Background: The BEPS Project and Transfer Pricing
Under the OECD/G20 Base Erosion and Profit Shifting (BEPS) Project, more than 135 countries are working together to tackle International tax avoidance, align international tax rules, and encourage a fairer, more transparent tax environment for all. Addressing the tax challenges raised by digitalization of the global economy has been a top priority of the OECD/G20 Inclusive Framework on BEPS since 2015 with the release of the BEPS Action 1 Report. The Action 1 Report recognized that digitalization of the economy raises broader tax challenges relating to taxing rights on income generated from cross-border activities.
The Action 1 Report called for continued work with a further report to be delivered in 2020. That day arrived on October 12, 2020 when the OECD officially released the Pillar One and Pillar Two reports described as “blueprints”. Although not the finished consensus documents contemplated to have been completed by the end of 2020, the reports reflect significant progress, and a new tentative deadline was set for mid-2021. Unsurprisingly, progress this year was slowed due to the COVID-19 pandemic as well as significant political differences among interested parties.
Pillar One and Pillar Two Reports
The Blueprint for Pillar One focuses on new nexus and profit allocation rules so that taxing rights are not as dependent on physical presence, which is of extreme importance in the digital age. The Blueprint for Pillar Two proposes a minimum level of tax that all international businesses must pay, although the exact rates and rules are left to individual tax jurisdictions to decide. Although no decision has been made yet, the US GILTI regime, which results in its own form of minimum tax on foreign profits of US multinational enterprise, may co-exist with Pillar Two. US multinational enterprises would remain subject to GILTI and not the Pillar Two rules. After several years of wrangling over difficult issues arising from the digital economy and proposing solutions in the form of detailed blueprint reports, one might wonder whether the efforts are expected to generate net gains in CIT revenues around the world, buttressing government budget shortfalls and funding social priorities. According to the OECD’s companion report to the Pillar One and Pillar Two Reports, entitled Economic Impact Assessment, the answer is a resounding…not so much.
Economic Impact Assessment
Implementing Pillar One and Pillar Two is estimated to raise global corporate income tax (CIT) revenues of $50-80 billion annually. This represents just 1.9 to 3.2 percent of global CIT revenues. Pillar Two, by imposing a minimum level of tax, could yield an increase in CIT revenues across a wide range of jurisdictions, and also reduce the incentives for businesses to shift profits to low-tax jurisdictions. The combined increase in taxes is estimated at $42-70 billion, comprised of direct gains collected through the minimum tax ($23-42 billion) and revenue gains from reduced profit shifting ($19-28 billion).
Pillar One is estimated to add only another $5-12 billion in global CIT revenues. The main effect of Pillar One is to change the way taxing rights are allocated among jurisdictions, as taxing rights on about $100 billion of profit could be reallocated to market jurisdictions under the Pillar One rules. ‘Investment hubs’ are expected to lose tax revenues as a result.
How might your organization be affected? How will you react?
As demonstrated above, Pillars One and Two are unlikely to generate significant global CIT revenue, but they can significantly impact your own organization, especially for highly profitable multinational enterprises in digitalized and intangible-intensive sectors. Now is the time to assess the Pillar One and Pillar Two proposals, model potential tax ramifications considering your company’s global footprint and transfer pricing policies, and develop a range of possible mitigating strategies should the proposals come to fruition.
Global Tax Management is closely monitoring the implications of Pillar One and Pillar Two and will continue to update you on any significant changes as they occur. For more information, contact me at firstname.lastname@example.org.