OECD Pillar Talk: Pillar Two looming; Pillar One one step closer
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Publications: 05 October 2023
Publications: 05 October 2023
Publications: 13 July 2023
Publications: 22 June 2023
- new “Agreed Administrative Guidance” on Pillar Two;
- a report on the Pillar Two “GloBE Information Return” (the GIR);
- a report on the subject to tax rule (the STTR), including model provisions and accompanying commentary; and
- a consultation document on “Amount B” of Pillar One.
In this article, we summarise the key developments and updates coming out of these new materials. The latest flurry of content from the OECD follows hot on the heels of the publication, on 11 July, of an agreed “Outcome Statement” by 138 members of the OECD/G20 Inclusive Framework on Base Erosion and Profit Shifting (the Inclusive Framework). The Outcome Statement summarises the package of deliverables developed by the Inclusive Framework members to address the “remaining elements of the Two-Pillar Solution”. In addition, further details were provided in a recent OECD Tax Talk held on 19 July. While there remains a clear focus, at the OECD level, on getting Pillar Two over the line and ironing out the points of (relative) detail, it is significant that this latest round of OECD materials also includes some movement on Pillar One.
Amount A of Pillar One
Notably, the Outcome Statement announced that the text of a multilateral convention (MLC) to implement “Amount A” of Pillar One (which reallocates a portion of taxing rights over the residual profits of large multinational enterprises (MNEs) in favour of market jurisdictions) has now been delivered. It is intended that the MLC will be opened in the second half of 2023, with a view to it entering into force in 2025.
Whilst the text of the MLC is not yet available, the OECD in its Tax Talk confirmed that this will, for the most part, look familiar to what has already been made public during the consultation process on Pillar One. However, there are a couple of changes on the horizon; firstly, a new exclusion for defence activities (on the basis these are rarely driven by market factors), and, perhaps of wider interest, a new “Autonomous Domestic Business Exemption” for purely domestic business activity in a jurisdiction that is completely autonomous from the rest of the group and which will be exempt from the application of Amount A.
In addition, in the small print of the Outcome Statement is a footnote that “efforts are continuing on a small number of specific items”. The OECD has indicated that the majority of these outstanding points relate to thresholds and quantitative metrics on the marketing and distribution safe harbour, and expressed optimism that these would be resolved and the MLC ready for signature by the stated deadlines.
Recognising the progress made on the MLC, the signatories to the Outcome Statement have also agreed to extend the moratorium on unilateral digital services taxes (and other relevant similar measures) between 1 January 2024 and the earlier of 31 December 2024, or the entry into force of the MLC. Interestingly, the statement only refers to a standstill on “newly enacted” measures, indicating that existing measures could be back on the table. Also significant is the fact that the moratorium is conditional on at least 30 jurisdictions accounting for at least 60% of the ultimate parent entities (UPEs) of in-scope MNEs signing the MLC before the end of 2023.
Pillar One has, for a number of reasons, lagged considerably behind Pillar Two for some time now. In particular, getting the US on board is crucial if Pillar One is to happen, and the US seems no closer to being able to ratify Pillar One in Congress, despite the initiative being spearheaded by the US administration. It remains to be seen how long jurisdictions will be prepared to hold off introducing their own domestic digital services taxes if no progress can be made here. The unwillingness of five Inclusive Framework members to sign up to the Outcome Statement, and the conditions that have been placed on the moratorium, reflect that we are getting close to a crunch point on this.
New Pillar Two administrative guidance
Pillar Two is designed to ensure that large MNEs pay a minimum level of tax on the income arising in each jurisdiction in which they operate. Pillar Two is centred around a “common approach”, comprising: (i) an agreed set of interlocking Global anti-Base Erosion rules (GloBE Rules) (first published in December 2021); and (ii) Commentary on those rules (first published in March 2022). Under the common approach, jurisdictions are not required to adopt the GloBE Rules; however, if they choose to do so, they agree to implement and administer the rules in a manner consistent with the agreed outcomes, and to accept the application of the GloBE Rules applied by other jurisdictions.
Under the terms of the GloBE Rules, Inclusive Framework members have further agreed that an implementing jurisdiction will “apply the GloBE Rules consistent with Agreed Administrative Guidance” – that is, guidance published by the Inclusive Framework on either “the interpretation or administration of the GloBE Rules”. Because the Agreed Administrative Guidance will reflect the Inclusive Framework’s collective understanding of how the GloBE Rules are to be interpreted and applied, it is expected to play a pivotal role in ensuring co-ordinated (or, at least, more co-ordinated) implementation of the GloBE Rules, and will be instructive for taxpayers and tax authorities alike.
