The Price Of Tax Reform: Pillar 1 Reduced To The Back Of A Napkin

Getty is a hand sketch on a paper napkin.
On the internet, you can come across some interesting stuff. I recently came across a Twitter debate about the OECD’s pillar 1 proposal that produced some insightful comments worth sharing. The discussion looked at how pillar 1 will effect different countries’ net revenue gains or losses. That is not a minor thing. The OECD project envisions the transfer of billions of dollars in taxing rights across countries.
The Organization for Economic Cooperation and Development (OECD) has produced its own estimations of the amount of global revenues that may be reallocated to market jurisdictions. The goal is to delve deeper and assess the income implications for certain countries. Governments and taxpayers should be aware of the situation before making political commitments.
France’s Minister of Finance, Bruno Le Maire, estimates that pillar 1 will bring in between EUR500 million and EUR1 billion each year. According to US Treasury Secretary Janet Yellen, pillar 1 will be substantially revenue neutral for the US.
The majority of countries have produced their own internal estimates of what to expect under pillar 1, but we often have little knowledge of the computational methodologies.
Dan Neidle, a London-based tax attorney at Clifford Chance, is the driving force behind this newest number-crunching exercise. The project is described by Neidle as a “back-of-the-napkin” analysis, which does not diminish its utility.
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He admits that his findings should be regarded with caution because he is compelled to rely on a number of assumptions, the most obvious of which is that the intricacies of pillar 1 are still being worked out.
Given that the OECD has yet to determine what the final version of pillar 1 will look like, any careful quantitative analysis must contain a slew of qualifiers. That’s OK. The exercise’s inherent imprecision is no reason to abandon it. Estimates in the ballpark are preferable to no estimates at all.
To refresh your memory, most countries will be subjected to two conflicting influences under pillar 1. The corporate tax base will grow to the extent that governments are positioned as market jurisdictions and gain new taxation powers that were previously unavailable. More tax income will be deposited in the national coffers as a result of this.
At the same time, countries’ tax revenues will fall as other governments claim new taxing rights over profits that were previously the exclusive province of another country. This reduction is based on the assumption that countries will grant some sort of credit for the consequent overseas tax payments.
The availability of those credits, as we’ll see later, may not be as clear as we expect. Let us not, however, get ahead of ourselves. The balance of these conflicting forces will determine whether a country emerges victorious or defeated from pillar 1. In a separate thread, Neidle discusses the impacts of pillar 2.
The first goal for Neidle was to predict how his country, the United Kingdom, would fare under pillar 1. Later, he expanded the study to include more countries. When pillar 1 is considered separately, his calculations predict a slight increase in UK tax income.

Double exposure of the flag and the buildings of Canary Wharf business center
However, once we account for the money lost as a result of the repeal of the country’s digital services tax, the benefit is completely negated. The removal of DSTs is an essential component of pillar 1 adoption, according to this perspective.
In terms of the United Kingdom’s future prospects, pillar 1 is a wash. Given our hopes of transformational change, that’s very unappealing. Don’t be concerned. The revenue estimate for the United States is what draws your attention.
The Forbes Global 2000 index is the starting point for the process, which ranks the world’s largest publicly traded corporations based on a combination of assets, profits, sales, and market value. Since 2003, Forbes magazine has published an annual list.
Privately held corporations are not included in the list. Neidle used the most recent data available for 2019, which before the COVID-19 pandemic’s economic collapse.
Neidle entered the company-specific data into a spreadsheet before eliminating banks and extractive sectors. The reason for missing these companies is that it was assumed that they would be left out of the final version of pillar 1’s scope.
It’s questionable whether this is correct. As previously stated, assumptions are unavoidable. About half of the top 20 entries in Forbes’ global ranking are banks and financial industry organizations.
Exclusions for extractive sectors and banks are not coincidental. The original OECD plan, which was motivated by subjective factors and focused on so-called consumer-facing enterprises and firms offering automated digital services, excluded both sectors.
The US Treasury fought back against that component of the OECD design by adopting a broad scope concept governed by objective reasons, which I believe was a smart decision.
After removing the banks and extractives, the Forbes index still leaves a large number of enterprises in the data set; more than the US Treasury considers desirable. Washington prefers that pillar 1’s reach be limited to the top 100 global corporations, with sectoral carveouts eliminated to the maximum extent practicable.
The OECD roadmap sets a global gross revenue requirement for pillar 1 that may be anywhere between EUR750 million and EUR5 billion. This reduces the number of companies covered by pillar 1 to between 620 and 2,300.
Given the large number of taxpayers who could be affected, using the Forbes index does not appear to be out of the question, at least until all scoping difficulties and the gross revenue criteria are resolved.
Following that, Neidle screened out companies with profit margins of less than 10%, which the OECD recommends as a first step in establishing the amount of profits due to reallocation. This is a rough approximation for removing routine profits from the pillar 1 allocation and just keeping residual profits.
The profit-margin cutoff gives a number of $835 billion using the Forbes data set, which may be seen as an approximation of in-scope aggregate earnings.
This computation overlooks intrafirm activity segmentation, which leaves a lot of residual revenues unaccounted for. Amazon, for example, may have a profit margin significantly below the industry standard of 10%. (According to my colleague Marty Sullivan, Amazon’s profit margin for 2017 is expected to be around 2%.)

