This article is written by Justin Cherrington, Jerome Tse and Amanda Kazacos with input and thanks to Tony Dong, Markus Hill, Jun Kang and Alberto Ruano
This is the third alert in the KWM series considering the future of the OECD Pillar One and Pillar Two initiatives.
On 1 July 2021, the OECD / G20 Inclusive Framework on Base Erosion and Profit Shifting issued a statement that agreed to the Pillar One and Pillar Two initiatives with a detailed implementation plan (together with remaining issues) to be finalised by October 2021 (OECD Statement). This marks agreement by 133 countries to implementing a truly multinational plan to tax in market/user jurisdictions (Pillar One) and implement or accept implementation by other states of a global minimum tax (Pillar Two), with a commitment to implement these tax reforms by 2022 (with effect from 2023).
This article highlights the broad changes made by the OECD Statement to the October 2020 Pillars Blueprint (see KWM alert) and outlines some key areas where clarity is still required for the implementation of Pillar One and Pillar Two.
While the consensus of 133 countries is commendable, the changes and concessions made by the OECD Statement from the Pillars Blueprint raise the question of whether the cost of consensus was too high. In addition, it is too early to applaud the consensus with the volume of technical issues required to be resolved in ascertaining whether and how Pillar One and Pillar Two will apply to each relevant jurisdiction.
The most significant changes to Pillar One (being the initiative to tax services companies in the jurisdiction in which they offer their services (the “market jurisdiction”)) are the divergence from a “digital services tax” to a broad based tax as well as the significant increase in global turnover for Pillar One to have application for a global entity.
More specifically, Pillar One now applies to all multinational enterprises and is not limited by sector (although the extractive and regulated financial services industry is excluded). However, for Pillar One to apply to a multinational entity, the entity must have a global turnover of more than €20 billion (a significant increase from the original threshold of €750 million) and must have pre-tax profit margin/ profitability over 10%.
This divergence from the original aim of Pillar One, being to target base erosion and profit shifting arising from the digitalisation of the economy, identifies the costs of achieving consensus of Pillar One. The increased global turnover threshold combined with the application of Pillar One to most industry sectors seems to have been formulated as a compromise to the opposing views of major G20 countries on the application of Pillar One, namely the United States and United Kingdom. The United States originally advocated for Pillar One to be limited to the 100 largest multinational companies with sectorial carveouts eliminated. However, the United Kingdom was strongly in favour of sectorial carveouts, particularly the retention of the regulated financial services exclusion, and the retention of the exclusion for this sector would have been key at achieving the United Kingdom’s support. Minimising the sector carveouts and increasing the global turnover required for Pillar One to apply, shows the evolution of Pillar One from a targeted multinational tax fundamentally aimed at automatic digital services businesses to a broad-brush tax on the largest multinational enterprises, in order to garner support from the G20 jurisdictions.
The threshold and excluded sectors in the revised statement on Pillar One should result in Australian multinational enterprises not initially being affected by Pillar One. However, Pillar One may have an impact on Australian multinational enterprises (particularly in the technology industry) if and when the global threshold is revisited in later years (expected to be seven years from implementation of Pillar One).
A significant step forward in the implementation of Pillar One, is the consensus reached surrounding the quantum of Amount A (being the residual profits allocated to the market jurisdiction) and relevant nexus to the market jurisdiction. Profits in excess of 10% of revenue are “residual profits” of which 20-30% will be allocated to the market jurisdiction. In addition, the allocation of Amount A to a market jurisdiction will only be enlivened when the in-scope multinational entity derives at least €1 million in the jurisdiction (for jurisdictions with a gross domestic product of less than €40 billion, the nexus required is only €250 000).
While this is a positive step forward, there are still a range of technical issues that require solving. By way of example,
- while the revenue is sourced to the “end market jurisdiction where the goods or services are used or consumed”, what is the relevant good or service, as many goods and services contain a range of inputs that themselves are products within their own “end market jurisdiction”.
- while the United States advocated safe harbour remains with respect to Amount A (i.e. to cap residual profits in the market jurisdiction where there are already sufficient residual profit in that market), no technical work has been done to design this safe harbour and determine the appropriate level of the cap and reduce the incidence of double taxation.
- Pillar One will require dispute resolution processes to ensure no double taxation of Amount A. However, there has not been resolution of the application of dispute resolution procedures in developing jurisdictions that do not have the relevant systems to operate these types of disputes.
The Pillar Two rules consist of certain domestic rules that impose top-up tax on a parent entity (in respect of low taxed income of constituent entity) (Income Inclusion Rule) and denial of deductions / adjustment to the extent the low tax income is not subject to tax under the Income Inclusion Rule (Undertaxed Payment Rule). The minimum tax rate used for the GloBE rules will be 15%. In addition, the subject to tax rule will apply where the payment is not subject to minimum tax in the recipient jurisdiction, where the minimum rate will be from 7.5% to 9%.
The OECD Statement provides that the Global anti-Base Erosion Rules (GloBE) rules will not be required to be mandatorily adopted, but where adopted, they must be consistent with outcome under the GloBE rules. In addition, Inclusive Framework members should accept the application of the GloBE rules by other jurisdictions, irrespective of whether it implements the rules. This non-mandatory approach to Pillar Two would seem to be a concession to ensure United States approval of Pillar Two, by seemingly allowing the US to keep its global intangible low-taxed income (GILTI) rules as well as their base erosion and anti-abuse tax (BEAT) measures domestically in play.
The threshold will be multinational enterprises that meet €750 million threshold (but the Income Inclusion Rule can be implemented in respect of any multinational enterprise headquartered in that jurisdiction regardless of whether the quantum threshold is met).
The OECD Statement itself highlights the early stages of development of a workable Pillar Two, being an indication of “the ambition” of the members for a robust global minimum tax. However, there is no practice guidance as to the application of the proposed rules. By way of example, the OECD Statement confirms that the GloBE rules use a “common definition of covered taxes and a tax base determined by reference to financial accounting income” to ensure consistency. However, there is no explanation of how adjustments will be determined, how timing differences will be managed or whether tax inputs will be integrated in considering application of Pillar Two (i.e. tax losses). There is no doubt that the compliance costs in implementing Pillar 2 will be substantial. Inclusive Framework members will need to carefully consider how to best reduce the burden on multinationals enterprises subject to Pillar 2, and we would encourage broad engagement with the tax, accounting and industry more generally. Questions about whether existing global disclosures such as CbCR reports or audited statutory accounts can be used or modified to satisfy Pillar 2 should, in particular, be explored.
The OECD/G20 Inclusive Framework on BEPS consists of 139 members. While some members (including Ireland, Hungary, Kenya) did not participate in the OECD Statement, this is the largest consensus reached by an OECD initiative. However, the two Pillars will be practically difficult to implement without consensus by all countries. For example, will there be legal or practical difficulties implementing the Pillars within the European Union if Ireland doesn’t change its stance?
The OECD Statement marks an important shift in international tax, from the OECD BEPS project in 2014/2015 which saw limited mutual agreement and implementation of unilateral taxing regimes, to the first step in truly multinational tax cooperation. However, this consensus has come at a cost of amending the Pillar One and Pillar Two initiatives to ensure cooperation of notably the United States and United Kingdom, so the question must be raised, was the consensus worth the concessions? In addition, while the OECD Statement is a step forward, the real assessment of success will not be ascertainable until the technical issues surrounding whether and how Pillar One and Pillar Two will apply to each relevant jurisdiction, are resolved.
For further detail on the Pillar One and Pillar Two initiatives we encourage you to contact us directly.