The OECD released a first set of Administrative Guidance in February 2023. The more recent, second set of guidance published on 17 July covers some new ground as well as, in some cases, building on the February guidance. This and the February guidance will be incorporated into a revised version of the Commentary on the GloBE Rules, to be released later this year, which will supersede the previous March 2022 version.
The latest Administrative Guidance includes guidance on the following topics:
- A new category of tax credits, “Marketable Transferable Tax Credits”, has been created, which will be treated as income rather than as a reduction in tax liability. Previously, a big concern for the US was that tax credits created under the Inflation Reduction Act (the IRA) did not fall under the definition of “Qualified Refundable Tax Credits”. This new category of Marketable Transferable Tax Credits is, amongst other things, presumably designed to accommodate the US by ensuring that the benefit of these IRA tax credits is not wiped out under Pillar Two.
- The application of the Substance-based Income Exclusion (or SBIE), i.e. the carve out from the GloBE Rules for an amount of income in respect of an entity’s substantive activities. Amongst other matters, the new Administrative Guidance considers the position of employees and assets which are located (at least some of the time) outside the jurisdiction of the relevant constituent entity or owner during the relevant period.
- The design and operation of Qualified Domestic Minimum Top-up Taxes (QDMTTs), including guidance on the application of QDMTTs to different kinds of entities (such as joint ventures, hybrid entities and investment entities), transitional provisions, and filing obligations. The guidance also addresses what happens where there is a challenge to the application of the QDMTT based on constitutional or other legal grounds or based on, for instance, a specific agreement limiting an MNE’s tax liability (such as a stabilisation agreement).
- Currency conversion rules when performing GloBE calculations, including issues such as which currency the GloBE calculations should be performed in, and the translation of amounts relevant to GloBE calculations into the necessary currency.
In addition, the new Administrative Guidance provides for two new safe harbours: a QDMTT safe harbour and a transitional Undertaxed Payments Rule (UTPR) safe harbour.
The QDMTT safe harbour is intended to relieve some of the computational obligations around Pillar Two. Although credit is given under the GloBE Rules for amounts payable under a QDMTT, without more, an MNE would still have to carry out two calculations for a QDMTT jurisdiction: one based on the local QDMTT legislation and a second under the GloBE Rules. The safe harbour therefore simplifies this process by deeming the top-up tax payable under the GloBE Rules to be zero for jurisdictions that apply QDMTTs, but only if the QDMTT meets certain standards set out in the guidance.
The UTPR safe harbour, on the other hand, may be more politically motivated. The UTPR acts as a “backstop” to the main Income Inclusion Rule (the IIR), and is intended to kick in where the application of the IIR is insufficient to collect the top-up tax payable. In practice, the way the GloBE Rules work means that if the jurisdiction of the UPE has not imposed a QDMTT, the UTPR is the key mechanism for imposing top-up tax in an MNE’s UPE jurisdiction. The official line is that jurisdictions needed more time to assess the impact of the GloBE Rules and how best to respond to them (including by making any necessary reforms to domestic tax systems, such as adopting a QDMTT), and therefore this new safe harbour provides transitional relief by deeming the UTPR top-up amount under the GloBE Rules to be zero for UPE jurisdictions with a corporate income tax rate of at least 20%. A perhaps more cynical view is that pushing this down the road until 2026 gives the US the opportunity to have another go at passing Pillar Two legislation after the elections. Interestingly, the guidance makes it clear that the transitional period cannot be extended (to ensure this does not turn into a disincentive for jurisdictions to adopt the GloBE Rules). So, perhaps another crunch point is coming.
Further detail on the GloBE information return
Following public consultation in March this year, the OECD has released a report on the standardised information return for the GloBE Rules, the GIR, which provides a template for the information and tax calculations that an MNE group has to provide. Adopting a standardised form of return is intended to streamline compliance for taxpayers, albeit, it is worth noting that the agreement of the standard form does not preclude tax administrations from requesting supplementary information. Additionally, the obligation to prepare a GIR is separate from a taxpayer’s obligation to declare and pay taxes under a tax return, and the responsibility for administration of tax return filing and payment obligations remains with each implementing jurisdiction to determine.
The GIR comprises a general section for the MNE as a whole, which calls for information about the MNE group, the identity of the filing entity, and an outline of its corporate structure. The GIR also includes jurisdiction-specific sections, which must be completed for each jurisdiction in which an MNE operates. The information to be provided in the jurisdiction-specific sections will require more limited information to be disclosed in respect of jurisdictions where relevant safe harbours and/or exclusions apply, and for the remaining jurisdictions, the effective tax rate computations, and (as necessary) the calculation and allocation of any top-up tax.
