In 2021, 137 out of the 141 countries in the OECD/G20 Inclusive Framework on Base Erosion and Profit Shifting (IF) reached a landmark agreement on a two-pillar solution to reform the international tax framework in response to the challenges relating to taxation of the digital economy. The OECD is coordinating the multilateral consensus approach—originally intended to be implemented with effect from 2023 but now delayed until 2024—with the framework designed to ensure that multinational enterprises (MNEs) pay a fair share of tax where they operate and that they pay a minimum corporate tax.
Advances in technology allow businesses to operate and generate profits in jurisdictions in which they have a limited or no physical presence without creating a taxable presence. Combined with the globalisation of the world economy and other factors, such as the ability of businesses to exploit gaps and differences in domestic tax rules, the new ways of conducting business have created tensions with traditional tax concepts and mechanisms and deprived certain jurisdictions of tax revenues.
Another consequence of the evolution of the digital economy and digitised businesses is the proliferation of taxes levied by individual countries on digital rather than physical presence, i.e., digital service taxes (DSTs), over the past several years. Many countries view DSTs as a mechanism to raise revenue. Part of the OECD’s two-pillar approach is the removal of all unilateral DSTs and similar measures and a commitment by countries not to introduce such measures in the future. Certain multilateral agreements have been reached on transitional measures to repeal DSTs and mechanisms to address double taxation issues that could arise under Pillar One and existing DSTs.
The OECD’s agenda on taxation of the digital economy evolved from—and continues—the work undertaken in the original BEPS project launched in 2013. What started as an initiative to tackle tax avoidance has morphed into reshaping the international tax landscape, from the way profits are allocated between countries to new obligations for documentation, reporting and disclosure, giving tax authorities unprecedented insight into corporate information. Referred to as BEPS 2.0, the two-pillar framework will modernise international tax rules by ensuring that businesses are taxed in the place where they generate value and profits.
The OECD’s two-pillar approach
The two pillars of BEPS 2.0 are:
- Pillar One will ensure a fairer distribution of profits and taxing rights among countries with respect to the largest and most profitable MNEs by re-allocating some taxing rights over MNEs from their home countries to the markets where they have business activities and earn profits, regardless of whether the MNE concerned has a physical presence in the market. MNEs that will be covered by the rules are those with global sales exceeding EUR 20 billion and profitability above 10%, with 25% of the profits exceeding the 10% threshold reallocated to market jurisdictions.
- Pillar Two will introduce Global Anti-Base Erosion (GLoBE) rules to ensure MNEs with consolidated annual revenues exceeding EUR 750 million pay a minimum (15%) level of tax on the income they derive from each jurisdiction in which they operate. Where the effective tax rate of an in-scope MNE in any of these jurisdictions is below the 15% minimum rate, it will have to pay a “top-up” tax to account for the difference. Generally, this will be paid to the jurisdiction of the MNE’s ultimate parent, though there is a back-stop rule that would give taxing rights to the jurisdictions in which the constituent entities of the MNE group operate. Finally, outside the GLoBE rules, Pillar Two provides for a Subject to Tax Rule that could override existing tax treaty rules benefiting payments that are not subject to a minimum level of tax in the recipient’s jurisdiction.
While not formally part of the model rules, Pillar Two permits a territory to implement a domestic minimum tax, which would have the intent of ensuring that companies of an MNE in a territory pay a minimum (15%) level of tax. Many territories have already expressed intent to proceed with implementation of such taxes, and the interaction of these domestic rules with the Pillar Two rules will need to be monitored.
Following the October 2021 endorsement of the two-pillar approach, developments have accelerated, with the OECD releasing model rules and commentary and public consultations, and a number of countries now exploring implementation of the measures.