Pascal Saint-Amans, Director, Centre for Tax Policy and Administration, OECD gives an overview of the ‘Statement on a Two-Pillar Solution to Address the Tax Challenges Arising from the Digitalisation of the Economy’.
On 1 July 2021, the OECD/G20 Inclusive Framework on Base Erosion and Profit Shifting (Inclusive Framework) released the historic ‘Statement on a Two-Pillar Solution to Address the Tax Challenges Arising from the Digitalisation of the Economy’, which laid out the key elements of a new global tax system.[i] As of 4 August 2021, 132 out of the Inclusive Framework’s 139 members, representing over 90 per cent of global GDP, have signed onto the deal, leaving only seven members[ii] not yet having joined the statement.[iii]
This achievement results from years of intensive negotiations and reflects the spirit of compromise and cooperation amongst Inclusive Framework members. In 2015, the Base Erosion and Profit Shifting (BEPS) project had yet to deliver a solution to the tax challenges arising from the digitalisation of the economy with respect to corporate tax issues, despite focusing on the issue under Action 1.[iv] The international community, spearheaded by the G20, resumed work from 2018 with several milestones until now, notably the October 2020 Reports on the Pillar One and Pillar Two Blueprints[v],[vi]. Pillar One modernises outdated rules to ensure a fairer distribution of profits and taxing rights among countries with respect to the largest and most profitable Multinational Enterprises (MNEs). Pillar Two seeks to put a floor on tax competition on corporate income tax (CIT) by introducing a global effective minimum corporate tax that countries can use to protect their tax bases. Pillar Two does not eliminate tax competition but it does set multilaterally agreed limitations on it.
The Biden Administration provided a strong dynamic in April 2021 with a new proposal for Pillar One and endorsement of Pillar Two. The G7 Finance Ministers strengthened the momentum early June with an agreement on some key features of the Two Pillars.[vii] As public support from finance ministers of Germany, Indonesia, Mexico, South Africa, and the US followed days later in the Washington Post[viii], there was growing high-level political support for the main elements of the two-pillar project.
As a result, negotiations intensified in the spirit of compromise and collaboration, leading to the broad support of 132 out of 139 countries obtained in July 2021. The Statement represents a balanced compromise which reflects a diverse group of countries and jurisdictions, large and small, developing and developed. The two-pillar solution contains a number of details on which Inclusive Framework members must still agree. These will be finalised in October 2021, complete with an implementation plan to develop model legislation, guidance, and a multilateral treaty in 2022, with implementation from 2023.
With the globalisation and digitalisation of the economy, MNEs have been able to earn significant income in market jurisdictions without paying tax there, due to century-old rules requiring physical presence to grant a taxing right. New business models that rely heavily on intellectual property like patents and trademarks have made it easier for MNEs to shift profits to low-tax jurisdictions. Pillar One will adapt international tax rules to 21st century business models by allocating some taxing rights to market jurisdictions over a portion of profits generated by the largest and most profitable MNEs, irrespective of their physical presence.
The new rules under Pillar One will apply to MNEs with global turnover of more than €20 billion and a profitability above 10 per cent (i.e. profit before tax/revenue). Pillar One’s broad scope based on turnover, without any distinction on activities, draws from the April 2021 US proposal. The Inclusive Framework agreed on a review for a reduction to €10 billion, contingent on successful implementation including of tax certainty on the new taxing right. The relevant review would begin seven years after the agreement comes into force and would be completed in no more than one year. Extractives and regulated financial services are excluded from Pillar One’s scope. The rationale for excluding regulated financial services is that a significant part of financial services activity is already heavily regulated and requires appropriately capitalised assets in market countries. Accordingly, profits are (already) taxable where customers are.
For in-scope MNEs, between 20 per cent and 30 per cent of the profits above 10 per cent of revenue (defined as residual profits) will be allocated to market jurisdictions where they have sales of over €1 million (or €250k for jurisdictions with GDP under €40 billion). Pillar One is expected to reallocate taxing rights over around US$100 billion annually to market jurisdictions.
