The landmark Organisation for Economic Cooperation and Development (OECD) deal, agreed by 136 countries and jurisdictions representing more than 90% of global GDP, aims to ensure all multinational enterprises (MNEs) will be subject to a minimum of 15% tax rate starting in 2023. It also reallocates more than $125 billion of profits from around 100 of the world’s largest and most profitable MNEs to countries worldwide. Today, we’ll discuss the deal and what it means to multinational enterprises.”
The 2007-2009 global financial crisis led to a significant dent in the tax revenues of many developed countries, as economic activity in various sectors of the global economy and tax collections contracted. For member countries of the Organisation for Economic Cooperation and Development (OECD), the crisis also presented a great opportunity to reexamine the international tax legal framework and how to reform it to match the ever-changing demands of a 21st century global economy. Thus, in February 2013, the first milestone in this colossal effort came in the form of a release, by the OECD and G-20 countries, of a report entitled Addressing Base Erosion and Profit Shifting (BEPS). In September of the same year, the OECD and G-20 countries adopted a 15-point Action Plan to Address BEPS. The Action Plan identified three pillars on which the reform of the international tax legal framework was based: Introducing coherence in the domestic rules that affect cross-border activities; reinforcing substance requirements in the existing international standards and improving transparency as well as certainty.
Action 1 focused on Addressing the Tax Challenges of the Digital Economy. The OECD released all the Action Plan final reports, including the Action 1 report, in 2015. Following the recommendations of the Action 1 report, member countries of the OECD’s BEPS Inclusive Framework (IF) got back to craft a new global legal framework on the taxation of digital economic activities. On October 8, 2021, the OECD announced that 136 of the 140 IF member countries had reached a final political agreement on a two-pillar corporate tax reform plan.
The Global Tax Reform Deal
The OECD global tax reform deal contains two pillars: Pillar 1 and Pillar 2. Pillar 1 seeks to revise profit allocation and nexus rules regarding digital economic activities to allocate a new taxing right to market countries. To achieve this goal, Pilar 1 has devised two amounts: A and B. amount A would ensure that in-scope companies (i.e., multinational enterprises with global turnover exceeding EURO 20 billion/USD 23 billion with profitability exceeding 10 percent) pay a portion of residual, or nonroutine, profits earned from activities in market jurisdictions even if they lack sufficient physical presence in such jurisdictions. Pilar 1 also contains a special nexus rule – the special purpose nexus rule – which would allow the allocation of Amount A to market countries when an in-scope MNE has at least EURO 1 million (USD 1,164,000) in revenue in a given market jurisdiction. The quantum of residual profits (defined as profits exceeding 10 percent of revenue) to be allocated to market jurisdictions is 25 percent.
Amount B, on the other hand, represents a fixed return for the baseline marketing and distribution activities an in-scope MNE undertakes in a market jurisdiction. This amount will be aligned with the arm’s length principle, and dispute prevention and resolution mechanisms to enhance tax certainty.
The second pilar – Pilar 2 – of the reform plan is designed to ensure that large MNEs (i.e., MNEs with annual revenue exceeding EURO 750 million/ USD 873 million) pay a minimum level of tax and will rely primarily on global anti-base-erosion (GLoBE) rules to achieve this purpose. Pilar 2 contains two key elements: The Income Inclusion Rule (IIR) and the Undertaxed Payments Rule (UTPR). The IIR would apply a top-up tax to an in-scope MNE’s income that is taxed below an effective tax rate of 15 percent. The UTPR, on the other hand, would deny deductions for payments that are taxed under the minimum tax rate of 15 percent. To address developing countries’ BEPS concerns, Pilar 2 also calls for an income tax treaty-based Subject-To-Tax (STT) rule, which allocates some taxing rights to source jurisdictions with respect to some related-party payments that are taxed below 15 percent.
Key Timelines in the Implementation of the Global Tax Reform Deal
Based on the detailed implementation plan annexed to the October 8, 2021, OECD/G20 BEPS Statement on a Two-Pillar Solution to Address the Tax Challenges Arising from the Digitalisation of the Economy, the following key timelines are worth noting:
- The OECD’s Task Force on the Digital Economy (TFDE) will develop a Multilateral Convention (MLC) to define and clarify the features of Amount A (e.g., elimination of double taxation, Marketing and Distribution Profits Safe Harbor, etc.), and negotiate its content to ensure that all jurisdictions committed to the global tax reform deal will be able to sign the MLC. The TFDE is tasked with concluding the text of the MLC and its Explanatory Statement by early 2022; with the expectation that the MLC will be open to signature and a high-level signing ceremony could be organized by mid-2022. Following its signature, jurisdictions will be expected to ratify the MLC as soon as possible, with the objective of enabling it to enter into force and effect in 2023 once a critical mass of jurisdictions, as defined by the MLC, have ratified it.
- The MLC will require all jurisdictions to remove all their unilateral Digital Services Taxes and other relevant similar measures with respect to all companies, and to commit not to introduce such measures in the future.
- The OECD’s Working Party 6 and the FTA (Forum on Tax Administration) MAP (Mutual Agreement Procedure) Forum will jointly define the in-country baseline marketing and distribution activities in scope of Amount B. Working Party 6 and the FTA MAP Forum will then jointly develop the rest of the Amount B components, with a view of releasing the Amount B final deliverables by the end of 2022.
- With respect to Pilar 2, the OECD will develop model rules by the end of November 2021. The rules will define the scope and set out the mechanics of the GLoBE provisions. A model income tax treaty provision will also be developed by the same November 2021 timeline in order give effect to the STTR. The model provision will be supplemented by commentary that will explain the purpose and operation of the STTR. This will be followed by a multilateral instrument (MLI), to be developed by the OECD by mid-2022, that will facilitate the swift and consistent implementation of the STTR in relevant bilateral income tax treaties.
