In 2015, more than 130 countries collectively known as the OECD/G20 Inclusive Framework on Base Erosion and Profit Shifting, or IF, partnered to create the BEPS program. The international collaboration is designed to “equip governments with domestic and international rules and instruments to address tax avoidance, ensuring that profits are taxed where economic activities generating the profits are performed and where value is created.”
The latest BEPS recommendation is comprised of two pillars that outline recommendations for countries to implement. Pillar One proposes a series of guidelines around the allocation of profits and taxation rights and the associated tax nexus. Pillar Two is referred to as the Global Anti-Base Erosion Proposal, or “GloBE.” It proposes to provide countries with a right to “tax back” when other countries have not imposed a minimum level of tax or not exercised their taxation rights. The overarching goal: Address the taxation challenges posed by economic digitalisation to ensure that internationally operating businesses are subject to a minimum tax rate.
Under most existing tax laws, a physical presence is required to trigger a local taxable presence, or permanent establishment. This concept has become outdated in our digital economy. Multinational enterprise (MNE) groups may now provide services electronically across borders to countries where they may not have a physical presence, thereby avoiding local tax obligations. Many experts assert that MNEs can exploit technology and differences in local tax rules to aggressively manage what tax they pay and where they pay it.
The BEPS framework provides recommendations to combat aggressive tax avoidance, but these recommendations must be implemented at each country’s discretion. There is still no international consensus on taxation, so mismatches remain and can be exploited by MNEs. In the absence of a global tax structure, some countries have enacted their own rules to collect taxes from MNEs that do not have a local physical presence. Examples include Australia’s diverted profits tax (sometimes called the “Google Tax”) and the UK’s digital services tax.
While broad alignment on a comprehensive, standardised international tax architecture has remained elusive, agreement on the core principles may now be within reach.
Latest efforts from the G20 to implement an equitable global tax architecture
In July, the Inclusive Framework countries met and agreed to back a comprehensive proposal on global tax reform. A joint statement from the finance ministers declares this “a historic agreement on a more stable and fairer international tax architecture.”
This attempt at standardising international architecture is complex and structured in relation to the two BEPS pillars. Below are some key elements of the agreed-on components. It's important to remember that these elements are still subject to further consultation and agreement.
- MNEs with a global turnover above €20 billion and profitability over 10 percent will be subject to the new regulations. Over time, and pending successful implementation, the threshold may be reduced to €10 billion.
- Measures will be taken to relieve double taxation.
- The package will provide “appropriate coordination” between a new international tax structure and the removal of all digital services taxes (DSTs) and similar measures.
- This element may apply to MNEs that meet the €750 million threshold (determined under BEPS Action 13, country-by-country reporting). In cases where a jurisdiction does not meet the minimum corporate tax rate (15 percent under the current proposal), cross-border income that is not taxed at least the minimum rate may be “topped up” by authorities in certain jurisdictions, depending on the scenario.
- A minimum tax rate of 15 percent will be implemented for the purposes of the GloBE rules.
- The package establishes a Subject to Tax Rule (STTR) with a minimum rate between 7.5 to 9 percent.
- All G20 countries have backed a proposed global minimum tax of at least 15 percent.
Support for this proposal marks a pivot for the US, which was previously resistant to a minimum tax rate, citing that it would unfairly affect American tech companies. US participation in this IF accord is likely contingent on countries rolling back their national digital services taxes or similar initiatives, a principle included in the OECD’s statement. The current statement also highlights coexistence with the US’ global intangible low tax income (GILTI), but the details of that arrangement have yet to be determined and could affect compliance requirements for US-based companies.
What changes to the international tax framework may mean for businesses
Although the recent IF agreement is certainly a marker of progress towards a standardised tax architecture, it’s likely that we have a long way to go before businesses are affected by any new regulations. Many of the specifics in this two-pillar tax architecture have yet to be determined, and it remains to be seen whether countries can come to agreement on the details.
Along with thresholds, the OECD statement includes carve-outs and other exclusions, such as an exclusion for financial services, with more likely to follow. It’s important to keep in mind that significant consultation and implementation challenges lie ahead for IF authorities. For instance, Pillar One of the BEPS framework shifts the basis of taxation for around 100 MNEs. Enacting this new agreement would effectively create two different international tax frameworks, pushing leaders to develop criteria to determine which multinational corporations are affected.
It’s likely that this proposal will be met with resistance from some countries, including Ireland and Hungary. Neither has signed the OECD's two-pillar statement and each has a corporate tax rate below the proposed 15 percent minimum. Establishing a minimum tax of 15 percent would likely only be accomplished through an EU directive, which requires backing by all 28 countries in the union, including of course Ireland and Hungary. They will want to protect their own interests by maintaining their low corporate tax rates, which attract inward investment.
The G20 will convene again in October to finalise an accord. For now, multinational organisations should be looking at their current tax positions as well as what services they are providing and where. This will put them in a good position to review the impact of, and effectively adapt to, any new proposed global tax changes if and when they are implemented.
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