A Two Pillar plan to reform international tax rules has obtained widespread governmental support from 136 of the 140 members of the Organization for Economic Cooperation and Development (OECD) Inclusive Framework on Base Erosion and Profit Shifting (BEPS), the OECD announced in October 2021.1 Shortly after the announcement the Finance Ministers of the G20 formally endorsed the plan for modernizing the global corporate tax system.
Brown Brothers Harriman & Co (BBH) has prepared these Frequently Asked Questions (FAQs), providing a high-level overview of the development and how it impacts clients.
What is the background to the Two Pillar Plan?
In 2013, the OECD issued 15 Action Plans as part of its BEPS initiative, the aim of which was to change international tax law and practice to restore integrity and fairness to the global tax regime.
Action 1 – Address the Tax Challenges of the Digital Economy – identified the main challenges the digital economy poses for the application of international tax rules and identified avenues to explore to address those challenges.
Based on the initial Action 1 report the OECD began to address ways to ensure proper taxation of the digital economy. In 2019, it issued a report identifying the Two Pillars and in 2020 issued Blueprints for consultation to address the principles and parameters of the Pillars and assist in identifying key challenges and policy issues to resolve.
In July of this year, the Two Pillar Solution was published setting out the OECD’s proposed framework to address the tax challenges of a digital economy and in October 2021, further details on the framework were released with 136 of the 140 Inclusive Framework members indicating their support for the Two Pillar approach.
What is the Two Pillar Plan?
The Two Pillar Plan is a proposal to update the existing international tax system by introducing measures to align with the modern digital economy thereby making the international tax system fairer. The proposal would realign taxing rights with value creation and establish a minimum level of tax on profits through the introduction of unified tax rules.
The Pillar 1 Proposal – The Pillar 1 proposal would revise profit allocation and nexus rules to fairly align tax revenue by amending who gets the right to impose taxes.
The Pillar 2 Proposal – The Pillar 2 proposal introduces a global minimum tax rate.
What does Pillar 1 Address?
Pillar 1 addresses the existing international tax rules that allow Multinational Enterprises (MNEs) to avoid paying tax due to a lack of physical presence by introducing provisions to ensure that MNEs pay tax in countries where they operate and generate revenue.
Pillar 1 proposes to establish taxing rights for market jurisdictions through the introduction of a formula to reallocate revenue based on residual profit.
Who is in-scope for Pillar 1?
Initially, MNEs with a global turnover of EUR 20 Billion and profitability of more than 10% will be in-scope. Under the existing proposal, MNEs predominantly undertaking financial services are not in scope.
As such, only the 100 largest MNEs will be impacted (approximately 1% of MNEs globally).
The existing provisions apply to direct taxes only, and the reallocation of profit will not create nexus for the application of Value Added Tax (VAT).
What does Pillar 2 Address?
Pillar 2 addresses tax fairness by introducing a global minimum tax of 15%. The minimum tax is not intended to prohibit tax competition but prevent governments from attracting business and development through a race to the bottom approach.
Who is in-scope for Pillar 2?
MNEs with annual revenue of EUR 750 Million would be subject to a global minimum tax of 15%. Jurisdictions can lower the annual revenue requirements and apply the minimum tax to MNEs headquartered in their jurisdiction.
The minimum tax does not apply to government entities, international organizations, non-profits, pension funds, and investment funds that are the ultimate parent entities of an MNE group under the existing proposal.
What is the proposed timeline?
The OECD set out an ambitious timeline, with proposed adoption in 2022 and the proposals taking effect in 2023. The European Union has indicated it will issue an implementing Directive by the end of 2021.
What steps need to be undertaken to implement the Two Pillars?
The OECD is not a governmental body and as such, for the Two Pillars to move forward the proposals need to be adopted by local governments through domestic legislation or the introduction of new treaty provisions.
The OECD is currently working to provide templates for governments to consider when implementing local legislation. Additionally, the OECD will introduce new provisions to its Model Tax Convention on Income and Capital. It is hoped that these templates will begin to answer the many outstanding questions that remain around: revenue sourcing, tax base determination, safe harbor rules, arbitration, timing differences, and the mechanics of implementation.
How do these developments impact you?
Unlike previous OECD-led initiatives, like the Common Reporting Standard, custodial institutions like BBH will not provide oversight or facilitate in the enforcement of the Two Pillar Plan.
Impacted entities will need to ensure they have updated procedures and policies to comply with newly developed legislation. If you think that your particular facts and circumstances may require you to comply with the provisions developed to implement the Two Pillar Plan we recommend you speak with your tax advisor.