New Frontiers of Dispute Settlement in a Pillar One World—Part Two
The success of Pillar One largely depends on the effectiveness of dispute settlement disciplines

Part One of this article, which appeared in the March/April 2022 issue of Tax Executive, discussed the evolution of the international tax system leading up to the modern proposal to implement an OECD-championed multilateral tax treaty to bring order to an increasingly complicated and digitized world. The recent impetus to complete a Pillar One treaty has been animated by the digitization of business and a growing number of trade disputes over digital services taxation.

In this second part, we focus on the challenges to a meaningful implementation of Pillar One. The need for effective dispute resolution mechanisms overshadows all of Pillar One, and the proposed multilateral approach will likely require new thinking in terms of managing global tax controversies and corporate risk. If the Pillar One output lacks the teeth to inspire confidence that commitments will be kept and controversies may be resolved with consistent and principled outcomes, then it will fail—and the patchwork of global tax measures and controversies will proliferate. Several potential solutions for harnessing the Pillar One deal may be found in international trade law, which provides a myriad of possible options for enforcing a tax deal. Such tools would also be useful in the event that the Inclusive Framework cannot reach a deal and corporate stewards are left to mitigate risk in an ad hoc environment.

None of the solutions, however, is without downsides. The best outcome would be for the Organisation for Economic Co-operation and Development (OECD) and the Inclusive Framework to adopt strong and nimble dispute settlement (DS) options within the treaty itself. In-house counsel and tax departments would be well advised to keep these options in mind, hope for the best, but prepare for the worst.

Challenges to Pillar One Success

As a project—the success of which already depends on securing not only political but also legislative agreement by sovereign countries to reallocate taxing rights—Pillar One naturally faces headwinds even in the best environment.¹ If one reflects on the fact that its market-is-the-measure approach represents a major deviation from the traditional international tax framework and could be perceived as a gateway to global formulary apportionment, then the outlook starts to dim.² Nonetheless, the swift reanimation of the business digitization and taxation narrative following the conclusion of the OECD/G20 Base Erosion and Profit-Shifting (BEPS) Project leads us to believe that the prospects for multilateralism are greater now than perhaps at any time in modern history.

Three main challenges, we believe, will determine Pillar One’s success or failure: 1) the US government’s willingness or ability to implement Pillar One, 2) the ability of the OECD to successfully simplify the substantive Pillar One design features that are not yet resolved and to unify the views of Inclusive Framework members in relation to them, and 3) a willingness on the part of the Inclusive Framework to commit serious time and resources to properly develop and implement meaningful tools and procedures to ensure that Pillar One’s multilateral and bilateral dispute resolution frameworks function efficiently and that Pillar One commitments are not undermined.

The first challenge to Pillar One’s success—the possibility that the United States may not implement it—is a wild card for several reasons, most important among which is the fact that a failure to implement by the world’s largest economy will reverberate throughout the Inclusive Framework by weakening other members’ commitments and emboldening unilateral action. The OECD has already seen countries back away from Pillar One due to design problems, and some in the tax community suspect that some countries may lose enthusiasm for Pillar One as the details are settled and the math is rerun on Amount A.³ However, an effective retreat by a major G20 member would likely imperil the effort, notwithstanding that some may believe there could be a world in which Pillar One is implemented without the United States.⁴

One practical reason the United States might not implement Pillar One, or at least not soon, relates to politics and to the novelty of multilateralism in the tax domain. From the US perspective, the use of a multilateral instrument to allocate taxing rights is unquestionably novel. Although the execution of a multilateral tax instrument should in theory be possible—assuming the existence of adequate stakeholder protections (such as good dispute resolution tools)—the United States traditionally signs only bilateral tax treaties and, to our knowledge, has never signed a multilateral tax treaty that allocates taxing rights.⁵ To do so, the United States presumably must craft new statutory taxing rights and ensure that its existing treaty network does not impede the operation of the Pillar One treaty—all of which suggests that implementation depends on a traditional legislative process involving the US Senate.

But the Senate is almost evenly divided between Democrats and Republicans, and even though the US Treasury may be willing to move forward on Inclusive Framework priorities, its engagement with the US Congress to date appears to have been so limited as to have drawn repeated sharp rebuke from all Republican members of the Senate Finance Committee.⁶ Given the fate of other Biden administration initiatives (for example, the Build Back Better Act and voting rights efforts), and the ongoing crisis involving Russia, there is a real risk that the US commitment to Pillar One could suffer a negative political outcome at least in the near term.⁷ Considering the pace at which the G20 finance ministers and the OECD seek to move Inclusive Framework initiatives forward, it would not be unreasonable to also conclude that such a delay might weaken the political agreement reached in October 2021.

The second challenge to Pillar One’s success relates to the myriad design features, rules, and definitions that must be engineered to animate the proper application of Pillar One but which as of this writing are just beginning to be socialized for stakeholder input. Proper construction of these “building blocks” is critical not only to ensure that the Pillar One system functions properly in a vacuum but also to build confidence among all stakeholders that it will be durable when unleashed on the world and can live up to the promises made in arriving at the political deal. Yet public consultation periods have been abbreviated (that is, each is approximately two weeks), and topics considered only in piecemeal fashion as the universe of elements have not yet been developed for holistic public review.⁸ This approach is understandable, since Pillar One is a monumental undertaking—one requiring both fundamental revisions to work done by the League of Nations in the 1920s and the development of mechanisms to ensure that new and existing tax systems interact properly—and is constrained by a political timetable, but it creates significant opportunity for confusion and error and is akin to Julia Child preparing beef Wellington in a microwave oven. We can appreciate not wanting the perfect to stand in the way of the good, but the political schedule (which envisages completion of technical work in 2022 and operability in 2023) may simply be too ambitious.⁹

To date, the Pillar One technical drafts released for consultation have reflected quantum-level complexity and left abundant room for subjective interpretation—foreboding signs of the multilateral (not mere bilateral) disagreements and controversies looming on the horizon. Given reported post-BEPS audit challenges associated with misinterpretations of core BEPS concepts, one can wonder whether Pillar One might eventually collapse on its own given its propensity for complexity, its potential for subjectivity, and the timing constraints imposed on its technical work development.¹⁰

