130 countries signed last week the global agreement on international tax reform, based on a two-pillar solution which allows multinational companies to pay more tax in the countries where they operate as well as a global minimum tax rate.
As estimated by the OECD, a total amount of USD 100 billion of profits per year will be reallocated to the market jurisdictions, under the rules agreed in Pillar One. Companies within scope include the largest MNEs with global turnover above 20 billion euros and profitability above 10% (profit before tax/revenue) with the turnover threshold to be reduced to 10 billion euros over time, subject to conditions. Financial services and extractive industries will be excluded from the agreement. The agreement creates new nexus rules, for a market jurisdiction where the MNE derives minimum 1 million euros in revenue from that jurisdiction. For smaller jurisdictions with GDP lower than 40 billion euros, a minimum of 250 000 euros is required to trigger the new nexus and bring the MNE within scope. In terms of revenue allocation, according to the agreement 20-30% of the residual profit (profit in excess of 10%) will be allocated to market jurisdictions using a revenue-based allocation key. Profitability of the in-scope companies will be determined with reference to financial accounting income, and loss carry-forward will be allowed.
The global minimum corporate income tax under Pillar Two set at 15% will generate USD 150 billion in additional global tax revenues annually. OECD also estimates additional revenue due to the stabilisation of the international tax system after years of uncertainty and patchwork of newly introduced rules concerning the digitalising economy. The global minimum tax is intended to be applied via specific sets of rules:
- Income Inclusion Rule, top-up tax on a parent company concerning the low-taxed income of the subsidiary/ constituent entity;
- Undertaxed Payment Rule, which allows adjustments or denies deduction if the low-tax income of the subsidiary/ constituent entity is not subject to tax under an income-inclusion rule;
- Subject to Tax Clause, a double tax treaty-based rule that allows source jurisdictions to impose source taxation on associated party payments below the minimum rate. These amounts will be creditable as a covered tax for tax treaty purposes.
The effective tax rate will be calculated on a jurisdictional basis using a common definition of covered taxes and a tax base determined by reference to financial accounting income. The rules provide for de minimis exemptions and substance carve-out that will exclude income of 5 – 7,5% of the carrying value of tangible assets and payroll. Further technical detail is yet to be discussed, with further updates expected in October 2021. Commenting the new OECD Secretary-General Mathias Cormann said: “After years of intense work and negotiations, this historic package will ensure that large multinational companies pay their fair share of tax everywhere. This package does not eliminate tax competition, as it should not, but it does set multilaterally agreed limitations on it. It also accommodates the various interests across the negotiating table, including those of small economies and developing jurisdictions. It is in everyone’s interest that we reach a final agreement among all Inclusive Framework Members as scheduled later this year,” Mr Cormann said.
The international community welcomed the agreement, facilitated by the recent proposals from US President Biden. Countries that refused to sign the agreement include Estonia, Hungary, Ireland, Kenya, Nigeria, Sri Lanka, Barbados, St Vincent & the Grenadines. Peru abstained due to absence of government. Cyprus announced that it will veto the adoption via EU directive. Harmonised EU implementation could be hampered due to the unanimity requirement for tax-related directives at EU level.
Ref. CFE’s Tax Top 5 – 5 July 2021