The Organisation for Economic Cooperation and Development (OECD) has been spearheading discussions on reforming international tax with the Base Erosion and Profit Shifting (BEPS) initiative. The July proposals, 'Statement on a Two-Pillar Solution to Address the Tax Challenges Arising From the Digitalisation of the Economy' [PDF, 175kb] outline in greater detail how Pillar One (Digital taxation) and Pillar Two (international minimum tax) will be implemented.
Pillar One - Re-allocation of taxing rights
The Pillar One proposals will apply to large multinational enterprises (MNEs) that have global sales of more than €20 billion and profitability greater than 10% (income before taxes/sales). These thresholds will be based on financial accounting income which will have a limited number of adjustments. The MNEs subject to Pillar One are not limited to digital businesses. Extractive and regulated financial services have obtained a carve-out from this proposal.
The objective of Pillar One is to transfer a portion of taxation rights from the jurisdiction of residence to the market jurisdictions, ie where the MNEs clients are located. The exact portion of profits to be reallocated has not been finalised. The July proposals indicate that between 20% and 30% of profits in excess of 10% of revenue will be allocated to market jurisdictions in which the MNE is considered to have taxable nexus. The allocation will be done using a revenue-based allocation key.
Profits will be allocated to a market jurisdiction if the revenues in that jurisdiction exceed a specified threshold. The revenue threshold depends on the gross domestic product (GDP) of of the jurisdiction and is proposed as:
- GDP of less than €40 billion: €250,000
- GDP of €40 billion or more: €1 million.
The determination of the income in the market jurisdiction will be based on where goods and services are used or consumed. Detailed source rules for specific categories of transactions will be developed and the methodology will have to consider the specific facts and circumstances of a particular MNE.
In many instances, profits may already be allocated to a market jurisdiction in the MNEs existing structure. In these situations, a marketing and distribution profits safe harbour will cap the residual profit that is allocated to the market jurisdiction. Further work on the safer harbour is being conducted.
With respect to baseline marketing and distribution activities, the application of the arm’s length principle will be streamlined and simplified. This work is expected to be completed by the end of 2022.
The Pillar One proposals will result in a significant shift of profits between jurisdictions. This will require mechanisms to ensure that double taxation does not occur via either a credit or exemption mechanism. The shift in profits will create risks of double taxation as jurisdictions may not implement the rules in the same way. These differences will be resolved via dispute resolution and prevention mechanism that will be mandatory and binding.
The legislative mechanism that will be used to implement will be via a multilateral instrument (similar to the one that was recently entered into with respect to treaty modifications). The OECD expects that the Pillar One multilateral instrument will be opened for signature in 2022, with a projected implementation in 2023.
The €20 billion sales threshold is expected to be reduced to €10 billion following a review that will begin seven years after the Pillar One agreement is adopted.
Pillar Two - Global anti-base erosion mechanism
The basic objective of Pillar Two is to establish a minimum taxation level on a country-by-country basis. The basic cadre of the proposals is to introduce Global anti-Base Erose Rules (GloBE). These proposals will apply to more taxpayers than the Pillar One proposals as the threshold is set at €750 million of sales, which is the existing threshold for country-by-country transfer pricing reporting.
The July proposals indicate that countries can introduce Pillar Two measures at a lower threshold. Hence, these proposals could eventually apply to small and medium entities (SME). Government entities, international organisations, non-profit organisations, pension funds and investment funds that are the Ultimate Parent Entities (UPE) are not subject to the GloBE rules. The only industry specific exclusion mentioned is for international shipping income.
The minimum rate will be at least 15%. The computation will be based on a common definition of covered base and the tax base will be determined with reference to financial accounting income (with similar adjustments as those considered under Pillar One).
A lower range of rates (between 7.5% and 9%) is proposed for certain income sources (interest royalties and a defined set of other payments) that are within the ambit of the ‘Subject to Tax Rule’ discussed below.
The July proposals reiterate an extensive collection of mechanisms that could be used to achieve a minimum level of global taxation.
Income Inclusion Rule (IIR) - The IIR imposes a top-up tax on the parent entity for low taxed income in a constituent entity. The IIR will allocate a top-up tax based on a top-down approach.
Undertaxed Payment Rule (UTPR) - The UTPR denies deductions or requires an equivalent adjustment to the extent the low tax income of a constituent entity is not subject to an IIR. This is a base erosion rule similar to the US’s Base Erosion and Anti-abuse Tax (BEAT).
Subject to Tax Rule (STTR) - The STTR is a treaty-based rule that allows a source jurisdiction to impose source taxation on certain related party payments subject to tax below a minimum tax rate in the country of residence of the recipient. The STTR will be creditable as a covered tax under the GloBE rules (whether IIR or UTPR).
Importantly, they also indicate that consideration will be given to the conditions under which the US Global Intangible Low Taxed Income (GILTI) regime can coexist with the GloBE proposals. This concession is important to ensure that the US will be onside with the Pillar Two proposals.
The OECD indicates that the Pillar Two proposals should result in a robust global minimum tax with a limit on MNEs carrying out real economic activities with substance. An implementation plan for Pillar Two will be released and it is expected that Pillar Two should be legislated in 2022 with an effective implementation in 2023.
One should note that Base erosion and profit shifting (BEPS) Action 1 – tax challenges arising from digitalisation, is not part of the minimum standards for which Singapore has agreed on as a member of the inclusive framework. However, by agreeing on the said blueprint and given that many multinationals have substantial presence in Singapore, it is inevitable that Singapore will be impacted by the developments.
The July proposals have provided the tax community with additional information on Pillar One and Pillar Two. There however remain many details to be determined and the OECD has committed to providing a detailed implementation plan in October 2021.