Moving forward with the OECD’s two-pillar solution
The countries that comprise the OECD/G20 Inclusive Framework on base erosion and profit shifting (BEPS) agreed the OECD’s proposed two-pillar solution. This could bring about significant changes to the international tax landscape as early as 2023.
The OECD believes that around $125bn of profits will be reallocated for tax purposes annually to countries worldwide as a result of the pillar one measures. An additional $150bn per year in new global tax revenues is expected to arise from both pillars combined.
The purpose of the two-pillar solution is to stabilise the international tax system and increase tax certainty for taxpayers and tax administrations. The OECD believe this is a fair and equitable solution. But what are the proposed pillars?
Pillar one proposes that where multi-national enterprises (MNEs) generate a profit before tax in excess of 10% of their total revenues, taxing rights over 25% of that excess profit will be re-allocated to the jurisdictions where the customers of those MNEs are located.
MNEs with global revenues greater than €20bn will be within scope of these new rules. The threshold is expected to be reduced to €10bn but this is contingent on successful implementation. This includes tax certainty on Amount A, with the relevant review beginning 7 years after the agreement comes into force, and the review being completed in no more than one year.
Some developing countries have voiced concerns that the pillar one measures could favour the larger global economies. However these will be countered through the use of elective regimes and the establishment of a simplified and streamlined approach to the application of the arm’s length principle in specific circumstances.
The tax compliance obligations arising in respect of pillar one will be rationalised to enable the reporting process through a single entity. The permanent removal of all digital services taxes (and other relevant similar measures) will also be implemented under pillar one.
A continued point of contention with pillar one has been reaching a consensus for the calculation of ‘Amount B’. Amount B involves the application of the arm’s length principle to in-country baseline marketing and distribution activities. The two-pillar solution agreement documents confirm that the calculation methodology will be simplified and have a particular focus on the needs of low-capacity countries. But currently it is still “watch this space” on Amount B.
The purpose of pillar two is the new global anti-base erosion (GloBE) rules which will provide for a global minimum tax rate of 15% on all in-scope MNEs. There was a lot of news headlines on this following the G20 Summit over the Summer.
MNEs that meet the €750m turnover threshold that applies for country by country reporting will be within scope of pillar two. The rules will also provide for specific temporary exclusions for businesses in the initial phase of international activity and for jurisdictions to adopt de minimis exclusions for low revenue and profit levels in defined circumstances.
The minimum tax rate may end the culture of corporate income tax rate cuts of recent years, but the OECD also stresses that ending other competition between tax authorities is not its intention. We will have to wait to see whether this will result in a explosion of new tax reliefs to reduce the level of profits subject to the minimum rate of 15%.
Pillar two will also introduce a new treaty-based rule that will require all Inclusive Framework jurisdictions, when requested to do so, to apply a ‘subject to tax rule’ (STTR) in their bilateral tax treaties. This will allow paying jurisdictions to charge withholding tax on cross border payments of interest, royalties and other defined payments that are taxed below 9% in the recipient jurisdiction. This provision is designed to protect the rights of developing countries to tax these payments if they are not already subject to tax at the minimum rate of 9%.
With 137 of the 141 members of the OECD/G20 Inclusive Framework signing up to the two-pillar solution agreement, it certainly suggests that the OECD is building a consensus and changes are on the way.
However, in order to implement these changes, member countries will need to introduce the legislation necessary to enshrine the solution on a consistent global framework. This consistency of implementation will be essential to provide MNEs within the scope of these new rules with the certainty that the OECD foresees.