Pillar One & Pillar Two

The OECD’s proposals to reform the international tax system under Pillar 1 and Pillar 2, taking in the progress made by the G7, G20 and the OECD’s 139 country strong Inclusive Framework.

The OECD/G20 Inclusive Framework on Base Erosion and Profit Shifting (BEPS) recently endorsed the key components of the two-pillar approach to International Tax Law. The agreement has set an ambitious and challenging timeline for both Pillars and whatever the final rules, most global businesses of any scale are likely to be impacted.

Pillar One: Nexus and profit allocation rules

Pillar One focus on the largest multinational groups focusing initially on those with at least EUR 20 billion of consolidated revenue and net profits of over 10% (i.e., profits before tax to revenue) and will require them to pay tax in the locations where their customers and users are located. A formulaic approach will be used to allocate a percentage of profits between each jurisdiction. Pillar One should effectively require in scope multinationals to pay at least some tax in the markets they interact with.

• Revisits profit allocation and nexus rules for in-scope groups

• Effectuates the view that a portion of an in-scope group’s residual profit (likely to be generated by capital, risk management functions, and/or intellectual property) should be taxed in the end-market jurisdictions where goods or services are used or consumed

• Will apply to groups with greater than €20 billion in worldwide revenues and a profitability before tax margin of at least 10 percent calculated using an averaging mechanism (the intention is to reduce the revenue threshold to €10 billion after seven years, contingent on successful implementation)

• Will allocate profits to market jurisdictions irrespective of any physical presence in those jurisdictions.

 Amount A:

• New taxing right allocates 25 percent of profits in excess of 10 percent of revenue to market jurisdictions based on a formula, not the arm’s-length principle.

• The allocation key is based on the revenue that is sourced (via to-bedeveloped sourcing rules) to each jurisdiction, but only jurisdictions that are allocated at least €1 million in revenue would receive an allocation (reduced to €250,000 for jurisdictions with GDP less than €40 billion).

• When the residual profits of a group are already taxed in a market jurisdiction, a marketing and distribution profits safe harbor (which may also apply to a broader set of activities) will cap the residual profits allocated to the market jurisdiction.

• Measures to eliminate double taxation and to provide tax certainty are being developed.

Amount B:

• The development of standard remuneration for in-county “baseline” marketing and distribution activities has been deferred pending further technical work, which is expected to be completed by the end of 2022.

What businesses should know: 

• These changes may affect groups around the globe, and despite simplification compared to previous proposals, remain technically complex.

• Digital services taxes and other similar measures would be repealed under the agreement (and there is a moratorium on new measures), but identification and timetable are not yet clear.

• Scope of covered businesses has moved far from the originally targeted highly digitalized business models; extractives and regulated financial services are exempt, but other industries are generally in scope.

• This provided more certainty with respect to Pillar One, but many details remain outstanding.

• Meant to finalize a new multilateral convention to implement Pillar One in early 2022, however the OECD has recently acknowledged that Pillar 1 implementation would not be ready before 2024.

More at: https://www.oecd.org/tax/beps/pillar-one-amount-a-fact-sheet.pdf

Pillar Two: Global minimum tax

Pillar Two, the key components of which are commonly referred to as the “global minimum tax” or “GloBE”, introduces a minimum effective tax rate of minimum 15%, calculated based on a specific rule -set. Groups with an effective tax rate below the minimum in any particular jurisdiction would be required to pay top-up tax in their head office location or in the location of other affiliates. The tax would be applied to groups with revenue of at least EUR 750 million, making it far more widely applicable than Pillar One.

According to the initial timeline released by the OECD, these rules would become effective in 2023, with the exception of the UTPR which would become effective in 2024. While EU Member States are working to reach agreement on the rules. Some countries, e.g., the UK and South Korea, have drafted domestic legislation, while others have initiated public consultations. Many countries have stated the need to push back the effective dates to 2024 and 2025, respectively. Given the enormity of the task ahead this is expected and welcome. However, many multinationals already are subject to Pillar Two, since the transition rules capture certain transactions occurring on or after November 30, 2021.

A number of uncertainties remain, but Pillar Two is likely to be a radical shift in the tax landscape.

More at: https://www.oecd.org/tax/beps/tax-challenges-arising-from-the-digitalisation-of-the-economy-global-anti-base-erosion-model-rules-pillar-two.htm

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