Multinational enterprises are facing the biggest shake-up in international taxation for a generation. In October 2021, more than 130 countries, including the U.S., China and India, agreed to implement the Organisation for Economic Co-operation and Development’s (OECD’s) two-pillar solution on taxing the digital economy and large global companies. Briefly, Pillar 1 sets up a framework for signatories to tax online sales for multinationals while Pillar 2 holds those countries to impose a minimum 15% tax on corporations.
For a full discussion of this new framework, see a replay of our recent webcast, “Global Developments in International Tax
Pillar 1 will usher in a reallocation of taxing rights to countries reflect an increasingly digitized global economy. According to new Pillar 1 provisions, some businesses will no longer just pay tax where they have a “bricks and mortar” physical presence. They will also need to register and pay tax where they create value, including e-commerce sales initiated outside the jurisdiction.
There is a high threshold of qualification for businesses to qualify for Pillar 1 taxation – a €20 billion global turnover and pre-tax profit margin of more than 10% of revenue. There are also sector exclusions for regulated financial services and extractive industries. In practice, this means that the new rules will only apply to around 100 corporate giants worldwide, though there is scope to review and reduce the qualifying threshold in coming years.
In a widely welcome move, the agreement would put an end to the patchwork of unilateral digital taxes that have sprung up in recent years. Signatory nations have agreed not to impose any new digital taxes in their jurisdictions and withdraw existing ones once the new rules go into effect worldwide.
Fair share of tax
In another major step, the signatories also agreed to impose a minimum 15% corporate tax to apply across all their countries -- OECD Pillar 2. The 15% minimum tax seeks to end the “race to the bottom” on tax rates worldwide where countries are competitively cutting corporate taxes to attract businesses and consequently forcing all countries to cut taxes to compete. In a further clampdown on aggressive tax planning, Pillar 2 would also make it much harder to minimize taxes by recording profits in low-tax jurisdictions while recording the costs in high-tax counterparts.
Crucially, the threshold for qualifying for the Pillar 2 minimum tax floor is much lower than Pillar 1 – a €750 million global turnover.
The agreement is a landmark in both how many economies have signed up and how quickly it has been finalized. The signatories include all the G20 economies, along with the majority of other OECD members.
Reflecting the political pressures driving these changes, the signatory countries have pledged to pass the rules into national legislation in 2022 and bring them into force in 2023.
Depending on the size of the business and the nature of its international operations, the need to bring taxation in line with the new laws will increase the number of permanent establishments and require a rethink of group structures and transfer pricing. In practice, this means aligning tax strategies and business models more closely.
Local legislative approval isn’t a given. In particular, without enactment in the U.S., the agreement could quickly unravel. The Biden administration played a strong role in driving the agreement over the line. But a two-thirds majority in the Senate would normally be needed to pass this kind of international treaty into law. Securing such support may be difficult. There is talk of using presidential executive authority to get around any hold-up in the Senate. For now, however, progress is by no means certain.
More generally, governments worldwide will be looking at whether the global agreement delivers what they believe is their rightful share of taxes. If it doesn’t, and consensus breaks down as a result, businesses could be left with the worst of all possible worlds. In particular, the situation could return to countries going it alone, with and all the discrepancy, complexity and instability this entails.
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