The third challenge that we see to Pillar One’s success relates to the willingness of the OECD and Inclusive Framework to treat the technical work on dispute resolution tools and processes (both from taxpayer-to-government and government-to-government perspectives) as on at least an equal if not greater footing when compared to all other Pillar One technical work. Pillar One itself is the embodiment of multilateralism, an approach that has long been theorized as an ideal model for addressing tax matters in an international setting.¹¹ Yet it is inescapable that multilateralism has played a very limited role to date in allocating taxing rights (as opposed to less politically sensitive matters such as information sharing), whereas bilateralism has proliferated within that realm.¹² And though we recognize that the prevalence of bilateralism in the tax domain can be viewed as the progeny of a historical compromise, its durability over the past century is better explained in simple and practical terms: it is easier to engage with and resolve matters bilaterally. Thus, in our view the true “heavy lifting” of Pillar One is the work to be done in relation to the rules that dictate how multilateral interactions among stakeholders (taxpayers and governments alike) will operate to resolve disputes and achieve legal certainty consistently and preferably efficiently. Tax history implies that this work will be hard, but it arguably is the legal foundation upon which all of Pillar One and its political agreement rest.¹³

When designing dispute resolution tools and processes for Pillar One, the OECD and the Inclusive Framework must pay special attention to taxpayer rights and remedies since in-scope multinational enterprises (MNEs) will be the subjugated party left swaying in the wind as disagreements (particularly those among governments) arise. After all, Amount A is designed to serve and to benefit tax authorities, and thus the principal benefits to be realized by in-scope MNEs are the certainty promised by a binding multilateral dispute resolution process for Amount A (that is, the possibility of achieving multilateral resolution with no need to resort to local courts, administrative bodies, or other traditional tools), the prospect that Amount A matters may be efficiently integrated with other matters arising under the existing international tax framework (for example, Amount B), and the freedom from digital service taxes (DSTs) and other unilateral measures resulting from standstill and rollback commitments.¹⁴ Without special attention to taxpayer rights and tax certainty in a multilateral environment, in our view MNEs attain no material benefit from Pillar One from a corporate risk management perspective. Although the venues for resolution that were previously available (such as bilateral mutual agreement procedures—MAPs—and local administrative and judicial bodies) remain options for settling disputes, their practical utility will be diminished in a multilateral environment where MNEs are subjected to new market-based taxing rights and formulary allocations without the possibility of final resolution by an ultimate arbiter (such as a “global” supreme court). And MNEs could easily be worse off if Pillar One succeeds but DSTs nonetheless proliferate. Thus, it is imperative that the OECD and Inclusive Framework ensure that: 1) the mandatory binding resolution process for Amount A in fact operates to legally bind affected tax authorities; 2) there is a way to efficiently integrate Amount A and Amount B (or other current law) determinations in a way that achieves certainty for MNEs; and 3) agreements reached and reflected in the Pillar One treaty or other such treaties, given their multilateral nature, can be effectively and efficiently enforced against recalcitrant countries (for example, those that reenact DSTs).¹⁵

The potential for a breakdown on rollback and standstill measures (if, for instance, DSTs prove too politically popular to repeal) is also a government-to-government concern that impacts Pillar One viability, and a country such as the United States might determine that a Pillar One vista is not worth the climb without strict adherence to such measures.¹⁶ For instance, Canada’s recent plan to enact a unilateral DST with retroactive features has been described as inconsistent with the country’s Pillar One commitments, and Senate Finance Committee leadership has admonished the US Trade Representative (USTR) to be ready to take trade action if Canada implements a DST in violation of its commitments.¹⁷ In February 2022, USTR provided comments to Canada on the proposed DST, noting “serious concerns” about the tax and urging Canada “to abandon any plans for a unilateral measure and instead redouble its commitment to the rapid implementation of Pillar One of the October 8 OECD/G20 agreement and the completion of a multilateral convention in 2022.”¹⁸

Lessons From Dispute Settlement in Trade

Trade law is instructive for assessing the potential effectiveness and durability of Pillar One and the envisaged dispute settlement processes discussed in Part One of this article in the March/April 2022 issue. An agreement without a meaningful enforcement mechanism is only as strong as the willingness of the signatory countries to abide by it. But moral suasion can go only so far. Adherents to public international law have often placed their hopes in treaties that in the end cannot deliver. For example, an international tribunal under the 1982 UN Convention on the Law of the Sea delineated the borders of the disputed South China Sea, but the Philippines continues to struggle with incursions by China, which refuses to respect the decision.¹⁹

Prior to the creation of the World Trade Organization (WTO) in the mid-1990s, the world trading system was ill equipped to resolve disputes over countries’ compliance with international trade obligations. The General Agreement on Tariffs and Trade (GATT) of 1947 established a dispute resolution mechanism, but the right of a losing party to block adoption of a panel report meant that the process could not effectively manage the resolution of bilateral disagreements.²⁰ Resorting to unilateralism, such as under Section 301, was much more frequent.

The WTO revolutionized trade by creating a binding dispute settlement system through the WTO Dispute Settlement Understanding (DSU), part of the Uruguay Round Agreements.²¹ Assuming that bilateral consultations fail to resolve a complaint, a dispute goes before a WTO panel, whose findings are usually appealed to the WTO Appellate Body. Members who prevail on their claims of WTO inconsistency have the right to enforce rulings through WTO-authorized trade retaliation or the required payment of “compensation,” mainly in the form of tariff concessions. Alternatively, disputants may reach a so-called mutually agreeable solution. The DSU has generally worked, but the DS process came to a halt during the Trump administration when the United States, to protest alleged overreach by the Appellate Body, began to block appointments needed to reach a quorum to decide appeals.²²

The United States and other countries have also adopted DS mechanisms in bilateral and regional deals. In fact, the United States was an early adopter, and binding DS has been a facet of US free trade agreements (FTAs) for decades.²³ Other countries have entered bilateral and regional multilateral deals with similar enforcement mechanisms.²⁴ FTAs also have incorporated investor-state provisions, which enable MNEs to challenge unfair and restrictive practices in the FTA partner market.²⁵ More recently, the United States and other nations have started to negotiate and conclude freestanding digital trade agreements that address taxation, among other issues.²⁶ The enforceability of these deals remains to be seen, particularly since some have tended toward a “softer” approach on disputes.²⁷

Pillar One holds much promise for restoring order to a world immersed in conflict over international taxation of digital businesses. Inclusive Framework members must be mindful to ensure that final DS provisions can address any disputes that may arise among the signatories to the Pillar One treaty; between MNEs and the Pillar One review panels; and between taxpaying corporations and taxing authorities implementing the treaty. The Inclusive Framework has begun to think through these issues and establish a framework to harmonize tax decisions and provide business certainty, but so far it appears to fall incredibly short on the questions concerning enforcement of Pillar One commitments and treaty provisions. Concluding a successful Pillar One deal requires that negotiators understand the pitfalls of public international law while borrowing successful elements from the world of DS in international trade.²⁸

What If Pillar One Succeeds?

