OECD Inclusive Framework

OECD Pillar One and Pillar Two explained

With its sweeping international tax reforms, the OECD two-pillar solution seeks to address pressing challenges that have developed as a result of digitalization of the global economy. Bloomberg Tax helps you stay ahead of these cross-border tax issues and effectively manage your corporate tax planning strategy with in-depth expert analysis, news, practice tools, and compliance guidance.

Your international tax connection

Take your international tax planning to the next level with expert insights and practitioner perspectives to help you respond appropriately and effectively to global tax developments.


GUIDE

OECD Global Minimum Tax: Pillar Two GloBE Decision Tree

Download the interactive flowchart for a step-by-step guide through Pillar Two requirements.

REPORT

OECD Pillar Two GloBE Rules: Status and Effective Dates Roadmap

This roadmap provides a high-level overview of the implementation status of the GloBE Rules across the Inclusive Framework jurisdictions.

ONPOINT

Pillar Two Safe Harbors and Penalty Relief

This OnPoint slide deck presentation outlines the new Safe Harbor and Penalty Relief coordinated system under the Pillar Two GloBE Rules that apply to multinational entities.

While the digital economy has grown substantially over the last three decades, international tax regulations have struggled to keep pace. This digitalization has changed the landscape for businesses that operate in foreign markets and undermined traditional tax structures. Because e-commerce enables goods and services to be sold around the world, businesses are no longer required to have a permanent establishment, or a physical presence, where they do business. This lack of physical presence means that e-commerce revenue may not enter a jurisdiction’s financial system and makes it harder for those taxing authorities to monitor transactions and enforce tax laws.

As a result, some multinational companies have avoided paying taxes using accounting techniques and international tax planning strategies that exploit differences in tax regulations to manage their tax liability in a manner that works against the tax collecting authorities where they do business.

What is base erosion and profit shifting?

Base erosion and profit shifting (BEPS) is a tax planning strategy implemented by multinational companies that involves exploiting gaps and mismatches in tax rules to avoid paying tax, such as moving profits to low- or no-tax jurisdictions where there is little or no economic activity. BEPS reduces tax bases through deductible payments, such as interest or royalties.

While some of these practices are illegal, most aren’t. But the use of BEPS practices can mean that countries – including developing countries, which rely more heavily on corporate taxes – don’t receive the tax revenue they would have otherwise. In fact, BEPS actions cost countries between $100 billion and $240 billion in tax revenue each year, according to the Organisation for Economic Co-operation and Development (OECD).

Some countries have tried to navigate these digital taxation issues themselves by levying digital services taxes (DSTs) to protect their tax base and tax revenue from certain digital commercial activities that occur within their jurisdiction. However, these DSTs can create the potential for double taxation, and don’t address the underlying issue of tax law and rate differences between jurisdictions.

What is the OECD Inclusive Framework?

Since 2013, the OECD has led the coordinated global governmental response to the challenges stemming from the rise of the digital economy. The scope of this BEPS initiative reflects how dramatically the operating environment has changed.

The OECD, which brings together 38 member countries and a range of partners to collaborate on key global issues, has been working with governments, policymakers, and citizens around the globe to develop its OECD/G20 Inclusive Framework on BEPS. Specifically, OECD and G20 member countries, along with participating developing countries, aim to standardize international taxation by establishing a “modern international tax framework to ensure profits are taxed where economic activity and value creation occur,” the OECD notes.

The BEPS package “equips governments with the domestic and international instruments needed to tackle tax avoidance” in addition to giving businesses “greater certainty by reducing disputes over the application of international tax rules,” according to the OECD.

Currently, the OECD/G20 Inclusive Framework members have agreed to a solution to address these noted tax challenges through a two-pillar proposal, known as Pillar One and Pillar Two.

OECD Pillar One summary

Pillar One of the OECD Inclusive Framework establishes new nexus and profit allocation rules and will require changes to both domestic tax law and double tax treaties. It uses revenue sourcing rules to determine whether revenue derives from a market jurisdiction, and profit allocation rules to allocate profits to those market jurisdictions. Pillar One eliminates double taxation and clarifies filing and payment requirements.

Multilateral instrument to prevent BEPS

As part of Pillar One, the Multilateral Convention to Implement Tax Treaty Related Measures to Prevent BEPS – also known as the Multilateral Instrument or the MLI – supplements and modifies existing income tax treaties to eliminate double taxation and remove the need for governments to bilaterally negotiate international tax treaties. The MLI entered into force on July 1, 2018.

The MLI includes minimum standards, which are provisions that must be adopted by every signatory to the MLI, as well as optional provisions. These mandatory minimum standards seek to “tackle issues in cases where no action by some countries would have created negative spillovers (including adverse impacts on competitiveness) on other countries,” such as with the issues of dispute resolution and combating harmful tax practices, according to the OECD.

Specifically, these minimum standards relate to:

  • Preferential tax regimes (Action 5)
  • The exchange of information on tax rulings (Action 5)
  • The prevention of treaty abuse (Action 6)
  • Reexamination of transfer pricing documentation (Action 13)
  • Dispute resolution (Action 14)

According to the OECD, more than 140 countries and jurisdictions are working to implement the BEPS package’s 15 Actions to tackle tax avoidance, improve the coherence of international tax rules, and ensure a more transparent tax environment. As of Jan. 17, 2024, there are 102 signatories and parties to the MLI.

What’s the economic impact of Pillar One?

