OECD Proposal Fails to Help Domestic US Manufacturers

October 09, 2019

Many in Washington look at the Organization for Economic Cooperation and Development (OECD) in Paris to help with pressing business concerns in the global community. And recently, the OECD promised to tackle cumbersome issues related to international corporate taxation. Unfortunately, it appears that the OECD isn’t positioned to provide a helpful solution when it comes to protecting America’s small businesses. 

Domestic manufacturers have long cited the problem of corporate tax avoidance practiced by multinational enterprises (MNEs). Smaller businesses based in the US—particularly ones without foreign subsidiaries—continue to pay more taxes on their US profits than competing MNEs. That’s because MNEs only pay the low rates that result from shifting profits to tax-haven countries. This gives an unfair advantage to more profitable MNEs.

In the run-up to the 2017 Tax Cut and Jobs Act (TCJA), many US manufacturers hoped that the adoption of a new corporate tax system might finally help to level the playing field. They wanted to see multinationals finally bear an equal tax obligation. However, the TCJA made only a slight dent in the overall problem.

While the TCJA did lower the corporate tax rate, it also added new complications to an already ineffective tax system. Ironically, this failure subsequently spurred a greater awareness in the global community to deal with tax inequities. And the Organization for Economic Cooperation and Development eventually responded by suggesting a new approach to potentially hold MNEs accountable.

Now, the OECD’s tax leadership group has devised what it sees as the start of a comprehensive solution. The OECD’s answer is to partially adopt the current method of corporate tax apportionment long practiced by many US states. (The OECD believes that system to be a superior method of handling tax avoidance mechanisms.) And the OECD believes that Washington should be able to tax a corporation with a strong economic presence in the US.

That sounds promising. But what the OECD has actually done is keep the old, ineffective tax system while simply adding a new method as an additional layer on top. Regrettably, this functions as only a bare minimum control of abuse—and that’s where the problems start.

What appears to have happened is that, in the face of complaints by MNEs, the OECD has essentially reined in the effectiveness of its proposal. First, the OECD will still allow the protection of a large chunk of profits as “routine” under the old tax avoidance system. And second, it will isolate abnormally high profits from only high-value companies. From those abnormal, or “residual” amounts, countries can then divide the profits in question under a “sales apportionment” method for taxation.

The problem is that this still preserves a large chunk of the status quo that has long allowed MNEs to shift profits to smaller tax havens. And so, the OECD’s proposal fails to establish a truly level playing field for  America’s domestic producers need. 

If domestic businesses hope to enjoy a level and competitive market again, Congress must disregard these limitations.

Realistically, the only practical solution would be if the US finally embraces a system that the OECD won’t truly embrace, “Sales Factor Apportionment” (SFA). In practice, SFA would impose the same corporate tax obligation on profits that any company might earn for its US sales—regardless of where the company claims to be based.

Essentially, if a company earns profits in the US, it must pay a tax on those profits. The rationale is that a corporation would finally be paying its fair share for the privilege of accessing America’s massive, lucrative consumer market. Such an approach would be particularly helpful for domestic companies.

America’s small businesses are still waiting for Congress to fix the nation’s tax system—and help them to compete successfully against large MNEs. If Congress studies the new OECD plan, it will recognize that it is limited—and won’t help America’s domestic businesses.

Washington should embrace a true SFA system rather than continue a failed approach. Otherwise, smaller American companies will keep losing market share.

Tax Strategy