If a significant number of G20 nations successfully implement Pillar One, the result would be a remarkable achievement and the culmination of a decades-long campaign advanced by academics and tax administrators to introduce multilateralism in the tax domain. It may also mark the beginning of a new era in which direct taxes on multinationals are more likely determined according to formulary principles, assuming the Pillar One agreement is durable and any cracks in the system are minor. Whether tax architecture and infrastructure keep evolving toward trade may depend on how sovereignty issues get sorted out. Regardless, the Pillar One project will have provided a foundation for this new era.

Potential Disputes

Once a Pillar One deal is complete and ratified to the satisfaction of Inclusive Framework members, disagreements over implementation are all but assured. Should the channels of dispute avoidance and mediation established under Pillar One fail, signatory countries or individual corporations must be prepared to identify, assess, and choose appropriate enforcement options.

Some bilateral issues that may arise following an implementation of Pillar One would best be handled between governments. For example, formal or informal talks between national representatives could provide a means to address patterns of alleged violations by a national tax authority in the amount of taxes imposed or in case of the adoption of DST-like measures. Inclusive Framework negotiators should consider incorporating a mechanism in the Pillar One treaty that would trigger mandatory consultations between government disputants in the event of Pillar One disagreements. However, even without a formal treaty provision the United States should anticipate such disputes and seek to establish arrangements for handling allegations of Pillar One infractions by other Inclusive Framework members (for example, a quasi-diplomatic bilateral or plurilateral process championed by US negotiators from the US Treasury and State Departments and USTR, which would be capable of achieving, or at least framing, bilateral or multilateral government-level solutions to such infractions).

Without binding DS such as the WTO’s, a consultative approach would depend heavily on members’ commitment to and good faith in seeking a satisfactory resolution. If members cannot resolve disputes, and the treaty offers no binding DS or enforcement, then governments are more likely to act unilaterally or through parallel means, as discussed more fully below. While the Pillar One approach implicitly suggests the need for a unified body with adjudication and enforcement over tax matters, this undoubtedly presents the most vexing issue facing Pillar One implementation, since legislatures are almost certain to oppose any suggestion that sovereignty should be ceded to an intragovernmental organization like the OECD.²⁹ Thus, US negotiators will need to think hard and be creative in identifying ways in which the Inclusive Framework membership could realistically incorporate mechanisms such as those under the WTO or FTAs, including what penalties for national violations would look like.

Issues that implicate Pillar One from an institutional standpoint would require involvement of all Inclusive Framework members and may necessitate changes in how the agreement operates in practice. Relevant complaints could include allegations that any arbitral body or review panel has misinterpreted treaty provisions. Inclusive Framework members should maintain some control over modifying the operation of the Pillar One arrangement without having to amend the treaty itself, such as regularly updating underlying commentaries as has been the tradition to date.³⁰ More specific treaty provisions would further help prevent cases in which “gap filling” leads to charges that DS panelists have abused their discretion. However, at some point, if faith in the Pillar One panel process erodes and members reach an impasse, then the entire enterprise could face an uncertain future.

Corporate Dispute “Management”

Corporate tax risk management is likely to be much different under Pillar One than it is today. Although there may be strategic costs, the ability to manage disputes multilaterally might in theory lead to efficiencies. At least with respect to Amount A, the process described in the Pillar One white paper provides MNEs with a strong advocate in the form of the lead tax administration (say, the IRS for US multinationals) and anticipates a process that seems to avoid the pitfalls of simultaneous audits and more closely resembles a multiparty joint audit (but with better timing and processes built in). Moreover, the fact that the representative panel process promises, within a reasonable period, a baseball-style arbitration result that is binding on affected tax authorities but not on MNEs is attractive.

However, managing the intersections of Amount A and Amount B will present real challenges, as will other intersections of the new international tax system with the traditional one.³¹ Even if we assume that Amount A controversies can be managed (at least within a vacuum), controversy management may quickly become unwieldy as Amount A impacts or is impacted by items elsewhere in the system—whether due to Amount B, transfer pricing items not addressed by Amount A or B, or transactions involving jurisdictions that may not have signed on to Pillar One or that take issue with determinations made in connection with it. Although the Pillar One white paper anticipates that there will be mandatory binding dispute resolution tools for items beyond Amount A, it arguably would be helpful if the Pillar One treaty included a multilateral MAP article (as complex and time-consuming as that may be in terms of engagement options), since the finality of all MNE-accepted outcomes should be able to be memorialized as legal obligations of all affected tax authorities. As noted earlier, a principal benefit of Pillar One to MNEs is the certainty that comes with being able to achieve multilateral resolutions to disputes without a need to resort to individual DS measures through local courts, administrative bodies, and other traditional means.

Additionally, novel issues will emerge as people gain experience with Pillar One. Will determinations relating to common Amount A issues be made public (for example, to prevent discrimination, the use of “secret comparables,” or to otherwise facilitate efficient dispute management)?³² Will these determinations lead authorities to take a “lowest common denominator” approach, or will there be room for differentiation based on argumentation? From a DS management perspective, it would be good to know if there ever will be an international body, such as one operating under the auspices of the OECD (like the WTO), that can help with interpretative matters beyond what is stated in various commentaries or with government-to-government issues (for example, if a country does not honor its commitments); and, if so, it will be important to know how, if at all, MNEs might engage with such a body.³³

Finally, even under Pillar One opportunities will still emerge to resolve disputes through local courts and administrative bodies, although any inefficiencies are likely to be magnified in this brave new world.

Trade Law Mechanisms to the Rescue?

Ultimately, the final DS provisions in Pillar One may prove insufficient to deliver meaningful outcomes for US MNEs or the US government. Other mechanisms, based in trade law, may facilitate government-to-government DS. As noted, DSTs moved quickly to the forefront of trade policy when the Trump administration initiated Section 301 investigations of France and other countries. But aside from unilateral enforcement—which brought the issue to the breaking point in the first place—the United States could leverage rights and obligations in multilateral or bilateral trade agreements to ensure compliance with the provisions of Pillar One. The threat of this type of back door enforcement could help keep Inclusive Framework members honest and prevent backsliding.

