OECD Two Pillar package – Is free trade finished? - opinion

Will your group’s taxes take off? Or will you outfox the OECD?

Calculating taxes (photo credit: INGIMAGE)
Calculating taxes
(photo credit: INGIMAGE)

The OECD presented on October 8 an updated version of its “Two Pillar” package of proposals for reforming international taxation of larger multinational enterprises (MNEs). On October 13, the G20 Finance Ministers endorsed the package, saying it will “establish a more stable and fairer international tax system.” But will it? The package now is supported by 136 countries representing over 90% of global GDP, after Ireland, Estonia and Hungary reluctantly fell into line.  Will your group’s taxes take off? Or will you outfox the OECD?

The problem

Until now, tax avoidance was relatively easy – little or no physical presence in the country where customers are, intellectual property and servers in sunny offshore locations.

The digital economy is the target of these proposals. Nonetheless, they catch many ordinary  businesses that supply goods, services, or digital products over the internet.

What’s ahead?

Illustrative photo of Israeli money (credit: MARC ISRAEL SELLEM)
Illustrative photo of Israeli money (credit: MARC ISRAEL SELLEM)

The proposals run to hundreds of pages and are still evolving. They refer to Pillar 1 and Pillar 2. Pillar 1 calls for tax in the market countries where customers are, Pillar 2 calls for a minimum global corporate tax rate of 15%.

Pillar 1 would require an MNE with global annual revenue above €20 billion to allocate two amounts of profit, A and B, to market jurisdictions. Amount A would be 25% of profits exceeding 10% of sales, but not to jurisdictions with less than €1 million sales (or €250,000 in smaller jurisdictions with GDP under €40 billion). Amount B is back to the drawing board for simplification after opposition from developing countries – intended as a minimum profit margin on “baseline marketing and distribution activities.” 

Pillar 2 calls for a minimum global tax rate of 15% on groups with annual revenue exceeding €750 million, through a variety of means:

• Top-up tax for the parent company (Income inclusion rule (IIR));

• Denial of expense in payor countries if no IIR applies (Undertaxed Payment Rule UTPR);

• Withholding tax of 7.5%-9% (via a tax treaty Subject To Tax Rule STTR)

Digital Service Taxes (turnover taxes in addition to VAT) enacted in several countries – including the UK, France, Spain, Turkey, and India – should be suspended until the earlier of December 31, 2023, or any agreed multilateral convention coming into force.

The starting point will be financial accounts.

Expected “Carve-Out” exceptions include

Exceptions to Pillar 1:

• Extractives;

• Regulated financial services.

Exceptions to Pillar 2

• If there is a distribution of earnings within four years and tax exceeds the minimum level.

• “Substance” of 5%-8% of tangible assets and 5%-10% of payroll.

• Where US GILTI rules apply.

• MNEs with tangible assets abroad under €50 million operating in no more than five other jurisdictions. 

Tax impact

Pillar 1 should apply to about 100 MNEs and result in new annual taxable profits (not tax) of $125 billion. Pillar 2 should bring in around $150 billion per year in taxes. 

Timing

The Biden administration and other governments are in a hurry to implement the package, perhaps as soon as 2023, to help pay for infrastructure spending and cover COVID-19 costs. The year 2022 is the projected date for further detailed rules and multilateral conventions and instruments.

Comments – general

Developments need monitoring and there are many issues affecting free trade, including:

• Taxation without representation? The world public does not get to vote on the OECD proposals.

• Political uncertainty in the US. The US Senate has special rules that make it unclear whether the Biden administration needs a 50.1% or 60% majority.

• Complexity – two Pillars, two amounts, 136 countries.

• Many open items and loose ends.

• Multiple taxation – income tax, VAT, sales tax, customs duty, etc.

• MNEs below the sales thresholds are not off the hook, as many other recent measures from the OECD (BEPS, MLI) impact them. Complexity and multiple taxations remain significant issues.

• Country by country rules in the proposals – making foreign tax credits harder.

• Unclear dispute resolution rules.

Comments – Israel

Israel is one of the 136 participating countries. 

Preferred technological enterprises that pay 5% or 7.5% company tax may soon find themselves paying 15% company tax unless distribute earnings within four years and withhold sufficient tax from the dividend to carry them over the 15% OECD minimum tax rate. It will be interesting to see how the Israeli tax authority’s online system (“Sham”) in Hebrew in Shekels interacts with any other tax system abroad using different languages and currencies, with complete data security.

And the Israeli Tax Authority is understood to be formulating its own international tax proposals.

Will there still be legitimate tax planning opportunities?

Yes.

As always, consult experienced tax advisers in each country at an early stage in specific cases.

leon@h2cat.com

The writer is a certified public accountant and tax specialist at Harris Horoviz Consulting & Tax Ltd.