- The OECD will develop, by the end of 2022, an implementation framework that will facilitate the coordinated implementation of the GLoBE rules. The implementation framework will cover agreed administrative procedures (e.g., detailed filing obligations; multilateral review processes, etc.) and safe harbors to facilitate compliance by MNEs and administration by tax authorities.
Implications of the Tax Reform Deal to U.S. Multinational Entities
The global consensus that has coalesced around the OECD’s Inclusive Framework on the BEPS initiative has achieved significant milestones to date. However, as the foregoing section on Key Timelines indicates, this initiative, particularly the implementation of the Action 1 report, is still very much work in progress. Thus, it is not possible to analyze fully how the global tax reform initiative will impact U.S. multinational entities at least until the texts and provisions of the instruments that will implement it are fully developed. Below I highlight a few significant implications U.S.-based multinationals should bear mind regarding the global tax reform plan.
Implementing the Plan under U.S. Federal Income Tax Law: The multilateral convention and multilateral instrument the OECD will be developing to implement Pillars 1 and 2 will require significant modifications to existing U.S. bilateral income tax treaties with other countries. Under the U.S. constitutional framework, these multilateral treaties, and existing bilateral treaties that will be amended to give effect to the terms of the multilateral treaties, will require the U.S. senate approval to become a part of the U.S. federal tax legislative framework. The U.S. senate approval requires a two-thirds majority of senators. Given that the current U.S. senate composition is a 50:50 split between Democrats and Republicans (with the vice president’s vote giving the Democrats a slim majority), the one procedural question that looms large over the global tax reform plan is how it is going to be implemented in the U.S. The U.S. Treasury Secretary, Janet Yellen, has been quoted in the press as indicating that the executive branch can implement Pillar 1 of the plan without the U.S. senate approval, but she hasn’t elaborated on how that can be achieved. Given the current U.S. constitutional framework, there is hardly any precedent on how the executive branch can successfully bypass the U.S. senate in the implementation of this monumental deal.
Repeal of Unilateral Digital Services Taxes: Many countries around the global, including Austria, France, Italy, Spain, and the United Kingdom, enacted and implemented unilateral Digital Services Taxes (DSTs) as the OECD-led negotiations for a multilateral tax reform deal were going on. These countries have signed onto the global tax reform deal. The deal requires them to repeal their unilateral DST provisions and prohibits them from introducing new ones in the transition period leading to its implementation. U.S.-based MNEs with operations in these countries should expect to see legislative and other efforts to repeal or unwind unilateral DSTs, and these efforts will intensify as the world inches closer to the implementation of the deal. The repeal of unilateral DSTs will also incentivize the United States to remove existing U.S. trade tariffs on countries with DSTs, which the U.S. considers to be discriminatory against U.S. MNEs.
Proposed GILTI Tax Reforms: The OECD global tax reform plan provides for an accommodation for the U.S.’s Global Intangible Low-Taxed Income (GILTI) regime. Regarding the implementation of Pilar 2, the plan statement indicates that consideration will be given to the conditions under which the U.S. GILTI regime will co-exist with the GLoBE rules, and this will be done to ensure a level playing field. In September, the U.S. House Ways and Means Committee Democrats released a draft text for a bill that addressed in detail many international tax changes to the Internal Revenue Code. Among the provisions of the bill is a proposal to increase the GILTI tax rate from the current 10.5% to 16.5625% (the increased rate would still fall short of the Biden Administration’s earlier proposal to increase the rate to 21%), and to determine the GILTI tax liability on a country-by-country basis. If the U.S. Congress increases the GILTI tax rate to 16.5625%, GILTI income inclusions would be subject to tax in the United States at a rate that is higher than the global minimum corporate tax rate of 15% under Pilar 2’s GLoBE regime. This, in addition to the intent to accommodate the U.S. GILTI regime in the implementation of Pilar 2, implies that U.S.-based businesses already subject to the U.S. GILTI regime are unlikely to be burdened further when Pilar 2 comes into force.
Repeal of the Jurisdictional Nexus Requirement for Claiming Foreign Tax Credits in the United States: To stem the tide of countries enacting unilateral DSTs around the globe, the Internal Revenue Service (IRS) issued proposed regulations in November 2020 that would deny U.S.-based MNEs foreign tax credits for DSTs paid in market jurisdictions in certain circumstances. The proposed regulations introduced a controversial jurisdictional nexus requirement for the creditability of DSTs. Under this requirement, a U.S. taxpayer would have to have a jurisdictional nexus (e.g., physical presence) with a foreign taxing jurisdiction for the taxpayer to claim a foreign tax credit for the income taxes paid in that jurisdiction. The jurisdictional nexus requirement was designed to have a chilling effect on both countries enacting unilateral DSTs, rather than concentrating their energies on negotiating a multilateral tax reform deal under the OECD’s BEPS initiative, and U.S.-based multinational entities investing in those countries. Given that an OECD-led global tax reform deal has been reached and countries with DSTs have undertaken to repeal those unilateral initiatives as a part of the effort to implement the deal, the IRS, too, is likely to amend the proposed regulations to remove the jurisdictional nexus requirement (or to finalize these regulations without such a requirement).
At Drucker & Scaccetti, we will keep monitoring developments regarding the implementation of the OECD global tax reform deal, and we will keep our clients updated on these developments. If you would like to discuss how these developments may affect your business operations, please contact us.
 To ensure consistency in the approach taken by jurisdictions and to support domestic implementation consistent with the agreed timelines and their domestic legislative procedures, the TFDE will develop model rules for domestic legislation by early 2022 to give effect to Amount A.