Not every dispute under Pillar One would qualify for consideration by the US government under formal DS mechanisms. A pattern of discrimination by a national tax authority against one or more major US digital services companies would raise concerns within the government, as would adopting DSTs or equivalent measures in flagrant violation of Pillar One commitments.³⁴ Isolated cases of discrimination are more likely to get a hearing through other channels, such as involvement by the relevant US embassy.

The WTO agreements provide a possible multilateral route to dispute resolution. Since the beginning, the WTO has grappled with the issue of discriminatory taxation.³⁵ The GATT and the General Agreement on Trade in Services (GATS) commit members to national treatment (like not discriminating against a WTO member’s imports in favor of domestic products) and most-favored-nation treatment (that is, not discriminating against products of one member in favor of products from another member).³⁶ These obligations apply not only to tariffs but also to measures like internal taxation, food safety regulations, and technical standards. The issue becomes more complicated with respect to direct taxation on corporate income, but WTO disciplines arguably apply to discriminatory corporate tax measures designed to diminish the comparative advantage of US digital products in foreign markets.³⁷

The WTO route is not without downsides. The applicability of WTO obligations to direct taxation in some circumstances—particularly in the case where there is a parallel convention regarding double taxation—is murky enough to render the outcome on some claims uncertain.³⁸ The process is resource-intensive and sometimes cumbersome, with several different phases. Disputes may move at a glacial pace,³⁹ and with the current impasse in the system, they are not being decided at all. The prospective nature of remedies for noncompliance under the DSU also means that economic damages or refunds may not be available to US MNEs facing discriminatory taxation.⁴⁰ On the positive side, a dispute could lead to a negotiated resolution under which the offending country refunds overpayment or commits to the nondiscriminatory application of national tax laws or regulations implementing Pillar One.⁴¹

Another route involves DS under US bilateral FTAs to which a Pillar One signatory is a party.⁴² The United States has tended to underutilize FTA DS mechanisms, but they may apply in the Pillar One context. As with the WTO Agreements, US bilateral FTAs contain rules on most-favored nation and national treatment that are subject to DS procedures. The US–Korea FTA, or KORUS, for example, even incorporates a specific e-commerce chapter that imposes the core obligation of national treatment on taxing digital products.⁴³ In other words, the United States and South Korea maintain their sovereignty over taxation, provided it is not used to punish the other’s digital exports.

As is the case with the WTO, DS under a bilateral FTA becomes more complicated concerning challenges to discriminatory income taxation measures. KORUS and other FTAs generally except “taxation measures” and favor the primacy of international tax conventions to the extent they are inconsistent with provisions of the FTA.⁴⁴ However, notwithstanding such restrictions, US FTAs tend to maintain the overarching obligation that parties respect national treatment commitments, even when imposing tax measures.

The United States, in terminating the various Section 301 investigations at the end of 2021, reserved the right to reactivate those cases. According to USTR, the agency, “in coordination with Treasury, will monitor the implementation of the political agreement on an OECD/G20 Two-Pillar Solution as pertaining to DSTs, the commitments under the joint statement, and associated measures.”⁴⁵ Should USTR have reason to question the implementation of Pillar One by the countries subject to the investigation, the agency “will consider further action under [S]ection 301.”⁴⁶ Resorting to unilateralism would indicate a very serious issue with the operation of Pillar One and a lack of confidence in other mechanisms to resolve a dispute.

Individual MNEs may likewise have recourse to international trade mechanisms to resolve disputes under Pillar One. The United States has concluded multiple bilateral investment treaties (BITs) in which the parties undertake commitments to refrain from discrimination against investors from the other party. Such treaties generally incorporate commitments related to national and most-favored-nation treatment, minimum standard of treatment, expropriation, and performance requirements.⁴⁷ (As noted above, US FTAs also have investor-state dispute resolution.) Private investors under BITs and some FTAs have the right to arbitration against a host government under these agreements, although this route may be one of last resort, since actions regarding taxes are often subject to deference provisions, and host countries inevitably will raise sovereignty issues.⁴⁸ Nonetheless, as the recent Cairn Energy (now Capricorn Energy) tax dispute with India demonstrates, BITs may prove useful in leveraging concessions from host countries in egregious cases.⁴⁹

Special Case: Developing Countries

An exception for developing countries under Pillar One presents the United States with enforcement challenges. Maintaining an opt-out or other alternatives to Pillar One dispute settlement means that developing countries would be less accountable, short of diplomatic pressure. Should bilateral tax disputes arise with developing nations—some of which are major markets for US tech companies—the United States could resort to the various multilateral or bilateral trade tools discussed, but also to additional enforcement specific to developing-country noncompliance. The Generalized System of Preferences (GSP) program provides duty-free access to eligible beneficiary developing countries.⁵⁰ Under GSP, USTR can still withdraw all or some preferences if a developing country fails to provide “reasonable and equitable” market access, adopts “trade distorting investment practices and policies,” or imposes “barriers to trade in services.”⁵¹ Other preference programs apply to African and Caribbean nations.⁵²

USTR could leverage benefits under GSP or other applicable programs to secure resolution of a disagreement over implementation of Pillar One. By initiating an eligibility review, USTR would have a greater ability to pressure a country into complying with Pillar One. Previous administrations have used such reviews to secure changes to trade-restrictive policies or have withdrawn preferential tariff rates when reaching an impasse in a dispute.⁵³ The threat of losing trade benefits could be a persuasive factor, particularly for countries that depend heavily on GSP or other preferential programs.

What If Pillar One Fails?

Inclusive Framework members share an ambitious goal with the Pillar One treaty. A breakdown in negotiations with a failure to reach a definitive and final agreement, a US Senate rejection of the treaty, or the overall abandonment of Pillar One could have very serious consequences for international trade. DSTs and other “creative” taxation measures would surely proliferate, and US MNEs—particularly high-tech and digital media enterprises—would continue to confront an uneven global landscape.⁵⁴ The ability to resolve non-DST cases via the MAP, and to bring tax disputes more generally before local administrative and judicial venues, would still provide patchwork options to manage corporate risk; however, the efficiencies of a well-designed multilateral dispute resolution system arguably would remain elusive. In this environment, tax departments, in combination with the general counsel and government affairs offices, may find opportunities in trade law to advance their interests and influence alternative outcomes.

