The August 2020 draft reports of the OECD containing the blueprints of Pillar I and Pillar II have been circulated on the Internet ahead of their intended publication in October 2020. These documents draw on the work conducted by the Steering Group of the Inclusive Framework on BEPS since January 2020 and elaborate on the technical aspects of the different building blocks and the political decisions still needed. These documents were originally circulated for comments and were discussed at the Steering Group of the Inclusive Framework on BEPS meeting on September 7 – 10, 2020. A second round of comments is expected to take place, after which the final documents are planned to be published in October 2020.
Please find below a short overview of the highlights prepared by Dentons’ Amsterdam tax team, comprising text excerpts from the documents, which allow you to quickly understand and get an idea of what is to come without having to dive into the blueprints themselves. Note that certain variables and thresholds are not yet filled in, presumably because no consensus over the amounts has been reached or because further research is required.
The ideas behind Pillar 1 and Pillar 2 are radical and we expect that they will become game changers for the international tax community if and once they gain traction, not in the least given the ambition to implement these plans on a global scale using further multilateral instruments. Actual implementation will not come overnight, but the course has been set.
Pillar 1 seeks to adapt the international income tax system to new business models through changes to the profit allocation and nexus rules applicable to business profits. Within this context, it expands the taxing rights of market jurisdictions (which, for some business models, are the jurisdictions where the users are located) where there is an active and sustained participation of a business in the economy of that jurisdiction through activities in, or remotely directed at, that jurisdiction. It also aims to significantly improve tax certainty by introducing innovative dispute prevention and resolution mechanisms. Pillar 1 seeks to balance the different objectives of Inclusive Framework members and result in the removal of relevant unilateral measures aimed at taxing highly digitalized businesses (e.g. digital service taxes).
The key elements of Pillar 1 can be grouped into three components: a new taxing right for market jurisdictions over a share of residual profit calculated at a multinational enterprise (MNE) group (or segment) level (Amount A); a fixed return for certain baseline marketing and distribution activities taking place physically in a market jurisdiction, in line with the ALP (Amount B); and processes to improve tax certainty through effective dispute prevention and resolution mechanisms in case of disagreements on the amounts of profit allocated to market jurisdictions.
The new taxing right (Amount A) applies broadly and is not limited to a small number of MNEs in a particular industry. However, the need to keep the number of MNEs affected at an administrable level is recognized, and thresholds and a phased implementation are considered. The key design features of the new taxing right include:
The purpose of Amount B is two-fold. First, it is intended to simplify the administration of transfer pricing rules for tax administrations and lower compliance costs for taxpayers. Second, Amount B is intended to enhance tax certainty and reduce controversy between tax administrations and taxpayers.
Amount B will standardize the remuneration of related party distributors that perform “baseline marketing and distribution activities”. The definition of baseline marketing and distribution activities covers distributors that (i) buy from related parties and resell to unrelated parties; and (ii) have a routine distributor functionality profile.
Further, the activities in-scope are first defined by a ‘positive list’ of typical functions performed, assets owned and risks assumed at arm’s length by routine distributors (based on a narrow scope, akin to limited risk distributors). A ‘negative list’ of typical functions that should not be performed, assets not owned and risks not assumed at arm’s length by routine distributors are also used to qualitatively measure the additional factors that would deem a distributor as being outside the scope of Amount B. Certain quantitative indicators are then used to further support the identification of in-scope activities.
Amount B will be determined in accordance with the arm’s length principle (ALP), therefore based on comparable company benchmarking analyses under the Transactional Net Margin Method (TNMM), with the quantum varying by industry, as well as region, provided any such variation is supported by the relevant benchmarking analysis. As a result Amount B will have a number of fixed points.
While there is consensus on the potential benefits from Amount B, in terms of tax certainty and as a simplification of the ALP, there remain divergent views on the range of baseline activities that should be included in its scope. This blueprint assumes that in-scope distributors are to be identified based on a narrow scope of baseline activities, which is a view shared by many Inclusive Framework members. There is interest, however, by some members to explore the feasibility of broadening the scope of Amount B.
The income inclusion and undertaxed payments rules (together, the GloBE rules) provide a systematic solution that is designed to ensure that internationally operating businesses pay a minimum level of tax regardless of where they are headquartered or the jurisdictions they operate in. As for Country by Country Reporting (CbCR), the application of the GloBE Rules is confined to MNE groups that have total consolidated group revenue above €750 million or equivalent in the immediately preceding fiscal year of the group. Investment funds, pension funds, sovereign wealth funds, government bodies, international organizations, and non-profit organizations are out of scope of these rules. Currently, it is still debated whether shipping companies will be out of scope.
To determine an MNE’s effective tax rate (ETR) under the GloBE rules, the MNE first determines its income for GloBE purposes and the covered taxes on that income. In the event that an MNE’s ETR is below the agreed minimum rate then the MNE will be liable for an incremental amount of GloBE tax that is sufficient to bring the total amount of tax on that income up to the minimum rate. To ensure transparency and a level playing field, the GloBE tax base is uniform across jurisdictions and will start with the financial accounts as prepared by the MNE in the jurisdiction of its headquarters. The minimum rate is not yet defined in this draft. The report addresses what constitutes a tax for the ETR calculation, the tax base, how to deal with government grants and credits, proposals for a formulaic substance-based carve-out based on payroll and tangible assets, whether the minimum ETR is determined on an entity or jurisdiction-level basis, how to deal with timing differences, how to calculate the ETR and proposals for exemptions.
The difference between an MNE’s actual ETR in a low-tax jurisdiction and the agreed minimum rate is referred to as the “top-up tax percentage” and the constituent entities located in the low-tax jurisdiction are referred to as “low-tax constituent entities”. Once the low-tax jurisdictions have been identified and the low-tax income and top-up tax percentage have been determined for each of those jurisdictions, the Income Inclusion Rule (IIR) and the Undertaxed Payments Rule (UTPR) operate to attribute that low-tax income and corresponding top-up tax to another constituent entity under the IIR or to determine the amount of adjustment to be made in respect of a taxpayer applying the UTPR.
Rules are proposed to scope out special situations such as joint ventures.
The GloBE rules are designed to ensure large MNEs pay a minimum level of tax on their income globally. The subject-to-tax rule complements these rules, but focuses on the bilateral context of tax treaties and the ability of source jurisdictions to protect themselves from the risks posed by BEPS structures which take advantage of low-tax outcomes in the other contracting jurisdiction. The subject-to-tax rule will incorporate the following design components:
The OECD considers preparing model legislation or a multilateral instrument that is a standalone public law instrument which ensures consistent, coordinated and comprehensive application of the GloBE /subject-to-tax rules. This instrument would exist alongside the Multilateral Instrument and the current bilateral treaties.