For a transitional period, a simplified version of the reporting requirements that applies on a jurisdictional (rather than an entity-by-entity) basis can be applied, albeit in relatively limited circumstances (i.e. where no top-up tax liability arises, or where it does arise but does not need to be allocated between different entities within a jurisdiction). But groups may still need to provide contemporaneous supporting information, so query how much this will really cut down the compliance burden.
The report also discusses how information provided in the GIR will be disseminated to other jurisdictions. To help streamline the process for both taxpayers and tax administrations, the OECD is turning next to developing information exchange mechanisms and XML schemas to support the central filing of the GIR.
Subject to tax rule model provision and commentary
While, to date, focus on Pillar Two has largely been on the headlining double act of the GloBE Rules (namely, the IIR and UTPR), there is a further piece of the Pillar Two puzzle which is now taking shape: the STTR. The STTR, despite not being part of the GloBE Rules, has from the outset been a central aspect of the overall Pillar Two package for developing countries. The STTR is a treaty-based rule, which applies to payments between connected parties of interest, royalties, and certain other defined amounts (so-called “covered income”). Specifically, the STTR aims to help developing countries (particularly those with lower administrative capacities) protect their respective tax bases by allowing them to “tax back” covered income where other jurisdictions have not exercised their taxing rights or where the payment is only subject to taxation at a low rate (i.e. below 9%).
The model provision for the STTR, published on 17 July, allows the jurisdiction in which an amount of covered income arises (i.e. the source state) to apply additional tax, beyond that applied in the jurisdiction in which the recipient is resident (i.e. the residence state), to the extent that the relevant covered income is subject to a tax rate below 9% in the residence state. There are certain exclusions, e.g. for pension funds and investment funds, as well as materiality thresholds below which the STTR will not apply. Although, unlike the GloBE Rules, the STTR is not limited to those groups with revenues over EUR 750 million.
The STTR does not hinge on the implementation of the GloBE Rules, but rather takes the form of a standalone bilateral treaty article. Inclusive Framework members that apply nominal corporate income tax rates below the STTR minimum rate to covered income have committed to include, when requested to do so, the STTR in their bilateral treaties with members that are developing countries.
Although the model provision can be adopted bilaterally, the OECD’s Outcome Statement of 11 July indicated that a multilateral instrument on the STTR will be released and open for signature from 2 October 2023 to facilitate swift and consistent implementation.
Pillar One, Amount B consultation
As noted at the outset of this article, Amount A of Pillar One has been proving difficult to progress and has been the source of much public debate and discussion. However, in contrast, work on Amount B seems to have been quietly ticking along in the background, and the OECD has now released a consultation document on this aspect of Pillar One.
Amount B is intended to provide a “simplified and streamlined approach to the application of the arm’s length principle to in-country baseline marketing and distribution activities”. Underlying Amount B is a concern that transfer pricing disputes with respect to so-called baseline marketing and distribution activities can be challenging for tax administrations, particularly those in “low-capacity countries” (which may lack local market comparables), and also result in compliance burdens for taxpayers.
The baseline marketing and distribution activities within scope of Amount B are essentially wholesale goods distribution activities, including commissionaires and sales agents. One of the big outstanding points appears to be how “baseline” should be defined for these purposes, with two camps emerging; some jurisdictions being of the view that no separate qualitative scoping criterion is required, whilst others disagree. The consultation document does indicate that common features of baseline distribution activities include the absence of unique and valuable intangibles, or certain economically significant risks. The performance of services and the distribution of commodities are explicitly excluded from Amount B’s scope.
The consultation proposes that the transactional net margin method is most appropriate to price in-scope transactions, and the OECD is seeking views (by 1 September 2023) on the appropriateness of, amongst other things, a proposed pricing matrix, mechanisms to address geographic variations, the proposed approach to documentation, and tax certainty.
The Outcome Statement indicates that the intention is for a final Amount B report to be prepared after the consultation closes, and that this will be used to update the OECD’s Transfer Pricing Guidelines by January 2024.
Although this collection of new documents has moved the dial in numerous ways, a number of big questions remain unanswered. The fate of Pillar One still hangs in the balance. If the prospect of a return to multiple layers of overlapping and inconsistent digital services taxes and counter-measures in the form of trade tariffs is not enough to persuade jurisdictions to adopt, perhaps the numbers might help. The OECD’s David Bradbury noted at the Tax Talk on 19 July that Pillar One could raise between USD 17 – 31 billion per year – with revenue gains being distributed across all jurisdictions other than investment hubs. The work on Amount B is not dependent on the political wranglings that are impeding progress on Amount A, so even if Amount A cannot make it to the finish line, Amount B may still come to fruition. On the other hand, with more countries implementing (or stating their intention to implement) Pillar Two, it is becoming a reality that multinationals are rapidly having to get to grips with.