As welcome as the commercial stability of a global arrangement might be, current trade law tools will exist whether or not a Pillar One deal passes. In a world without a Pillar One treaty, US MNEs should continue to apprise USTR and other government agencies about discriminatory tax measures in foreign jurisdictions. Such dialogues would bring trade issues to the attention of policymakers and government counsel and assist with building cases at the WTO or under FTAs.

And Section 301 grants private parties the right to petition USTR to launch investigations, an option MNEs could consider if the unilateral route seems better suited to resolving disputes.

Additionally, a breakdown at the OECD need not represent the end of the line. The United States is actively considering digital trade agreements, particularly in the Indo-Pacific region, and US MNEs should work with negotiators to ensure the insertion of strong and binding DST disciplines. Although the United States has exhibited an allergy to new FTAs, they may eventually return to favor, and, again, US MNEs should push for a seat at the table in designing state-of-the-art digital taxation commitments and effective enforcement mechanisms.

J. Brian Davis is a partner in and leader of BakerHostetler’s international tax practice.
Ronald J. Baumgarten Jr. is of counsel in BakerHostetler’s international trade and national security practice and formerly served as Deputy Assistant US Trade Representative (USTR) in the Office of Southeast Asia and the Pacific.

Endnotes

1. Just because multilateralism is possible in trade does not mean there is an equal case for it in tax. Tax and trade both contribute to foreign policy, and tax treaties surely play a role in a country’s trade policy. However, national sovereignty considerations and a divergence in underlying goals make multilateralism difficult to achieve in the tax space (for example, because each country’s revenue needs, and policy decisions related to meeting those needs, may materially diverge) yet possible in the trade space (for example, because the goal for all participants is to reduce or eliminate tariffs and other barriers to international commercial transactions). The digitization of business and the architecture of the Pillar One approach have thus far permitted Inclusive Framework members to move past national sovereignty issues as a political matter, though legislative bodies may of course have different views. Some commentators believe that this gap (that is, between the “political” and “legal” agreement needed to implement Pillar One) may be a bridge too far, particularly since the truly hard questions regarding implementation have not been adequately addressed and the existing October 2021 “agreement” is not legally binding on anyone. See, for example, Scott Wilkie, “Next Steps for the OECD Pillars: Moving From a Political Deal to an Enforceable Law,” 104 Tax Notes International 889, November 22, 2021.
2. See Joseph L. Andrus and Richard S. Collier, “Transfer Pricing and the Arm’s-Length Principle After the Pillars,” 105 Tax Notes International 543, January 31, 2022 (noting that although post-BEPS work on the digitization of the economy did not embrace “a wholesale conversion to a formula-based income attribution system,” the work of the Inclusive Framework “likely represents a way station on a potentially tangled path to somewhere else” and “it seems hard to conclude that we are not on a path that leads away from the arm’s-length principle, at least to some degree”). It is of course possible that this is what some sovereigns have been hoping for all along. See, for example, Joann M. Weiner, “Michael Mundaca,” 51 Tax Notes International 1019, September 22, 2008 (regarding US Treasury/OECD work on electronic commerce matters during the Clinton administration, when electronic commerce was still in its infancy: “There was a lot of pressure to move to a different definition of [PE], especially since many thought that physical presence was no longer needed with electronic commerce…”).
3. See Stephanie Soong Johnston, “‘Expectation Gaps’ Led Nigeria to Pull Out of OECD Tax Deal,” 104 Tax Notes International 1280, December 13, 2021 (Pillar One design problems caused Nigeria to pull out, and Nigerian tax officials warned that there is a pending problem as the project has not accounted for the fact that countries may realize too late that they are unable to ratify the Pillar One treaty or implement the new rules). Such speculation is not limited to Pillar One, and some in the tax community believe that countries such as Ireland might reevaluate commitments to the Inclusive Framework’s efforts if the United States were to fail to implement Pillar Two—which arguably would be the easier of the two pillars for the United States to implement. Compare with Sarah Paez, “Ireland Risks Debt Problem With Corporate Tax Declines,” 105 Tax Notes International 1056, February 28, 2022; Andrus and Collier at 554 (noting potential interest in a decoupling of the pillars and discussing the impacts on transfer pricing if Pillar Two were implemented but Pillar One failed).
4. See, for example, Sarah Paez, “More Work Remains Before Pillar 2 Model Rules Are Ready,” 104 Tax Notes International 1152, December 6, 2021 (a top OECD tax official confirms that the odds of the United States implementing Pillar One have never been high, and such a failure would put the Inclusive Framework “back at square one”); Scott Wilkie, “Next Steps for OECD Pillars: Moving From a Political Deal to an Enforceable Law,” 104 Tax Notes International, November 22, 2021, 899–900 (suggesting that it may be unwise for countries to recalibrate their tax systems along the lines of Pillar One if the United States does not implement it); and Andrew Velarde and Stephanie Soong Johnson, “Senate Republicans Attack Treasury for Pillar 2 Surrender,” 105 Tax Notes International 953, February 18, 2022 (in relation to Pillar Two, Professor Wei Cui sees a bigger challenge for Canada if the pillar is widely adopted without United States participation than if the pillar was simply not widely adopted). We briefly discuss below other reasons the Inclusive Framework might choose to not implement Pillar One without the participation of the United States.
5. The US Treasury has historically preferred bilateral tax arrangements, presumably because dealing with a single counterparty is manageable and an entire treaty network is not disrupted if the United States determines it needs to make changes in response to local or regional events. The United States declined to sign the multilateral instrument associated with the BEPS Project (which would have modified the taxing rights in bilateral tax treaties) but did sign the OECD’s Convention on Mutual Administrative Assistance in Tax Matters (which does not modify taxing rights).