Pillar One’s new nexus and profit allocation rules expand the taxing rights of market jurisdictions regardless of physical presence. For instance, under the draft nexus and sourcing rules for the OECD Pillar One Amount A, nexus is triggered when, over a 12-month period, an in-scope multinational enterprise derives at least €1 million in revenue from a market jurisdiction. For smaller jurisdictions with a GDP of less than €40 billion, the nexus is €250,000.

Pillar One also establishes a fixed return for baseline marketing and distribution activities and improves tax certainty through effective dispute prevention and resolution mechanisms.

Pillar One reallocates the profits of approximately 100 of the world’s largest and most profitable multinational enterprises to market jurisdictions: those with global turnover of more than €20 billion and a profitability margin of more than 10%, calculated using an averaging mechanism. The turnover threshold can be reduced to €10 billion upon the successful implementation of the Pillar One proposals, including the tax certainty aspects.

OECD Pillar Two summary

Pillar Two ensures multinational enterprises (MNEs) pay a global minimum tax of 15%, regardless of where the headquarters are located or the jurisdictions in which the company operates. Pillar Two establishes this minimum effective tax rate (ETR) for large MNEs through its Global Anti-Base Erosion (GloBE) rules – two interlocking domestic rules known as the Income Inclusion Rule and the Undertaxed Payments Rule – which calculate and impose additional top-up taxes if the ETR falls below the 15% minimum.

Pillar Two is expected to bring in about $150 billion in additional global tax revenues annually, along with the stabilization of the international tax system and increased tax certainty for taxpayers and administrations.

How Pillar Two is reshaping the digital global economy

Tax Law Analyst Alexis Sharp breaks down the importance of GloBE rules and the Subject to Tax Rule, which are key components of the OECD’s Pillar Two.

Who does Pillar Two apply to?

Pillar Two applies to large MNEs that meet the requisite revenue threshold – targeting approximately 2,000 corporations – and seeks to ensure that these MNEs pay a minimum level of tax by applying the GloBE rules and Subject to Tax Rule.

The Subject to Tax Rule is a treaty-based rule that allows source jurisdictions to impose limited source taxation on certain base-eroding payments between related parties subject to tax below 9%. For example, if a jurisdiction applies a 5% tax rate for royalty receipts, a 4% top-up tax could be collected by the payer’s jurisdiction.

The GloBE rules apply to multinational enterprises and their subsidiaries that have annual gross revenues of €750 million in the consolidated financial statements of the Ultimate Parent Entity (UPE) in at least two of the four fiscal years immediately preceding the relevant fiscal year. However, various types of entities are exempt from these rules, including government entities, international organizations, nonprofit organizations, pension funds, investment funds, and real estate investment funds when they are the UPE.

When will the Pillar Two rules go into effect?

Model rules to implement the global minimum tax were issued on Dec. 20, 2021. In December 2022, the European Commission finalized a directive on Pillar Two implementation with unanimous agreement from EU member states, requiring each to transpose key aspects into domestic law by Dec. 31, 2023. The OECD secretary-general previously acknowledged in May 2022 that practical implementation was more likely from 2024 onward.

Country-by-country implementation of the Pillar Two rules vary widely, as the GloBE rules need to be enacted and implemented through domestic legislation by member countries. Implementation of the Subject to Tax Rule requires the development of a model treaty provision and subsequent multilateral instrument. The OECD published a progress report in July 2023 that included guidance on model treaty language to enact the Subject to Tax Rule.

Notably, members of the Inclusive Framework aren’t required to adopt GloBE rules. But if they do, they must implement and administer the rules consistently with the outcomes provided for under Pillar Two. For instance, jurisdictions that adopt GloBE rules will apply an effective tax rate test using a common tax base and common definition of covered taxes to determine whether an entity is subject to an ETR below the agreed 15% minimum tax rate in any jurisdiction where it operates.

Nearly one-third of the more than 140 Inclusive Framework member jurisdictions have either committed to implementing, taken steps toward implementation, or enacted legislation to implement the framework.

How to prepare for Pillar Two deadlines

With so many jurisdictions at various stages of implementing the OECD/G20 Inclusive Framework on BEPS two-pillar solution, tax professionals should start their international tax planning now so they are equipped with the tools for compliance as this massive framework goes into effect.

First, companies should confirm which countries are relevant to their operations. Then, answer the following questions to track their progress toward Pillar Two adoption and implementation:

  1. Have those relevant countries already adopted the framework?
  2. If a relevant country hasn’t adopted the framework, how might this affect the business’s operations and taxation?

Tax professionals may also want to consider undertaking high-level calculations to determine the additional taxes that may be due upon the framework’s implementation.

Second, multinational companies can consider their internal plans for gathering information on taxation and related requirements. This may require establishing a multifunctional team that goes beyond the tax department and includes representatives from both the financial accounting and information technology departments.

Navigate digital services tax changes with confidence

As the OECD Inclusive Framework goes into effect around the world, Bloomberg Tax Research can help you stay ahead of any potential tax changes in the digital economy. Download a collection of Practitioner Perspectives on Pillar Two for a look into the status of Pillar Two in various countries around the world and the multidimensional approach to the challenges posed by the global economy.

With global tax law and regulation changes always on the horizon, tax professionals need the right corporate tax planning strategies to stay ahead of cross-border developments and avoid unintended international tax consequences. Request a demo to see how Bloomberg Tax Research can keep you ahead of the shifting international tax landscape.

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