In October 2021, a significant number of member jurisdictions of the OECD/G20 Inclusive Framework on Base Erosion and Profit Shifting (BEPS) came together to reform global tax rules through a Two-Pillar solution. These reforms, often called BEPS 2.0, seek to tackle the tax challenges arising from the digitalisation of the economy, ensuring that multinational enterprises (MNEs) pay a fair share of taxes where they operate. The first Pillar gives taxing rights over MNEs’ profits to countries where the final users are through Amount A, while Pillar Two introduces a global minimum tax of 15% on MNEs’ profits.
Since initiating the Two-Pillar solution discussions, Pillar Two appears to be progressing toward coming into effect soon, with the EU and about sixteen countries planning to introduce the minimum tax as soon as 2024 and 2025. In contrast, the implementation of Pillar One seems to be paused.
Pillar Two: Imminent Implementation
Starting in January 2024, the EU and ten countries (Switzerland, United Kingdom, New Zealand, Liechtenstein, Japan, Canada, Australia, South Korea, Vietnam, Norway) are expected to adopt the 15 per cent minimum tax on MNEs with revenues of at least 750 million euros. By January 2025, additional countries such as Singapore, Malaysia, Thailand, Jersey, Guernsey, and Hong Kong, are anticipated to follow. Within the EU, member states have the option to postpone the introduction of the minimum tax for six years if they have no more than twelve MNEs in scope of the Pillar 2 Directive.
IIR or QDMTT?
Under Pillar Two, countries have the choice to implement either the Income Inclusion Rule (IIR), the Qualified Domestic Minimum Top-Up Tax (QDMTT), or both. The IIR allows revenues from the top-up tax to be collected by the headquarters country. In contrast, the QDMTT assigns these revenues to the host country. Within the EU, the minimum tax applies not only to foreign profits of EU-based MNEs but also to their domestic profits in the EU. That won’t be the case in other countries, as they won’t necessarily tax the domestic profits of their multinationals.
Together with my co-authors in Baraké et al (2022), we presented country-specific estimates from the global minimum tax under Pillar Two. These estimates, updated and published in the EU Tax Observatory’s Global Tax Evasion Report 2024, suggest that if all countries adopt the 15 per cent minimum tax, global revenues would be around $220 billion, representing about eight per cent of global corporate tax revenues.
The revenue implications under IIR and QDMTT vary from one country to another. A country with a large number of MNEs that are operating abroad in low tax jurisdictions would benefit under IIR. In contrast, for a country to gain from QDMTT, it should host many foreign MNEs taxed below 15 per cent. For example, France could generate $5.53 billion under IIR and merely $0.03 billion under QDMTT, while Luxembourg could see $6.88 billion from IIR and $17.2 billion from QDMTT. In both scenarios, the bulk of profits—around 90 per cent—would accrue to high-income countries. While IIR favours countries with substantial MNEs, QDMTT benefits investment hubs.
Factors Influencing Minimum Tax Revenues
The minimum tax is not a simple 15 per cent top-up tax. Several elements, such as carve-outs, UTPR, and tax credits shape it.
Carve-outs: Substance-based carve-out rules allow for a reduction in the tax base subject to the top-up tax. Carve-outs would subtract from the tax base eight per cent of tangible assets’ carrying value and 10 per cent of payroll (employee compensation). Over a 10-year transition period, these carve-out rates will decline from eight per cent and 10 per cent to reach five per cent each. The rationale behind carve-outs is to target affiliates lacking significant economic activity, while reducing the burden on those affiliates that have substantial economic activity.
Globally, without any carve-outs, revenues from Pillar Two would stand at approximately $269 billion, decreasing to $220 billion in the short term (an 18 per cent reduction) with the carve-out rates of 10 per cent and eight per cent. In the long run, with five per cent carve-outs, the decline would be around 11 per cent. These deductions might incentivise MNEs to relocate employees and assets to low-tax jurisdictions to benefit from effective tax rates below 15 per cent.
UTPR: The Undertaxed Payment Rule (UTPR) allows country A to collect the revenues from the top-up tax from country B if country B has either not implemented Pillar Two or failed to collect the full amount. The amount that country A could collect from country B is based on the number of employees and assets that multinationals of country B have in country A. This mechanism was introduced as a backstop in case IIR and QDMTT are not applied.
The UTPR Safe Harbor currently exempts entities in jurisdictions with a statutory corporate income tax (CIT) rate above 20 per cent from the top-up tax. Therefore, although the US hasn't adopted Pillar Two, other nations cannot apply UTPR on USA MNEs as the USA has a CIT rate of 21 per cent, higher than 20 per cent.
Tax Credits: Tax credits affect the effective tax rate of a multinational. The Pillar Two rules clarify that tax credits that are refundable within four years are qualified tax credits that would be treated as income and do not reduce the covered taxes. For instance, an MNE’s covered taxes will not be reduced by the amount of the tax credit, and this tax credit would be considered as income. If the tax credit is not qualified, the amount of tax credit would be deducted from the covered taxes reducing the ETR and increasing the amount of top-up tax.
This gives incentives to MNEs to offer tax credits that would fall into the category of qualified refundable tax credits. From a race to the bottom with tax rates, we might end up with a race to the bottom with tax credits where governments would compete in offering qualified tax credits.
So What About Pillar One?
Pillar One consists of reallocating 25 per cent of revenues exceeding 10 per cent of profitability to countries based on the final user location. Unlike Pillar Two, its aim isn't revenue generation, but profit reallocation based on end-consumer locations. That is why Pillar One from one side reallocates profits to countries, and in parallel, eliminates double taxation by taking away taxing rights from countries with the highest profitability (profits to assets and payroll).
Pillar One’s scope is much smaller than the scope of Pillar Two, as it applies on the largest and most profitable MNEs with revenues above 20 billion euros and profitability above 10 per cent (profits to revenue), excluding the financial sector and extractive industry sector.
As a result, covered groups would only be around 69 multinationals. From these covered groups, 31 are headquartered in the USA and 13 in China, constituting 64 per cent of the total covered groups. Non-ratification by the USA could significantly undermine Pillar One, as almost half of these MNEs would be excluded, substantially diminishing potential benefits and leading to Pillar One's ineffectiveness.
In terms of gains from Amount A Pillar One, around 94 billion euros of profits could be reallocated, leading to net gains totaling 15.5 billion euros. In Baraké & Le Pouhaër (2023), we provide detailed country by country estimates from Pillar One's Amount A implementation. Our findings indicate that the majority of net gains from Amount A would be accrued to developed countries (12 billion euros), with developing nations receiving a lesser share (3.5 billion euros). In relative terms, gains would be around 0.15 per cent of tax revenues for developing countries and 0.17 per cent for developed ones.
The revenue gains from Amount A are similar to those expected from digital service taxes (DSTs). As DSTs are unilateral uncoordinated measures, the tax burden of MNEs is expected to increase whereas under Pillar One the “elimination of double taxation” limited the tax burden. A condition of Pillar One requires signatory countries to eliminate their digital taxes. Should Pillar One fail, we could see a return to the race of countries to introduce or reactivate their digital taxes.
Dr Mona Baraké
Mona Baraké is a PostDoctoral Researcher at the EU Tax Observatory and the Paris School of Economics, specialising in public economics, financial economics, and taxation. She has several publciations related to tax havens, tax planning and tax revenue, and won the Best paper award (Franco-German Fiscal Policy Seminar 2022) for work on Pillar Two. She has a PhD in Economics From Paris 1 Panthéon Sorbonne (2021).