6. See the Letter from Republican Members of US Senate Committee on Finance to Secretary Janet Yellen, December 22, 2021, which expresses concern with the lack of detail about Pillar One’s underlying approach and open design features and asserts that any multilateral tax agreement must get the advice and consent of two-thirds of the Senate. Secretary Yellen had earlier made statements suggesting that the Biden administration may be able to bypass Congress in implementing Inclusive Framework measures, which agitated these members, some of whom presumably feel that the Secretary deviated from statements made during her confirmation process. See Dr. Janet Yellen, Responses by Dr. Yellen to Finance Committee Questions for the Record, Hearing on the Nomination of Dr. Janet Yellen, US Senate Committee on Finance, January 21, 2021, in which Senator Grassley questions 16 and 17. See also R. Goulder, “Pillar 1 or Bust: Article II Ratification Is for Losers,” 104 Tax Notes International 471, October 25, 2021. These same senators have also chastised the US Treasury regarding its approach to Pillar Two matters. See the Letter from Republican Members of US Senate Committee on Finance to Secretary Janet Yellen, February 16, 2022. More recent statements from the US Treasury suggest that it is now more aligned with the view that Pillar One implementation will require bipartisan legislative support. See Stephanie Soong Johnston, “US Fully Committed to Pillar 1 Implementation, Grinberg Says” 105 Tax Notes International 1076, February 28, 2022 (US Treasury official is quoted as stating, “We fully believe that a pillar 1 instrument can move through the U.S. Congress and…that consultation is necessary in order to make that happen”).
7. See, for example, Velarde and Johnston (prominent international tax scholar believes that “thinking about US participation in BEPS 2 is frankly not even on the front burner in Congress” as of late February 2022).
8. As of this writing, public consultations regarding the following elements have concluded: 1) nexus and revenue sourcing rules for Amount A (February 4 to 18, 2022); and 2) tax base determinations for Amount A (February 18 to March 4, 2022). Building blocks relating to Amount B and the text of a Pillar One treaty had not yet been released.
9. The G20 Finance Ministers and Central Bank Governors nonetheless reaffirmed a commitment to this timetable in mid-February following meetings in Jakarta, Indonesia.
10. See, for example, Andrus and Collier, 548 (attempts by tax authorities to apply the term “value creation” in post-BEPS transfer pricing audits illuminated the inadequacy of the technical work done to articulate the concept and the significant divergence in understanding among tax authorities as to the meaning and importance of the concept).
11. Tax professors and public service professionals have long advocated for the use of multilateral tax instruments to police tax avoidance opportunities that arise from discontinuities in international tax law (for example, in source rule issues). See, for example, E. Kleinbard, “Stateless Income’s Challenges to Tax Policy,” 68 Tax Notes 499, October 29, 2012, at footnote 47 (citing Michael Graetz as advocating for a multilateral treaty for apportioning interest); Victor Thuronyi, “International Tax Cooperation and a Multilateral Treaty,” Brooklyn Journal International Law 26, no. 4 (2001). For other commentators, a multilateral tax instrument may serve as a pragmatic solution for resolving transfer pricing disputes or addressing a divergence in views among countries in relation to novel or complex matters. See, for example, R. Reinhold, “Some Things That Multilateral Tax Treaties Might Usefully Do,” 57 Tax Lawyer 661 (Spring 2004), concerning a potential solution in e-commerce space; M. Schadewald and T. Kaye, “A Look at the Source of Income Rules and Treaty Relief from Double Taxation Within the NAFTA Trading Bloc,” 21 Tax Notes International 1063, September 4, 2000 (limited multilateral tax treaty to address differences in treatment of compensation and benefits packages among NAFTA countries); and D. Wickham and C. Kerester, “New Directions Needed for Solution of the International Transfer Pricing Tax Puzzle: Internationally Agreed Rules or Tax Warfare?” 56 Tax Notes 339, July 20, 1992, which argues that a multilateral treaty with unified rules and a robust dispute resolution mechanism is a more efficient way to resolve global transfer pricing matters.
12. For instance, even the recent BEPS multilateral instrument did not allocate taxing rights to the same degree envisaged by a Pillar One treaty. While the BEPS multilateral instrument did allocate taxing rights by updating existing bilateral tax treaties, countries were able to select how the update would operate in practice and the bilateral nature of relationships was maintained. In contrast, a Pillar One treaty contemplates multilateral relationships, and any option to electively determine whether taxing rights are allocated presumably would render the Pillar One approach ineffective.
13. Technical work relating to tax certainty and dispute settlement mechanisms has suffered from underinvestment and a lack of attention over the years. For instance, initiatives like BEPS Action 14 seem to regularly take a back seat to efforts that promise to give tax authorities greater leverage over MNEs (Pillar One included). See, for example, Andrus and Collier, 548 (“while some improvements were made in the mechanisms for resolving disputes, those improvements fell substantially short of creating a system in which taxpayers and tax administrators could be confident that transfer pricing controversies would be resolved expeditiously and with confidence that consistent and principled outcomes could be achieved”). This trend of disinvesting in matters important to taxpayers has not abated, and concerns were expressed in late 2021 regarding a lack of community engagement regarding open design features of Pillar One. See, for example, Letter from William H. Morris, Chair of the Business at OECD Committee on Taxation and Fiscal Affairs, to OECD’s Task Force on the Digital Economy and Working Party 11 (November 16, 2021) (expressing “significant concern” with lack of formal and informal engagement since January 2021, a concern that “this current process will not lead to administrable outcomes” and identifying dispute resolution as foundational to Pillar One’s implementation) and Letter from Republican Members of US Senate Committee on Finance to Secretary Janet Yellen, December 22, 2021 (expressing concern with lack of detail regarding Pillar One’s underlying approach and open design features that could materially impact US enterprises, including open issues related to dispute resolution measures). As the world starts to shift toward multilateralism, it is the paucity of work done in relation to tax certainty and dispute resolution measures—particularly given the decades of academic advocacy in favor of tax multilateralism—that is most troubling. See note 11 above.
14. Because of the anticipated scope creep associated with Amount A, this arguably is of interest to all MNEs (not solely those that are in scope today). Design failures in the implementation of this first step toward formulary apportionment will linger as the Amount A parallel international tax system slowly evolves into the dominant international tax system.
