The OECD recently issue a Statement on a “Two Pillar Solution to Address the Tax Challenges Arising from the Digitalisation of the Economy”. The OECD/G20 Inclusive Framework, agreed to by more than 130 countries is the OCED’s and G20’s vision for the international tax future. There are two aspects (referred to as “Pillars”):
- Pillar One - A fairer distribution of profits and taxing rights via reallocation to markets where certain large multinational enterprises (“MNE’s”) have business activities and earn profits, and
- Pillar Two – A global minimum tax rate
The measures were endorsed by the G20 at their meeting in Venice in early July, having been endorsed earlier by the G7 at their meeting in the UK in June.
There is a lot of detailed work to be done and political and technical hurdles lie ahead. However, the OECD’s ambitious timeline is:
- Detailed rules – September/October 2021
- Multi-lateral conventions and model legislation – late 2021 or early 2022
- Enacted into law by countries in 2022 for a 2023 start
What are the reasons that change is required?
It has been widely recognised that the existing global tax system (designed when physical presence was the key to economic activity) requires updating to meet the needs of the digital economy. This has been compounded by:
- The requirement to fund the Covid-19 recovery,
- Recognition that single country solutions to digital taxation bring inconsistency, double taxation, and continued uncertainty,
- All businesses are increasingly digital in nature so taxation of “digital companies” is not the answer.
What is the likely tax revenue that will be raised?
The OECD estimate that $100 billion of profits could potentially be reallocated between countries because of Pillar One, with the global minimum tax rate expected to generate approximately $150 billion in additional global tax revenues.
How will it work and who will it apply to?
Pillar One will introduce a new nexus rule that will replace the old permanent establishment rules and provide taxing rights where products are sold, or services provided. This seeks to align the market value of goods and services with where they are consumed rather than produced.
It will apply where:
- Global turnover of a MNE exceeds 20 billion euro, and its profitability exceeds 10,
- The amount of profit to be allocated is yet to be determined but is expected to be between 20-30% of profit, and
- The MNE would need to derive at least 1 million euros from that country (for smaller economies, with GDP less than 40 billion euros, the nexus will be 250,000 euros)
Pillar Two will introduce a global minimum tax rate (i.e., the minimum floor beneath which the global tax rate cannot fall), so that if countries have a tax rate below this threshold, other countries will have the right to impose a top up tax.
It will apply to:
- MNEs that have a global turnover that exceeds 750 million euro.
What are the technical challenges?
The technical challenges with introducing changes of this size are clearly considerable, particularly given laws will eventually need to be passed in all participating countries to give effect to the global policies, for example:
- Detailed sourcing rules will need to be developed to allocate where goods or services are used or consumed,
- Agreement over how accounting profits will be measured (and if applicable adjusted) for the determination of profit,
- The extent to which “safe harbours” will be available to reduce the compliance burden for taxpayers,
- A global dispute resolution procedure will be required to deal with disputes promptly and effectively between countries over taxing rights, and
- Mechanisms will need to be in place to avoid double taxation via exemption or credit mechanisms
What are the other potential roadblocks?
- The timetable itself is one challenge, and the longer the negotiations take, the greater will be the likelihood of single country or regional measures being introduced (even if announced as “temporary”, such measures often remain in place for longer than originally announced),
- The EU has agreed to defer its planned digital levy whilst the OECD work continues, but the EU has not committed to the withdrawal of its proposals,
- The US faces domestic political challenges to the introduction of a global solution and has publicly stated its preference for a global solution with no local exceptions,
- Ireland, Hungary, and Estonia in Europe have held out against the OECD Inclusive Framework, putting more pressure on the need for unanimous EU support.
What should business be doing now?
More details will not be announced until September or October, but the trend has been established and we expect this to continue, so we recommend the following preliminary analysis:
- Review your international tax structure (and related party transactions) to ensure you have up to date and reliable information regarding the MNE’s global activities. The MNE’s most recent transfer pricing report will be a good starting point,
- Test your information management systems – digital exchange of information is already well advanced between countries’ Revenue Authorities and this will accelerate,
- Corporate social responsibility and governance. Many countries already have disclosure rules on tax policy and information, and more should be expected, so develop and/or test your policies,
- Communication with stakeholders (employees, suppliers, customers etc.,) is essential to maintain their support and understanding.
There are difficult negotiations ahead, both technical and political, but the discussions will not get easier with more time. In our view, the direction has now been clearly established and resorting to the existing rules is not a sustainable outcome, so significant change will take place.
The economy continues to evolve as new digital technology is developed and introduced into business, so the search is not for perfection, but for a solution that is significantly more suited to the global economy of 2020 – 2050 than the current global tax system.