On October 8, 136 countries agreed, under the auspices of the OECD, to a two part deal meant to address the tax challenges arising from the digitalization of the economy. However, the deal goes far beyond addressing digital taxation, laying out a framework for a new set of international taxing rights.
The two parts of the deal are Pillar 1, which is an agreement to allocate a portion of the profits of the world’s 100 most profitable companies (with significant industry carve-outs) based on where sales take place, or destination-based principles, and Pillar 2, which is a global minimum tax with back-ups (a global application of a modified form of the U.S. GILTI and BEAT rules with other additions).
The companies governed by Pillar 1 are multinationals with a global turnover in excess of €20 billion and profit before tax/revenue of more than 10%. For those companies, 25% of residual profit (defined as profit in excess of 10% of revenue) will be allocated to market jurisdictions with nexus, using a revenue-based allocation key (this amount is referred to as Amount A).
Extractives and Regulated Financial Services are specifically excluded.
The agreement provides for a new “special purpose nexus rule” that would reallocate Amount A to market jurisdictions in cases where the company derives at least €1 million in revenue from that jurisdiction. In some cases, for smaller jurisdictions with GDP lower than €40 billion, the nexus threshold is lower. The revenue is to be reallocated based on where goods or services are used or consumed.
The tax base on which the above determinations are made is supposed to be calculated based on financial accounting income, with what the OECD says is a small number of adjustments. A special rule, the “Amazon rule,” allows for making the required calculations along business lines for companies that are highly profitable in one segment, but loss-making in others.
The new allocation method comes with a mandatory and binding dispute resolution procedure. In some cases, the binding dispute resolution may be elective, such as for developing countries.
In addition to the reallocation methodology for Amount A, the agreement also notes simplification and streamlining for application of the arm’s length principle to in-country baseline marketing and distribution activities (known as Amount B), work that it says will be completed by the end of 2022.
For the United States, Pillar 2 represents fewer radical changes to the tax rules, but still opens up significant questions as to how it will be reconciled with existing law and proposed domestic law changes.
The OECD proposal is supposed to apply to companies that have €750 million in gross revenue (consistent with the country-by-country reporting threshold). Excluded from scope are government entities, international organizations, non-profits, pension funds and investment funds. There is also an exclusion for international shipping income.
As explained in the OECD statement, Pillar 2 includes two interlocking domestic rules: an Income Inclusion Rule (the “IIR”), which imposes a top-up tax (of 15%) on a parent entity in cases where an affiliate has low taxed income, and an Undertaxed Payment Rule (“UTPR”), which denies deductions or requires an equivalent adjustment to the extent an affiliate’s low-taxed income is not subject to tax under an IIR. The second part of Pillar 2 is the Subject to Tax Rule (“STTR”), a treaty-based rule, that allows source jurisdictions to impose limited taxation on certain related party payments subject to tax below a minimum rate of 9%.
The IIR has close similarities to U.S. GILTI, but also important differences, and the UTPR has some similarities to U.S. BEAT, again with significant differences.
The OECD says that the rules will have the status of a common approach, which means that a country is not required to adopt the rules, but, if they choose to do so, they agree to implement and administer them in a way that is consistent with the outcomes provided for under Pillar 1, and that they accept the application of the rules applied by other Inclusive Framework members (i.e., the members of the OECD/G20 Inclusive Framework on BEPS) including agreement as to rule order and the application of any agreed safe harbors.
As with Pillar 1, important details about how the rules would work have not been released, beyond the broad policy statements. It is also not clear how the differences between the proposal laid out by the OECD and the bill introduced by the House Ways & Means Committee – which incorporates changes to both GILTI and BEAT – are to be reconciled.
For example, the OECD agreed-upon IIR would provide for an exemption for 10%of payroll, but GILTI has no such exemption, nor has the administration or the Ways & Means Committee proposed modifying it accordingly.
Issues to be Resolved
The terms of the deal struck are as notable in what has been left out as in what has been agreed. Much work remains to determine the technical rules that will implement the broad principles that have been agreed to.
The OECD says that Pillar 1 will be implemented through a multilateral convention to be developed and opened for signature in 2022, with the reallocation terms coming into effect in 2023. Pillar should be brought into law in 2022, to be effective in 2023, with the UTPR coming into effect in 2024.
Many questions remain – for Pillar 1, in particular – as to how these changes will be implemented in the United States, what process can be used to ensure Congressional approval, and whether members of Congress will agree to the agreement’s adoption.
Digital Services Taxes (“DSTs”)
The United States’ stated rationale for entering into negotiations for this deal are in large part to ensure that U.S. companies will not be subject to digital services taxes that other countries have recently enacted. The OECD statement says that all parties agree to remove all DSTs and other relevant, similar measures, and to commit not to introduce such measures in the future. It says that no country will impose newly enacted DSTs or other relevant, similar measures on any company from the date the agreement was entered into (October 8, 2021), until the earlier of the end of 2023 or the coming into force of the multilateral convention implementing Pillar 1.
Please contact your Mazars professional for additional information.
This Tax Alert was prepared in conjunction with the Potomac Law Group.
Published on October 27, 2021