15. Although bilateral treaties normally do not establish rules that guarantee that countries will abide by agreements reached and reflected in such treaties, the nature of a multilateral treaty makes such enforcement particularly important to its durability (for example, since there is not simply one country against which diplomatic leverage might be asserted). This may be an area where trade law can inform tax law.
16. See Stephanie Soong Johnston, “US, European Countries Avert Trade War Over Digital Taxes,” Tax Notes Today Global 203-1, October 22, 2021, in which the author suggests that some countries may have been pressured to go along with Pillar One in the near term but may not feel the same when it comes time for implementation. See also Wilkie, 893–895 and 902, concerning a litany of legal issues that might reasonably cause countries to back away from implementation.
17. See, for example, Letter from US Chamber of Commerce to US Treasury Assistant Secretary for Tax Policy Regarding Canadian Proposal to Enact a Retroactive DST (December 8, 2021) (enactment of such a retroactive unilateral measure is directly contrary to spirit and explicit terms of Inclusive Framework agreement signed October 8, 2021); Letter from US Senate Committee on Finance Leadership to US Trade Representative Regarding USMCA Matters (January 12, 2022) (Canada’s proposed DST would subject US companies to targeted, discriminatory taxation, and Canada’s efforts to move forward with a unilateral DST “risk setting a troubling precedent that could undermine years of work by negotiators at the OECD”).
18. “Comments of the Office of the United States Trade Representative (USTR) on Canada’s proposed Digital Services Tax Act,” February 22, 2022, at https://ustr.gov/sites/default/files/USTR%20Cmts%20on%20Canadian%20DST%20Proposal.2022.02.22.pdf. Another possible measure includes the Digital Markets Act, which received initial approval from the EU Parliament in January 2022. The legislation does not contain a digital service tax but attempts to use other requirements, like content moderation, to control US high-tech giants. See Gary Clyde Hufbauer and Megan Hogan, “The European Union Renews Its Offensive Against US Technology Firms,” Peterson Institute for International Economics, February 2022, www.piie.com/sites/default/files/documents/pb22-2.pdf.
19. Bonnie Gerard, “Even Duterte Can’t Get Around the Thorn in China–Philippine Relations,” The Diplomat, December 1, 2021, https://thediplomat.com/2021/12/even-duterte-cant-get-around-the-thorn-in-china-philippine-relations/.
20. Nina M. Hart and Brandon J. Murrill, “The World Trade Organization’s (WTO’s) Appellate Body: Key Disputes and Controversies,” Congressional Research Service, July 22, 2021, https://crsreports.congress.gov/product/pdf/R/R46852.
21. Ibid.
22. See, for example, Jennifer Hillman, “A Reset of the World Trade Organization’s Appellate Body,” Council on Foreign Relations, January 14, 2020, www.cfr.org/report/reset-world-trade-organizations-appellate-body.
23. See, for example, US–Israel Free Trade Agreement, Article 19 (1985); US–Canada Free Trade Agreement, Chapter 18 (1989) (superseded by North American Free Trade Agreement, Chapter 20 (1994), and the US–Mexico–Canada Agreement (USMCA), Chapter 31 (2020)); and US–Korea Free Trade Agreement (KORUS), Chapter 22 (2012).
24. See, for example, Australia–Singapore Free Trade Agreement, Chapter 16 (2003); Comprehensive and Progressive Trans-Pacific Partnership, Chapter 28 (2018).
25. See, for example, USMCA, Chapter 14; KORUS, Chapter 11.
26. See, for example, Agreement Between the United States of America and Japan on Digital Trade (USJDTA) (2019); Singapore–Australia Digital Economy Agreement (2020). The United States has also incorporated a digital trade chapter into USCMA. See USMCA, Chapter 19. Other FTAs contain e-commerce provisions. See US–Singapore FTA, Chapter 14 (2004); KORUS, Chapter 15.
27. The USJDTA, considered part of “phase 1” toward fuller trade liberalization with Japan, does not have DS provisions. An eventual FTA could subject digital trade to binding DS.
28. Wilkie shares this sentiment. See Wilkie, page 895, where he observes that “at this juncture, while the object may be tax, many of the most important questions involve public international law and need to be addressed” and
    “[c]ontributions by knowledgeable public law and trade law practitioners [to] government departments are at least as necessary as those from people fluent in taxation,” and page 902, where he notes that although Pillar One is seen by the OECD as fairly easy to implement, it will touch every aspect of existing international tax law thus leading the professor to ask “[h]ow will it address disputes that involve different but possibly overlapping private and public stakeholders” and observe that Canada’s failed attempt to accommodate international financial reporting standards is a cautionary tale regarding the difficulty of trying to integrate parallel regimes.
29. See, for example, Wilkie, 891, 893–94, and 902.
30. WTO members, for example, have also adopted recommendations and guidance to facilitate the national implementation and enforcement of various agreements. See, for example, World Trade Organization Committee on Sanitary and Phytosanitary Measures, “Recommended Procedures for Implementing the Transparency Obligations of the SPS Agreement (Article 7),” G/SPS/7/Rev. 4, June 4, 2018, https://docs.wto.org/dol2fe/Pages/SS/directdoc.aspx?filename=q:/G/SPS/7R4.pdf&Open=True.
31. See, for example, Wilkie, 902; Andrus and Collier, 550–552.
32. Notwithstanding the fact that the civil law tradition is well represented within the Inclusive Framework, matters such as decision transparency and precedent might positively contribute to the Pillar One DS architecture. See D. Wickham, Written Statement at Public Hearing Before the US Senate Committee on Governmental Affairs Regarding Possible New Directions for Dealing with Techniques for Apportioning International Business Income, March 25, 1993, Tax Analyst Doc. 93-3827 (Professor Wickham advocated for a multilateral treaty with binding DS mechanisms and argued that in that context, the decisions [or lack thereof] of authorities, and any associated reasoning, should be made public as
    “[s]unshine can be therapeutic. It imposes a certain discipline on all concerned”). Of course, trade secrets and other competitive or business-sensitive information would need to be fully safeguarded in the process.
33. See T. Field, “International Tax Policy Conference in New York Focuses on ‘Flawed Miracle,’” 21 Tax Notes International 2341, November 20, 2000, whereby a panel of distinguished international tax experts discusses relevance of international bodies in context of theoretical adoption of a multilateral tax treaty; and Wilkie, 891 (noting that the Pillar One white paper implies that the OECD itself might play a pivotal adjudicative role).
