OECD Pillars, the digital economy and minimum taxes
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To date, 132 jurisdictions have committed to the OECD’s two-pillar plan to reform international tax rules, as set out in its statement of 1 July 2021. Although the genesis of the proposed reforms relates to the taxation of multinationals in the context of digitalisation in particular, the proposals are not limited to digital profits.
Broadly, Pillar One contemplates the transfer of a portion of taxing rights from an enterprise’s jurisdiction of residence to the “market jurisdiction”. That is, new taxing rights will depend on the location of the customer, rather than the business. Pillar Two (the global anti-base erosion mechanism (GloBE)) effectively imposes a minimum level of taxation, currently anticipated to be 15%.
While much of the detail has to be agreed, the agreement represents a remarkable consensus of divergent political thought. The projected timetable is nothing if not ambitious; the OECD intends that the new regime will enter into force in 2023.
How did we get here?
Work on the difficulties caused by the increasing digitalisation of the global economy began as part of the OECD’s project on Base Erosion and Profits Shifting (BEPS), launched in 2013. The project proposed 15 actions, each of which was designed to prevent forms of aggressive tax planning by multinationals.
Action 1 sought to identify and overcome difficulties posed by the digital economy for the application of existing international tax rules. The subsequent report, published in October 2015, commented in particular on the ability of a company to have a "significant digital presence" in the economy of another country without being liable to taxation. This is because existing international rules (broadly) require either residence or permanent establishment as the requisite nexus for taxation. The report also noted the attribution of value created from the generation of marketable data through the use of digital products and services.
However, the BEPS project was primarily focused on addressing aggressive tax planning. Whether digitalisation of the economy required more fundamental reform of the allocation of profits between residence and source states was not considered to be within scope. Instead, the OECD formed a Taskforce on the Digital Economy to consider the issue further. Consensus was difficult to achieve, however, and has necessitated a slow, iterative process, with a number of possible options. During this time, a number of jurisdictions implemented unilateral measures. These included the digital services taxes introduced by the UK and a number of EU states, including France, Spain and Italy. In parallel, the EU has sought to develop proposals for a digital taxation levy. However, the measures were subjected to strong criticism from the US, which felt it had the most to lose, and which has, to date, staunchly supported tax sovereignty.
Eventually, in October 2020, the OECD published “blueprints” for Pillars One and Two. In December 2020, Joe Biden was elected as US president, and the series of tax reforms he unveiled in April 2021 meant international agreement was a much more realistic possibility.
On 5 June 2021, the G7 Finance Ministers pledged their support to the principles of Pillars One and Two, and this was followed by the July 2021 statement.
Where are we? The two Pillars in more detail
Pillar One: Reallocation of taxing rights
Pillar One reallocates taxing rights to market jurisdictions. The intention is that the new provisions will apply to multinationals with global sales over EUR 20 billion and in relation to between 20% and 30% (the exact percentage has not yet been confirmed) of profits exceeding a 10% threshold. These profits (“Amount A”) will be reallocated to the market jurisdiction(s), based on where goods and services are used or consumed. Amount A will be apportioned among threshold jurisdictions, depending on their GDP. An “Amount B” will provide a standardised return for baseline marketing and distribution activities.
The new taxing right will apply to all profits, not just those derived from digital business. However, the July 2021 statement confirmed that there will be a carve-out from Pillar One for extractive businesses and regulated financial services. The latter is particularly important to the UK economy, and there was an initial concern that the initial G7 announcement made on 5 June did not address this issue.
Pillar One will be effected through a multilateral instrument, and will include extensive dispute prevention and resolution mechanisms. Significantly, it is a tenet of Pillar One that all unilateral digital tax measures should be removed. France has already announced that it intends to repeal its digital tax as soon as the OECD agreement is implemented. The EU has also confirmed that it intends to put its plans “on hold” until October 2021.
Pillar Two: global anti-base erosion mechanism
Pillar Two introduces a minimum level of taxation, so that multinationals must pay a minimum effective tax rate of 15% on profits in all countries, with the tax base determined by reference to financial accounts income, (rather than taxable profits).
The minimum level will apply to multinationals with consolidated revenue of EUR 750 million, but jurisdictions can apply lower thresholds to multinationals headquartered in their jurisdiction. As in relation to Pillar One, the scope of Pillar Two is not limited to digital businesses, although there is a carve-out for international shipping income.
The primary mechanism for implementation of Pillar Two will be an income inclusion rule (IIR), under which additional top up amounts of tax will be payable by a parent entity of a group where one or more constituent members of the group has been undertaxed. A secondary backstop will be provided by an undertaxed payment rule, which denies deductions, where the IIR has not been applied.
The OECD has announced that a detailed implementation plan together will be finalised by October 2021. It intends that a legislative framework will be put in place during 2022, and that the proposals will come into force in 2023.
In relation to the outliers, as at 14 July 2021, the only members of the OECD/G20 Inclusive Framework that have not signed up to both Pillars are Barbados, Estonia, Hungary, Ireland, Kenya, Nigeria and Sri Lanka. Ireland, in particular, has been historically unwavering in its commitment to a 12.5% minimum corporation tax rate. However, it has accepted the Pillar One proposals and, in relation to Pillar Two, may well be vulnerable to encouragement from the EU.
Clearly there is a great deal of work to be done in order to achieve the Pillars One and Two outcomes by 2023. However, it is likely that the OECD perceives the tax policies of the current US administration as a unique opportunity for progress. Many did not anticipate the significant progress that was ultimately made by the BEPS project when it was first launched. However, the initiative ultimately led to very substantial international change. An increasing number of commentators suspect that there is no reason why the proposals on Pillars One and Two will not do the same.