Aug 25, 2021

The OECD Two-Pillar Plan: A Joint Solution to a Global Tax Problem

According to the OECD Secretary-General Report to G20 Finance Ministers dated July 1, 2021 (OECD Report), 130 member jurisdictions of the G20/OECD Inclusive Framework on BEPS (Base Erosion and Profit Shifting), representing more than 90% of the global GDP, joined an agreement for the two-pillar plan to reform current international tax rules and to address tax challenges, including those arising from an increasingly digital economy.

Since the release of the OECD Report, three additional member jurisdictions have joined the agreement, bringing the total up to 133 (out of 139 total members) as of August 12, 2021. Notably, the U.S., Russia, China, and India have all signed on. But what about the six remaining countries that have not joined and may choose not to join in the foreseeable future?  In an interview with Pascal Saint-Amans, Director of the Center for Tax Policy and Administration at the OECD, he suggested that so long as the agreement reaches critical mass (which it appears to have done), the agreement will make a global impact.

Under Pillar One, approximately one hundred of the world’s largest multinational enterprises (MNEs) will be subject to new rules to reallocate a portion of their profits to “market jurisdictions with a nexus.”  In other words, a country’s right to tax a company will be more closely aligned with that company’s revenue sources, with revenue sourced to its end market jurisdictions (or where goods and services are used or consumed), rather than focusing on a company’s physical presence under current tax rules.

Under Pillar Two, which applies to hundreds more MNEs, member countries have agreed to a minimum tax rate of 15%. Unquestionably, there are exclusions and carve-outs that are included in the two-pillar approach. For example, mining companies and regulated financial services are excluded from Pillar One and Pillar Two. The basis for their exclusion is that profit is already tied to the place where it is earned. Shipping companies are another business type that is excluded due to the practical aspects of applying sourcing rules to shipping activities.

While neither the OECD Report nor the interview with Pascal Saint-Amans directly explained how the OECD arrived at the 15% minimum rate, Saint-Amans did point out that the current effective tax rates paid by MNEs are nowhere near 15% (and further suggested that actual rates hover closer to the 3-7% range).

Business communities are justifiably concerned, not only with whether there would be a rise in their tax costs but also with the potential cost and complexity of compliance, whether the new rules would effectively provide more tax certainty for all companies, and whether a two-pillar approach will truly strike a balanced deal.

If the two-pillar plan can effectively address all (or at least most) of the concerns described above, then the member countries and jurisdictions will more likely cooperate with each other and coordinate their respective countries’ tax rules. If not, there could be a loss in political momentum for the members to finalize the agreement.  Even if finalized, member countries may slowly re-incorporate carve-outs, exclusions, and exceptions into their domestic legislation.

Notably, at the heart of this decades-long effort to work on a joint plan to reallocate and redistribute profits is an underlying consensus by member countries and jurisdictions that a predictable, efficient and sustainable international tax system is critical to an ecosystem of economic growth and global welfare. As the OECD pointed out, a clear, consistent, and coordinated tax system lies in its balance. Without that delicate balance sensed by most (if not all) of its members, the progress made thus far could stall, and countries could instead start taking unilateral actions, thereby negatively affecting investment and economic growth and the ability of governments to raise revenue for necessary expenditures.

A lot of progress has indeed been made, and last month marked a turning point as member jurisdictions representing over 90% of the global GDP agreed to work together toward a multilateral solution to a global, present-day tax issue. But to carry the two-pillar plan to fruition, that delicate balance to be struck will require evermore coordination, cooperation, and, perhaps most importantly, patience.

While the agreement is set to be finalized in October 2021, additional technical details are expected to be hammered out in 2022. These include an implementation plan, model legislation, guidance, and a multilateral treaty. Finally, the actual implementation is expected to begin in 2023.

Companies and businesses need to be resilient and adapt to changing circumstances in order to survive, whether that circumstance is a global pandemic or a global tax. As the technical developments of the two-pillar plan continue to unfold, MNEs must consider the potential impact that these new rules will have on their business and recalibrate accordingly.

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