The Amazon logo is shown at the entrance to the Amazon logistics center in Amiens, northern France… [+] On July 23, 2019, in France. (AFP photo by DENIS CHARLET) (The photo should be credited to DENIS CHARLET/AFP via Getty Images.)
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However, the business’s lucrative web services division is expected to have a far larger profit margin, and if the corporation were separated into component components, it might easily be in scope for purposes of pillar 1. Many huge global firms could be said to be in the same boat.
While business line segmentation is more inclusive if you’re looking for a complete picture of residual earnings, it’s a huge source of complication that the OECD has been grappling with for quite some time. The US Treasury wants segmentation to be phased out, seeing it as the most complicated aspect of the pillar 1 design.
According to the OECD blueprint, 20 percent of profits in scope would be up for grabs. The percentage is subject to change. The blueprint specifies a range of workable rates between 10% and 30%, with 20% serving as a convenient middle point.
We get $167 billion by multiplying the value for in-scope aggregate profits ($835 billion) by 5. This is the same as the concept of amount A, which represents the amount of revenues that can be reallocated to market jurisdictions utilizing formulary techniques.
According to the OECD plan, amount A is allocated based on a jurisdiction’s proportional share of a company’s worldwide sales. Neidle chose to estimate country-level results by making an assumption about each country’s percentage of global consumption rather than making that calculation for each firm in the Forbes data. He used the World Bank’s global index of private consumption expenditures for this purpose.
The United Kingdom accounts for 3.76 percent of worldwide private consumption, according to World Bank figures. As a convenient plug-in for the sales factor apportionment ratio, we can utilize the 3.76 percent national consumption statistic.
Calculating 3.76 percent of amount A (estimated at $167 billion) yields a profit allocation of $6.3 billion to the United Kingdom.
The percentage of U.K. sales compared to global sales for any given taxpayer may not be exactly 3.76 percent. As additional enterprises join the fold, the average percentage should converge near the national consumption level.
For example, Apple’s U.K. sales as a percentage of global sales may be nowhere near 3.76 percent, but when you assess a bigger pool of companies, the percentage is likely to reflect the national consumption to global consumption ratio.
The next phase is to convert the United Kingdom’s expected amount A allocation ($6.3 billion) into business tax collections. Neidle does this by multiplying the value by a presumptive tax rate of 25% and converting the product from US dollars to British pounds. Using a 0.71 currency conversion ratio, this equates to around GBP1.12 billion.
That is only part of the story. We must factor in the fact that a portion of the current UK tax base will be shared with market jurisdictions in our calculations.
Due to the fundamental principle of avoiding double taxation, some adjustments are required. This could be in the form of the taxpayer being able to claim a foreign tax credit from their home country. Al/nRead More