OECD Announces Agreement on International Tax Overhaul
After years of negotiations, the OECD announced on October 8 that 136 countries had reached agreement on a sweeping overhaul of the international tax system that will impose a 15% minimum tax rate on some multinational enterprises (MNEs) and reallocate more than USD 125 billion of profits from approximately 100 of the world’s largest and most profitable MNEs to countries worldwide.
The OECD released an eight-page statement that updates its July 1 blueprint and includes an annex that provides important details regarding implementation of the agreement. The new statement follows the outline of the original global tax reform plan: a two-pronged framework, with Pillar One addressing taxing rights and distribution of profits and Pillar Two the imposition of a global minimum tax.
The G-20 finance ministers endorsed the new statement at their October 13 meeting.
Pillar One
Pillar One will apply to MNEs with global turnover above EUR 20 billion and profitability above 10%. That threshold could be reduced to EUR 10 billion upon review seven years after the agreement enters into force.
A new special-purpose nexus rule will be introduced to permit the allocation of a share of the residual profit--Amount A--to market jurisdictions where an in-scope MNE derives at least EUR 1 million in revenue. In the case of smaller jurisdictions with GDP lower than EUR 40 billion, the nexus threshold will be EUR 250,000.
The July 1 statement had left open the question of how much residual profit would be subject to the new reallocation rules, estimating that between 20% and 30% of profit in excess of 10% of revenue would be allocated to market jurisdictions that meet the nexus test. The new statement has now clarified that 25% of residual profit will be reallocated.
The new statement confirms that in-scope businesses will benefit from mandatory and binding dispute prevention and resolution mechanisms designed to avoid double taxation for Amount A, including all issues related to Amount A (for example, transfer pricing and business profits disputes). The July statement had left open the possibility of introducing an elective binding dispute resolution mechanism for Amount A issues that would be available only to some developing economies; the new statement now explicitly sets out that option, specifying that only jurisdictions with low levels of mutual agreement procedures (MAPs) would be able to access it.
Perhaps the most significant open question in the July 1 statement revolved around digital services taxes (DSTs). That statement called for the removal of all DSTs and similar measures but did not provide any details as to the timing or the mechanism to accomplish that removal. The new statement provides that a multilateral convention (MLC) will require all parties to remove all DSTs with respect to all companies, and to commit not to introduce such measures in the future. No newly enacted DSTs can be imposed on any company from 8 October 2021 and until the earlier of 31 December 2023 or the coming into force of the MLC.
The new annex explains that Amount A will be implemented through an MLC and, when necessary, through correlative changes to domestic law. The MLC will be supplemented by an Explanatory Statement that describes the purpose and operation of the rules and processes in the convention. The OECD’s Task Force on the Digital Economy will seek to conclude the text of the MLC and its Explanatory Statement by early 2022, with the goal of enabling it to enter into force and effect in 2023 once a critical mass of jurisdictions have ratified it.
Pillar Two
The overall design of Pillar Two did not change from what had originally been described in July: two interlocking domestic rules that are together known as the Global anti-Base Erosion (GloBE) rules, and a treaty-based rule, the Subject to Tax Rule (STTR). These rules combine to impose what has been commonly referred to as the global minimum corporate tax, a concept that has garnered much attention and been the subject of heated debate.
As originally proposed, the minimum tax rate would have been equal to “at least 15%.” Several countries with corporate tax rates lower than the proposed 15% -- Estonia, Hungary and Ireland among them -- balked at the language, pointing out that a minimum tax of “at least 15%” could in the future be increased beyond that rate. All three countries have now joined the OECD statement, and the global minimum tax has been set at 15%.
The global minimum tax rules will apply to MNEs that meet the EUR 750 million threshold as determined under the country-by-country reporting rules. The statement provides a carve-out for government entities, international organizations, nonprofits, pension funds and investment funds that are ultimate parent entities of an MNE group, which will not be subject to these rules.
The GloBE rules will provide a carve-out that will exclude an amount of income that is 5% of the carrying value of tangible assets and payroll. In a transition period of 10 years, the amount of income excluded will be 8% of the carrying value of tangible assets and 10% of payroll, declining annually by 0.2 percentage points for the first five years, and by 0.4 percentage points for tangible assets and by 0.8 percentage points for payroll for the last five years.
The GloBE rules will also provide for a de minimis exclusion for those jurisdictions where the MNE has revenues of less than EUR 10 million and profits of less than EUR 1 million.
The annex provides an ambitious schedule for implementation of Pillar Two, with a plan to have model rules to give effect to the GloBE rules and a model treaty provision to give effect to the STTR developed within two months, by the end of November 2021. A multilateral instrument will be developed by mid-2022 to facilitate the implementation of the STTR in relevant bilateral treaties.
Reaction to Announcement
Not surprisingly, the announcement was greeted with enthusiasm by the Biden administration, which has been a vocal supporter of the plan. Treasury Secretary Janet Yellen released a statement praising the agreement, saying “The international tax agreement will stop the four-decade long race to the bottom on corporate taxation—where tax authorities offer lower tax rates to attract business, leading others to respond with lower rates.”
Yellen pointed out that the only country that currently imposes a minimum tax on foreign earnings is the United States. The new framework, she said, “will allow nations and businesses to compete on the basis of economic fundamentals—on the skill of our workforces, our capacity to innovate, and the strength of our legal and economic institutions—rather than tax strategies.”
Next Steps
The G-20 leaders are expected to endorse the plan at their Leaders’ Summit on October 30-31, in what should be the final step in the process of adoption by the international community.
With international support secured, the process now moves to the individual countries, which will have to enact the plan into their domestic legislation. In the United States, it is not completely clear what that process will look like, but adoption of the two pillars may have to be bifurcated. Because Pillar One is to be implemented through an MNC, the question arises whether the U.S. Senate must ratify the plan as a treaty, which under the Constitution would require a two-thirds vote of approval, equal to 67 votes. However, the U.S. has entered into other international agreements without a formal treaty, which may be why Secretary Yellen testified before the Senate Banking Committee that “there are a number of ways in which Congress could implement” the Pillar One agreement, including the possibility of a congressional executive agreement.
Unlike Pillar One, enactment of Pillar Two would require only a simple majority in the U.S. Senate if accomplished through the budget reconciliation process. Secretary Yellen has made public statements that the global tax could be part of the budget reconciliation bill currently before Congress.
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