parent entity is located in a jurisdiction that has not adopted the IIR and the intermediate parent entity is located in a jurisdiction that has adopted the IIR. In this case, we recommend that the intermediate parent's share of the equity in a low tax jurisdiction entity be used. There is no need to apply the split-ownership rule to cases where both the ultimate and intermediate parent entity are located in jurisdictions that have adopted the IIR.

Our particular concern is that the parallel application of this rule and the simplified IIR might place an extremely heavy compliance burden on MNEs. If one of the two rules were to be implemented, the simplified IIR might be relatively more practicable in terms of the compliance burden.

7. Undertaxed payments rule (UTPR)

We support the UTPR being defined as a backstop to the IIR. However, as the Blueprint implies the coexistence of the IIR and the UTPR (e.g., Example 6.3.1A), we are concerned that the rule may increase complexity. It is important for countries to adopt GloBE rules consistently once an agreement is reached.

8. Simplified IIR

The Simplified IIR, as a rule applying to equity-method entities (associates and joint ventures), would overly expand the scope of taxable entities. Whether this rule is necessary and acceptable should be reconsidered for the following reasons:

First, as MNEs do not control equity-method entities, the risk of these entities being used for tax avoidance purposes is minimal.

Second, the simplified IIR requires that top-up taxes be calculated based on financial statements data, which might result in an MNE being subject to excessive top-up taxes if its associate recognized large nontaxable capital gains. Also, in cases where an associate is resident in a low-tax jurisdiction and the income earned by that associate is subject to the CFC rules, not allocating those CFC taxes to the associate in the ETR calculation would result in double taxation.

Third, whereas the Pillar Two Blueprint proposes simplified calculation methods (paragraph 545 and thereafter), obtaining information from equity-method entities is more difficult than doing so from subsidiaries. Gathering additional information would entail an enormous administrative burden, such as negotiating with partner companies that are majority shareholders in the equity-method entities and establishing reporting routes and processes.

If the simplified IIR were to be implemented, the second point above would have to be resolved. Associates that are not equity method entities on the grounds of materiality should be excluded from Simplified IIR because it may be expected to be more difficult to obtain information from them, and the exclusion would not cause material impact.

9. Subject to tax rule (STTR)

We do not support the STTR for two reasons. Firstly, it overlaps with the GloBE rules. And secondly, the STTR deviates from existing taxation principles by taxing gross revenue, not net income. At the very least, each jurisdiction should be allowed to decide whether to implement the STTR. If implemented, the covered payments should be limited to interest and royalties, and the top-up tax percentage should be set at a moderate level. Furthermore, to save the compliance burden of checking, at every payment, whether the payment is subject to a low rate of tax in the payee's jurisdiction, simplified measures should be made to render the STTR more practicable, such as by making it applicable to the amount of payments on an annual basis.

10. Implementation and rule coordination

The implementation of the GloBE rules is expected to reduce the risk of tax avoidance. Each jurisdiction should consider simplifying the existing CFC rules and other anti-avoidance rules to alleviate both tax and compliance burdens.

Many MNEs have structured investments in Asia and other regions premised on jurisdictions' existing tax regimes. Accordingly, to protect these investments, sufficient transitional measures need to be instituted.

Business Law