On October 8, 2021, the Organisation for Economic Co-operation and Development (OECD) and the Group of Twenty, commonly referred to as G20, released a statement that the 136 member jurisdictions reached an agreed-upon approach to taxation of companies regarding tax issues arising as a result of the digital economy. The agreement would significantly overhaul the taxation of multinational enterprises (MNEs) that operate in various countries worldwide.
The agreement has two pillars addressing the distribution of profits among counties in which the MNEs operate (pillar one) and a global minimum tax on MNEs (pillar two).
Pillar One – Distribution of Profits
- This provision only applies to MNEs with global revenue in excess of 20 billion euros and profitability above 10%. Regulated financial services are excluded from this provision.
- An allocation of 25% of the residual profits is permitted to a country where the MNE derives at least 1 million euros in revenue from that jurisdiction. If the country has GDP of less than 40 billion euros, the threshold is reduced to 250 thousand euros.
- Residual profit is defined as profit in excess of 10% of the MNEs’ revenues.
- The allocation will be made based on a revenue-based allocation key.
- Any country with current rules on the taxation of digital services is required to remove the rules and commit to not introducing any new rules in the future.
- It is anticipated that these rules will be implemented through a multilateral convention that each country would be allowed to join even if there is no existing tax treaty between participating jurisdictions.
Due to the high revenue threshold, this first pillar of the proposal will apply only to the largest MNEs that operate worldwide in a digital environment.
Pillar Two – Global Minimum Tax
- The provision has two interlocking domestic rules (1) New Global Anti-Base Erosion (GloBE) rules and a Subject to Tax Rule (STTR).
- GloBE will impose a top-up tax on a parent entity in respect of the low taxed income (Income Inclusion Rule (IIR)) and deny deductions or require adjustment to the extent the low tax income is not subject to tax (Undertaxed Payment Rule (UTPR)).
- STTR allows the imposition on certain related-party payments that are subject to tax below a minimum rate.
- The GloBE rules would apply to MNEs with at least 750 million euros in revenue similar to the requirements of the country-by-country reporting rules of BEPS Action 13.
- A jurisdictional exception will be provided for MNEs that have less than 10 million euros in revenue and 1 million in profits.
- Effectively these rules would provide for a minimum tax of 15% on MNEs’ profits based on an effective tax rate test which will be applied on a jurisdictional basis.
- It is anticipated that this provision would have to be implemented through an amendment to an income tax treaty.
The second pillar will have broader applicability. Whether this applies to your company or not will depend on the mechanics of computing the jurisdictional effective tax rate and potential carve-out/exclusions to the rules. The current plan to implement these provisions by 2023 is very ambitious given the need to reach an agreement among the 136 participating countries. Additionally, there are many technical details that still have to be worked out.
We will continue to monitor these developments. In the meantime, if you have any questions or would like to discuss the potential applicability to your business, please contact us.
Article written by:
Kevin Dunn, CPA
Director, Tax & Business Advisory Services