Tax News & Views International Weekly: Pillar Two and the Data Surge

For more than a decade, one of the foundations of international tax reform efforts has been the notion that tangible physical assets ought to be paramount when allocating income.

That makes sense when it’s a factory. But what about a data center?

The surging growth in server farms and data centers, powering new artificial intelligence technologies and other applications that require massive, lightning-fast computations, is disrupting politics in the United States and around the globe. As voters express concerns about potential negative effects, lawmakers have been calling for ways to slow the buildout. They’ve also questioned whether tax policies such as bonus depreciation or research and development incentives are boosting the trend.

But how will it affect international taxes? The rules for the Organization for Economic Cooperation and Development’s Pillar Two global minimum tax, as well as the “side-by-side” agreement released in January, encourage countries using incentives to lure investors to include requirements for substance, defined as employees and depreciable tangible assets. This grows from the principle, until recently a bedrock of the U.S. system, that high income with the absence of significant substance was a likely indicator of profits artificially shifted for tax avoidance.

If lawmakers are scrutinizing tax breaks that seem to be assisting a trend they feel has spun out of control, the Pillar Two substance requirements could be next on the list.

On the other hand, data centers do require comparatively fewer employees, so their payroll costs may be lower than would be expected for other facilities. Given the money pouring into data center construction and use, it’s possible these facilities could trigger Pillar Two taxes even if they aren’t using local incentives or aggressive tax planning.

And from a policy standpoint, what type of return should these facilities receive? Due to technological constraints (including that information cannot travel faster than the speed of light), data centers are often located near the paying users—but not always. In cases where the data center’s jurisdiction is separate, how much of that revenue is it entitled to? If a data center is involved in developing new intellectual property, would it satisfy the OECD’s requirements that an IP-based return must be justified through substantive activities such as development or maintenance?

Data centers themselves aren’t new, but the explosion in interest is creating new dynamics that are tricky to define. And this is demonstrating that one of the few constants in international tax policy is how quickly economic changes can threaten to make the rules out of date.

Noteworthy Items This Week

Some African Nations Use U.N. Plenary to Push Tax Cooperation – Sarah Paez, Tax Notes ($):

Sierra Leone and Uganda specifically mentioned their support for a U.N. framework convention on international tax cooperation, which is currently under negotiation in committee. Delegates must produce a final text and present it to the General Assembly by the second half of 2027. The General Assembly approved the terms of reference for the framework convention — which is considered the blueprint for the international agreement — in December 2024.

“An inclusive international tax system is critical for strengthening global cooperation, curbing illicit financial flows, and addressing profit shifting by multinational corporations,” Ugandan Vice President Jessica Alupo said September 23.

Democratic Republic of Congo Prime Minister Judith Suminwa Tuluka said September 23 that countries must cooperate to combat “illicit financial flows, tax evasion, transfer pricing manipulation, and the laundering of revenue from natural resources.” The Gambia also pushed for “decisive action against illicit financial flows.”

Belgian Court Ruling Leaves EU Minimum Tax Compliance in Limbo – Jan Stojaspal, Bloomberg Tax ($):

By allowing the challenge by US business groups to continue, the Sept. 24 ruling leaves open the question of whether the EU minimum-tax framework will withstand scrutiny by the Court of Justice of the European Union or require substantial changes, according to tax practitioners.

“Companies should not have to plan investment and operations around a tax mechanism whose compatibility with fundamental EU legal principles remains unresolved,” said Jeffery P. Langer, chair of the Kentucky Association of Manufacturers’ Legal Affairs Council.

The Kentucky Association of Manufacturers is one of the business groups that joined the American Free Enterprise Chamber of Commerce in seeking to annul parts of Belgium’s minimum tax law that implement the so-called undertaxed profits rule.

What Comes Next In the Trump Trade Wars: Supply Lines – Shawn Donnan, Bloomberg Tax ($):

The big takeaway from last week’s Washington summit between Donald Trump and Xi Jinping was that it was heavy on pageantry and light on substance.

That’s invited all sorts of comparisons and analysis.

Stephen Roach, the former Morgan Stanley Asia chairman, dubbed it “America’s first vanity summit.” Hoover Institution visiting fellow Matt Turpin turned to Victor Hugo and the awkward significance of the Les Misérables songs performed at the state dinner. Author and analyst James Crabtree invoked Goodfellas and Wolf Hall. Richard Fontaine of the Center for a New American Security observed there were “more military flyovers than substantive agreements.”

AI May Require EU to Rethink Tax Policy, Central Bank Chief Says – Bengt Ljung, Tax Notes ($):

“Inequality is a really important aspect of what AI will produce and how the gains will be redistributed,” Lagarde said, adding that this wasn’t directly a question for central banks but for governments and parliaments.

However, there is currently more hiring than firing of workers because of AI, Lagarde said.

“If there is more replacement [of workers] than strict enhancement, it will require us to rethink the base on which tax is levied. Displacement or enhancement will have consequences both at the public level for tax authorities to think it through, and at the corporate level for training programs to be financed,” Lagarde said.

Asian Governments Use Tax Policy to Capture Tourism Value – Bart Schaneman, Tax Notes ($):

In an interview with Tax Notes, OECD Head of Tourism Jane Stacey said she has seen a heightened focus on tax policy in countries with an influx of visitors because tourism “relies on a lot of public infrastructure and a lot of services.”

However, even as visitor numbers rise and governments consider how to finance these costs, Stacey said that “the evidence is limited at the moment on how these taxes may be limiting demand.”

Similarly, the Danish tourism consultancy Group NAO has found limited evidence that tourism taxes significantly affect visitor numbers. Indeed, group co-founder Peter Hansen told Tax Notes, “We haven’t found any evidence that it’s slowing demand.”

Public Domain Superhero of the Week

Every week, a new character from the Golden Age of Comics, who’s fallen out of use.

This week’s entry: The Moth

Debut Year: 1940

Debut Publication: Mystery Men Comics #9

Origin Story: Unknown.

Superpowers: It's unclear where they come from, but he can fly with giant, moth-like wings.

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