In recent years, Organisation for Economic Co-operation and Development (OECD) and G20 countries have been debating significant changes to existing international tax rules that apply to multinational companies and taxation of digital economy. In this regards on July 1st, 2021 an outline for the new rules relating to taxation of digital economy and MNE was released by the Organisation for Economic Co-operation and Development (OECD). 130 countries including members of the OECD and the G20, representing more than 90% of global GDP, joined the Statement establishing a new framework for international tax reform creating momentum to change the century-old international tax system, which is no longer fit for purpose in a globalised and digitalised 21st century economy.
The levy applies to multinational corporations with annual sales of more than 20 billion euros or approximately $24 billion and before-tax profit margins above 10 percent. The OECD/G20 Inclusive Framework on Base Erosion and Profit Shifting (IF) has agreed a two-pillar solution to address the tax challenges arising from the digitalisation of the economy. Companies in the extractives sector (like oil, gas, and other mining companies) and financial services companies would be excluded from the policy.
- Pillar One will address the shortcoming of "nexus" rules based on physical presence and will warrant a rational distribution of profits and taxing rights among countries with respect to the targeted MNEs, including digital companies. It would re-allocate some taxing rights over MNEs from their home countries to the markets where they have business activities and earn profits, regardless of whether firms have a physical presence there. Under Pillar One, taxing rights on more than USD 100 billion of profit are expected to be reallocated to market jurisdictions each year.
- Pillar Two seeks to put a floor on competition over corporate income tax, through the introduction of a global minimum corporate tax rate that countries can use to protect their tax bases. The global minimum corporate income tax under Pillar Two - with a minimum rate of at least 15% - is estimated to generate around USD 150 billion in additional global tax revenues annually.
Multinational Enterprises (MNEs) are able to make large profits in countries without necessarily booking these profits in these countries while using Digitalisation, Globalisation and New Business Models as a tool to shift their tax base to low tax jurisdiction. Aiming to address the tax challenges of globalised and digitalised 21st century economy this two pillar approach has been framed by the OECD/G20. Following are the key component of each pillar:
- Contains “Amount A” apply to multinational groups that have more than EUR 20 billion of global turnover and profitability above 10 percent (i.e. profit before tax/revenue). Turnover threshold to be reduced to 10 billion euros, contingent on successful implementation including of tax certainty on Amount A, with the relevant review beginning 7 years after the agreement comes into force.
- There will be a new Special Purpose Nexus Rule permitting allocation of Amount A to a market jurisdiction when the in-scope MNE derives at least 1 million euros in revenue from that jurisdiction. For smaller jurisdictions with GDP lower than 40 billion euros (comprise less than 2% of total global GDP), the nexus will be set at 250 000 euros.
- For Calculation of New Taxing Right, The statement provides that for in-scope MNEs, between 20 and 30 percent of residual profit (defined as profit in excess of 10 percent of revenue) will be allocated to market jurisdictions with nexus using a revenue-based allocation key.
- The statement provides that Amount A will be implemented through a multilateral instrument, which will be opened for signature in 2022. Amount A is anticipated to take effect beginning in 2023.
- The statement also contains a brief outline about “Amount B” which is intended to streamline the application of the arm’s length standard to routine marketing and distribution activities.
- Pillar Two which is mainly address Global Minimum Tax contains two interlocking domestic rules (together the Global anti-Base Erosion Rules (GloBE) Rules):
- (i) an Income Inclusion Rule (IIR), which imposes top-up tax on a parent entity in respect of the low taxed income of a constituent entity; and
- (ii) an Under taxed Payment Rule (UTPR), which denies deductions or requires an equivalent adjustment to the extent the low tax income of a constituent entity is not subject to tax under an IIR;
- And a treaty-based rule (the Subject to Tax Rule (STTR)) that allows source jurisdictions to impose limited source taxation on certain related party payments subject to tax below a minimum rate. The STTR will be creditable as a covered tax under the GloBE Rules.
- The GloBE rules will apply to MNEs that meet the 750 million euros threshold as determined under BEPS Action 13 (country by country reporting). Countries are free to apply the IIR to MNEs headquartered in their country even if they do not meet the threshold.
- Government entities, international organisations, non-profit organisations, pension funds or investment funds that are Ultimate Parent Entities (UPE) of an MNE Group or any holding vehicles used by such entities, organisations or funds are not subject to the GloBE Rules.
- The IIR allocates top-up tax based on a top-down approach subject to a split-ownership rule for shareholdings below 80%. The UTPR allocates top-up tax from low-tax constituent entities including those located in the UPE jurisdiction under a methodology to be agreed.
- The minimum tax rate used for purposes of the IIR and UTPR will be at least 15%.
What Next For Tax Leaders?
The framework for reforms agreed by the 130 members will have a wide reaching effect on many MNEs. Given the ambitious timeline for implementation, it is important that potentially impacted businesses understand what is coming and prepare for the resulting changes:
- United Arab Emirates (UAE), Saudi Arabia, Bahrain, Oman and Qatar five Gulf Cooperation Council (“GCC”) Countries are amongst the 130 members that have backed the proposals. Consequently, both Pillars will impact MNE groups operating in these countries.
- Companies with a presence in the UAE will need to undertake a Pillar One analysis to identify their in-country revenues and understand what additional tax may be due under Amounts A and B.
- The scope of Pillar Two is much wider and it will cause a significant impact for the UAE and other GCC countries. MNE groups operating in UAE will need to comply with international tax liabilities on UAE profits. Positively for the UAE, this may act as an encouraging reason for the introduction of a domestic corporate tax in the short term.
- While the statement represents very significant progress, many key political and technical issues remain open. However given the firm commitment by the 130 members on an effective implementation date of 2023, UAE MNE group has only 18 month to identify and analyse the possible impacts and to understand what is coming.
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