The Statement also addresses recent instability in the tax system. The digital tax project has been driven by a need to build consensus and prevent the proliferation of unilateral measures that can escalate to trade wars. Around 40 countries have introduced or announced some unilateral measures, such as digital service taxes (DSTs). As these measures and countermeasures undermine tax certainty, hinder investment, and drive up compliance and administration costs, it is clear that a unified international approach was needed. The issue became particularly problematic due to the friction caused between trading partners. The United States Trade Representative’s office launched so-called “section 301” investigations against Austria, India, Italy, Spain, Turkey and the UK for their DSTs. It found the measures inconsistent with prevailing international tax and trade principles, leading the US to immediately suspend billions of dollars in retaliatory tariffs in June 2021. It had done the same in January 2021 for France’s DST. The suspension of tariffs allowed negotiations to continue and added pressure to finding a consensus solution. Without such solution, up to 1 per cent of global GDP could have been lost to trade wars.
The 1 July 2021 Statement noted, “This package will provide for appropriate coordination between the application of the new international tax rules and the removal of all digital services taxes and other relevant similar measures on all companies”.
Pillar Two draws from the momentum established by the 2017 US tax reform which introduced a minimum tax on US multinationals that paid an effective offshore tax rate of 10.5 per cent on a global basis. It establishes a floor on corporate income tax competition.
Under the Statement, the minimum tax rate used for Pillar Two will be at least 15 per cent. The rules will apply to MNEs meeting a global revenue threshold over €750 million, as determined under BEPS Action 13 on Country-by-Country reporting. Government entities, international organisations, non-profit organisations, pension funds or investment funds that are Ultimate Parent Entities (UPE) of an MNE Group or any holding vehicles used by such entities, organisations or funds will not be subject to these rules.
Pillar 2 will work through two sets of rules: the “GloBE” rules and a treaty-based “Subject to Tax Rule”.
The GloBE rules will have the status of a common approach under which Inclusive Framework members will not be required to adopt these rules but, if they choose to do so, they will have to implement and administer them in a way that is consistent with the outcomes provided for under Pillar Two. In addition, Inclusive Framework members will have to accept the application of the GloBE rules applied by other members including agreement as to rule order and the application of any agreed safe harbours.
Pillar Two is designed with strictly limited carve-outs and exclusions. The GloBE rules will only provide for an exclusion for international shipping income, as defined under the OECD Model Tax Convention. It will also provide a general formulaic substance carve out and a de minimis exclusion. The formulaic substance carve-out will exclude an amount of income equal to at least 5 per cent (in the transition period of five years, at least 7.5 per cent) of the carrying value of tangible assets and payroll.
Pillar Two is expected to bring in around US$150 billion in extra tax revenues annually. The increased CIT revenues will be a boon to pandemic-strained budgets across the world, but may not be equally evident to all governments.
Developing countries have been particularly concerned about Pillar Two’s consequences for tax incentives in place to attract foreign investments. However, Pillar Two does not eliminate tax competition but merely places some multilaterally agreed limits on it. Almost all global financial centres have signed on to the Statement, even though they are likely to feel the impact of Pillar 2 as MNEs react to the impact of a global minimum tax on structures that are designed merely to shift profits away from higher tax jurisdictions. However, financial centres that add value through their infrastructure, networks of expertise, and experience will continue to play a role in the global financial system.
While the details of the proposal will be finalised by October this year, the Statement gives a clear outline of a new global tax system that enhances stability and fairness. As work continues, it is important that all parties remain engaged and represented in the negotiations. The agreed timeline is ambitious with the development of model legislation, guidance, and a multilateral treaty in 2022 and their implementation from 2023.
[ii] Barbados, Estonia, Hungary, Ireland, Kenya, Nigeria, and Sri Lanka
Pascal Saint-Amans is the Former Director of the Centre for Tax Policy and Administration at the OECD. Mr. Saint-Amans, a French national, joined the OECD in September 2007 where he played a key role in the advancement of the OECD tax transparency agenda in the context of the G20. Prior to his appointment as Director, he was the Head of the Global Forum on Transparency and Exchange of Information for Tax Purposes since 2009. Mr. Saint-Amans graduated from the National School of Administration (ENA) in 1996, and was an official in the French Ministry for Finance for nearly a decade.