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We outline each of the proposals in turn below, providing details of what to watch out for, what is known and what has yet to be agreed.
The Organisation for Economic Co-operation and Development (OECD) has been leading discussions on reforming international tax with the Base Erosion and Profit Shifting (BEPS) initiative. The latest proposals 'Statement on a Two-Pillar Solution to Address the Tax Challenges Arising From the Digitalisation of the Economy' outline in greater detail how Pillar One (Digital taxation) and Pillar Two (international minimum tax) will be implemented.
Pillar One - Reallocation of taxing rights
The Pillar One proposals will apply to large multinational enterprises (MNEs) that have global sales of more than €20 billion and profitability greater than 10% (income before taxes/sales). These thresholds will be based on financial accounting income, only having a limited number of adjustments. The MNEs subject to Pillar One are not limited to digital businesses, however extractive and regulated financial services have been carved-out from this proposal. The OECD are aiming to issue a public consultation document for Pillar One in mid-2022, with a public consultation event to follow.
The Pillar One’s main objective is to transfer a portion of taxation rights from the jurisdiction of residence to the market jurisdictions, i.e. where the MNEs clients are based. The final details on how the profit allocation will apply is still in discussions, with a number of options being considered. Based upon the latest proposals, it is expected that between 20% and 30% of profits in excess of 10% of revenue will be allocated to market jurisdictions in which the MNE is considered to have taxable nexus. The allocation will be calculated using a revenue-based allocation key which is still being finalised.
Profits will be allocated to market jurisdictions if the revenues in that jurisdiction exceed specified thresholds. The revenue threshold is dependent on the gross domestic product (GDP) of a jurisdiction, and is currently proposed as:
- GDP of less than €40 billion: €250,000 revenue threshold
- GDP of €40 billion or more: €1 million revenue threshold
The determination of the income in the market jurisdiction will be based on where goods and services are used or consumed. Detailed source rules for specific categories of transactions are in development and the methodology will have to consider the specific facts and circumstances of a particular MNE.
In many instances, profits may already be allocated to a market jurisdiction within an MNEs existing structure. In these situations, a marketing and distribution profits safe harbour will cap the residual profit that is allocated to the market jurisdiction. Further work on the safe harbour is in progress.
For baseline marketing and distribution activities, the application of the arm’s length principle will be streamlined and simplified. This work is expected to be completed by the end of 2022.
The Pillar One proposals will result in a significant shift of profits between jurisdictions with appropriate mechanisms required to ensure that double taxation does not occur via either a credit or exemption mechanism. The shift in profits will create risks of double taxation as jurisdictions may not implement the resulting rules in the same way. These differences will be resolved via a dispute resolution process and a prevention mechanism that will be mandatory and binding.
The legislative mechanism expected to be used is a multilateral instrument (similar to the one that was recently entered into with respect to treaty modifications). The OECD expects that the Pillar One multilateral instrument will be opened for signature in 2022, with a projected implementation in 2023.
Pillar Two - Global anti-base erosion mechanism
The basic objective of Pillar Two is to establish a minimum taxation level on a country-by-country basis. The basic idea of the proposals is to introduce Global anti-Base Erosion Rules (GloBE). These proposals are aimed to effect more taxpayers than the Pillar One proposals, with a threshold set at €750 million of sales, (i.e. the current threshold for country-by-country transfer pricing reporting).
The latest proposals also indicate that countries can introduce Pillar Two measures at a lower threshold. Hence, these proposals could eventually apply to small and medium entities (SME) with turnovers below €750 million. Government entities, international organisations, non-profit organisations, pension funds and investment funds that are the Ultimate Parent Entities (UPE) are not subject to the GloBE rules. Income from international shipping is the only industry specific exclusion mentioned at this time.
The minimum tax rate will be at least 15%. The computation will be based on a common definition of covered base and the tax base will be determined with reference to financial accounting income (with similar adjustments as those considered under Pillar One).
A lower range of rates (between 7.5% and 9%) is currently being proposed for certain income sources (interest royalties and a defined set of other payments) that are within the scope of the ‘Subject to Tax Rule’ discussed below.
These proposals reiterate an extensive collection of mechanisms that could be used to achieve a minimum level of global taxation.
Importantly, they also indicate that consideration will be given to the conditions under which the US Global Intangible Low Taxed Income (GILTI) regime can coexist with the GloBE proposals. This concession is important to ensure that the US could agree with the Pillar Two proposals. Commentary relating to the model rules for Pillar Two were released on 14 March 2022.
A model Subject to Tax Rule treaty provision and a multilateral instrument are expected to be developed by mid-2022, as the current model does not include these considerations. An implementation framework is expected to be developed before the end of 2022, which should facilitate the coordinated implementation of the GloBE rules.
The OECD indicates that the Pillar Two proposals should result in a robust global minimum tax with a limit on MNEs carrying out real economic activities with substance. Pillar Two is expected to be effectively implemented by the end 2023.
These proposals have provided the tax community with additional information on Pillar One and Pillar Two. There are still a significant number of details which are still being finalised by the OECD. For Pillar One a consultation document is expected to be released in mid-2022. The expectation is that the rules will be finalised in 2022 and take effect beginning in 2023.
For pillar Two, the timeframe being considered for the rules to take effect is, at the earliest, 2023 for the Income Inclusion Rule (IIR) and in 2024 for the Undertaxed Payments Rule (UPR).
If you would like to discuss any of the points raised in this article and how they may affect your business, please speak to your local Grant Thornton office or one of the contacts listed below.