34. Countries could also resort to equivalent non-taxation measures, such as the EU’s proposed Digital Markets Act. See note 18 above. By way of analogy, a WTO member may offer very low bound tariffs for agricultural goods but impose stringent food safety standards that render market access more difficult.
35. See, for example, Appellate Body Report, Korea—Taxes on Alcoholic Beverages, WT/DS75/AB/R (January 18, 1999); Appellate Body Report, Philippines—Taxes on Distilled Spirits, WT/DS403/AB/R (December 21, 2011); Appellate Body Report, Japan—Taxes on Alcoholic Beverages, WT/DS8/AB/R (October 4, 1996); Appellate Body Report, Chile—Taxes on Alcoholic Beverages, WT/DS87/AB/R (December 13, 1999).
36. GATT 1947, Arts. I (MFN), III (National Treatment); GATS, Arts. II (MFN), XVII (National Treatment). The issue of whether a digital product is a “good” or “service” is beyond the treatment of this article, but in any event, similar WTO protections apply to both types of products.
37. GATS contains an explicit exclusion related to income taxation. Under Article XXII:3,“A Member may not invoke [national treatment] . . . with respect to a measure of another Member that falls within the scope of an international agreement between them relating to the avoidance of double taxation.” Overall, the applicability of WTO rules to direct income taxation has been the subject of much debate. WTO members have argued that direct forms of taxation, such as a national income tax, fall outside the scope of national treatment disciplines. However, others have taken the view that national treatment and other disciplines cover income taxes. See, for example, Vincent M. Beyer, “Income Tax in the WTO—Substantive Reach and Rivaling Proceedings,” CTEI Working Papers, April 2016, https://repository.graduateinstitute.ch/record/294788/files/CTEI-2016-04-Beyer.pdf, and Michael Daly, “The WTO and Direct Taxation,” WTO Discussion Paper No. 9, June 2005, at www.wto.org/english/res_e/booksp_e/discussion_papers9_e.pdf. See also Appellate Body Report, US-FSC, WT/DS/AB/R, paragraph 90 (adopted March 20, 2000). A WTO challenge to a corporate tax decision by a national tax authority pursuant to Pillar One would present novel issues beyond the scope of this paper.
38. A dispute concerning a tax on specific sales of goods or services, like a DST or equivalent measure, would resemble the type of tax that is normally subject to WTO DS and would be far less complicated than a direct challenge to a corporate income tax decision.
39. By way of example, the dispute by Brazil against the United States in Upland Cotton, WT/DS267, took twelve years (2002–2014) between complaint and mutually agreed-upon solution.
40. See DSU, Article 22.
41. Under the WTO Joint Initiative on E-Commerce, over eighty members are involved in plurilateral negotiations toward a digital trade agreement. Many contentious issues separate the parties, including cross-border data flows, and it is unclear whether the final text will include digital taxation provisions and how ambitious they would be.
42. For a comprehensive list of US FTAs and final texts, see https://ustr.gov/trade-agreements/free-trade-agreements.
43. KORUS, Chapter 15.3.1 note 1.
44. See KORUS, Article 23.3.
45. “Termination of Actions in the Section 301 Digital Services Tax Investigations of Austria, France, Italy, Spain, and the United Kingdom and Further Monitoring,” 86 Federal Register at 64,591.
46. Ibid.
47. For a current list of all US BITs, see https://tcc.export.gov/Trade_Agreements/Bilateral_Investment_Treaties/index.asp.
48. Digital service-related taxation raises some particularly interesting questions under ISDS. For instance, MNEs may have limited physical investments in a country that imposes discriminatory taxes on a revenue basis; however, given the relatively loose interpretation of “investor” it is possible that an action based on claims of discrimination could be available to an aggrieved MNE with sales offices or other minimal local presence. Moreover, BITs generally carve out tax matters in deference to bilateral tax treaties—although discriminatory action may still provide a cause of action.
49. Cairn Energy PLC invoked the UK–India BIT in the Permanent Court of Arbitration in The Hague (PCA), asserting that India’s 2012 retrospective amendment of its Income Tax Act of 1961 (that is, after the India Supreme Court ruled in favor of global telecom giant Vodafone in its indirect transfer tax dispute) amounted to a gross violation of the fair-and-equitable treatment provisions of the BIT. In December 2020, the PCA issued a lengthy unanimous opinion finding India in breach of the BIT and awarding Cairn more than $1.2 billion in damages, interest, and costs. Cairn Energy subsequently sought to enforce the award in French and US courts. In the US courts, Cairn Energy argued that Air India was the alter ego of India and as such its US assets were available to secure the PCA award. In July 2021, a French court moved to secure certain India-owned property in Paris for potential satisfaction of the award. In August 2021 the India government took steps to reverse the 2012 tax law changes and in December 2021, after reaching an agreement with India, Cairn Energy voluntarily dismissed its action in the US courts. For more detail regarding the Cairn Energy case, see, for example, Michael Smith, “Cairn Energy to Drop Suits, Receive $1 Billion Indian Tax Refund,” 105 Tax Notes International 357, January 10, 2022.
50. See 19 U.S.C. Sections 2461 et seq. GSP expired on December 31, 2020. Renewal is pending in Congress and is likely to occur in 2022.
51. 19 U.S.C. Section 2462(c)(4), (6) & (d). Congress is considering the addition of digital trade eligibility criteria to the program. See, for example, Bret Fortnam, “Wyden Introduces Trade Preference Bill With New GSP Conditions,” Inside US Trade, May 18, 2021, https://insidetrade.com/daily-news/wyden-introduces-trade-preference-bill-new-gsp-conditions.
52. See African Growth and Opportunity Act, 19 U.S.C. Sections 2466a et seq.; Caribbean Basin Economic Recovery Act (CBERA), as amended by the Caribbean Basin Trade Partnership Act (CBTPA) (also known collectively as Caribbean Basin Initiative), 19 U.S.C. Sections 2701 et seq.
53. See, for example, USTR, “USTR Announces GSP Enforcement Action, Country Successes, and New Eligibility Reviews,” Press Release, October 30, 2020, leases/2020/october/ustr-announces-gsp-enforcement-action-country-successes-and-new-eligibility-reviews; and USTR, “Fact Sheet: Obama Administration Actions Open South African Market to US Agriculture,” March 2016, https://ustr.gov/about-us/policy-offices/press-office/fact-sheets/2016/march/fact-sheet-obama-administration-actions.
54. A Pillar One “failure” that involves widespread adoption of Pillar One by countries other than the United States may pose a particular risk for non-US MNEs. For instance, in such a scenario one could envisage the United States rewriting its domestic laws regarding “effectively connected income” to apply Pillar One-type concepts to non-US MNEs seeking access to the US market. Given the size of the US market, this possibility may mean that from a practical perspective Pillar One requires US participation to succeed.