Global tax reform more details released

Political agreement has now been reached on some of the key thresholds and tax rates to be applied in the OECD's Pillar One and Pillar Two global tax reform proposals, with further information on timing also published. Pillar One provides for a new taxing right for market jurisdictions over certain profits of the largest multinationals and Pillar Two sets the rules for a global minimum tax.

Businesses will, however, need to wait for further information on matters such as the principles for calculating their effective tax rate for Pillar Two before the impact on them can be fully assessed. More detailed rules are not likely to emerge until November at the earliest.

What new information has been released?

136 countries are now signed up in principle. Ireland, Hungary and Estonia have newly joined the agreement, having received assurances in respect of the minimum tax rate and implementation periods. Nigeria, Kenya and Sri Lanka have refused to sign up and Pakistan, which had signed the July agreement, has now withdrawn its support.

The OECD brochure sets out all of the agreed principles and timelines. We do not seek here to give a comprehensive summary, but instead note key new information as follows:

Pillar One

• The largest global businesses (i.e. those with global turnover above €20bn) will have 25% of their profits above a 10% profit margin reallocated and then subjected to tax in the countries in which they operate and earn revenue of at least €1m per year (or €250,000 for smaller jurisdictions) (so called "Amount A"), rather than all taxing rights sitting where the business has physical presence. Previously, the agreement had only referenced that somewhere between 20% - 30% of these excess profits would be reallocated.

• Amount A of Pillar One will be implemented via a Multilateral Convention, due to be finalised and available for signing in 2022 and coming into effect in 2023, together with changes to domestic laws where necessary. Work on Amount B (the fixed return for baseline marketing and distribution physically taking place in a market jurisdiction) will be finalised by the end of 2022. It will be determined according to the arm's length principle.

• Dispute prevention and resolution mechanisms, designed to avoid double taxation for Amount A and aid certainty for MNEs, will be mandatory and binding. Certain developing economies with no or low levels of MAP disputes may be eligible for an elective mechanism.

• The agreement commits countries to remove unilateral Digital Services Taxes when Pillar One comes into effect. And in the meantime, it requires that no newly enacted Digital Services Taxes or equivalent may be imposed on any company from 8 October 2021 and until the earlier of 31 December 2023 or the coming into force of the Multilateral Convention. Negotiations are ongoing with regard to appropriate transitional arrangements.

Pillar Two

• It has been confirmed that the Pillar Two minimum tax rate will be 15% (previously expressed as "at least 15%").

• The substance based carve-outs have been fleshed out – these provide for an initial mark-up on tangible assets of 8% and of 10% on payrolls, with each reducing to 5% in 10 years.

• The subject to tax rule (STTR), which allows jurisdictions to impose withholding taxes on certain related party payments, has been limited to those payments which are subject to a corporate statutory tax rate below 9% (i.e. the top of the previously announced 7.5% - 9% range).

• The model treaty provision in respect of the STTR should be published next month, along with the model rules for the scope and mechanics of the income inclusion rule (IIR) which imposes a top-up tax on a parent entity where a subsidiary is taxed below the minimum rate, and the undertaxed payments rule (UTPR) which denies deductions or otherwise adjusts the tax position to the extent that the low tax income of a subsidiary is not caught by an IIR.

• There will be an exclusion from the UTPR for businesses in the initial phase of their international activity i.e. those with a maximum of €50m of tangible assets abroad and that operate in no more than five other jurisdictions. This exclusion is limited to a period of 5 years after the business comes into the scope of these rules for the first time.

• A Multilateral Instrument will follow by mid-2022 to facilitate implementation of the STTR into relevant bilateral treaties, with the aim of Pillar Two becoming effective in 2023, other than the UTPR which has been pushed back to 2024.

What do we still not know?

Despite broad agreement over the framework of reform, little has been shared with the public about the precise methodology for calculating tax due or to be reallocated under the new rules.

For Pillar One, there is now reference to an averaging mechanism for calculating profitability to determine if a business is within scope, but no details have been given of this mechanism. It is also unclear how it will be determined exactly which entities within a group will have their profits reallocated to markets, and the Amount B fixed return for marketing and distribution will not be finalised until the end of next year. Detailed sourcing rules for specific categories of products and services have yet to be developed in order to determine where are the relevant market jurisdictions for reallocation.

The agreement is also not definitive on the unilateral measures which must be repealed when the global reforms come into effect. We can be sure that those countries with a DST in force are included in this, but it is less clear how this will affect the EU proposal for a digital levy which is due to be published later this month.

For Pillar Two, there are a number of details on matters such as the scope of the substance based carve-outs that remain to be finalised, but the critical concern is the methodology for calculating the effective rate of tax paid by in scope businesses in each country. In particular, appropriate adjustments to accounting profits, and treatment of deferred tax assets and domestic tax incentives must all be negotiated.

What next?

The proposed time scales are breathtakingly ambitious. The OECD has an impressive record at pushing through previous BEPS reforms but, despite the political headline agreement achieved so far, there remains much work to be done both in hammering out the final details and in securing domestic implementation.

We should have increased clarity on both in the coming couple of months.

You can find a full list of our global tax partners here.