On 9 September 2021 the OECD made available a podcast on the global digital tax agreement.
The international tax system has become outdated during the past 30 to 40 years owing to the effects of globalisation. Multinational enterprises are more mobile and can structure their business operations so that taxable profits arise in low tax jurisdictions where there is little or no activity. In this way they can lower their tax rate to close to zero. This is not fair because people who cannot move around in the same way – employees and self-employed individuals – cannot avoid paying tax and must pay their fair share.
To combat the base erosion and profit shifting by multinational enterprises the OECD has worked out a two-pronged solution.
Pillars One and Two
Pillar One deals with the challenges presented by globalisation and the digital economy. Under the proposed rules multinational enterprises can be taxed in a country even if they are not physically present there – they will be taxed even if they do not have a permanent establishment in a country. This is referred to as the new nexus. If a multinational has sold goods or services in a particular country, it can be taxable there. Between 20% and 30% of the profits of the largest multinationals will be allocated to the market jurisdictions – the jurisdictions where they have sold goods or supplied services.
Pillar Two provides for a global minimum tax of 15%, so the largest multinationals will be paying at least that amount globally. This may not sound very high but it is a safety net to ensure that multinationals do not pay much lower tax rates on their global income. Currently many multinationals are only paying tax of 3% to 7% on their foreign income so in practical terms the minimum tax is a large step forward.
Developing countries
Developing countries are concerned with the level of taxing rights that they can obtain under the system. The discussions in the Inclusive Framework have reached a compromise solution incorporating some of the requests made by developing countries. For example, under the nexus rule the threshold of sales in a country that brings the nexus rule into play will be EUR 250,000 rather than the much higher threshold that developed countries would have preferred.
Some Inclusive Framework members have not yet joined the arrangement; however, the reform can be implemented even if not all countries are part of the agreement.
Exceptions
There is only one exception from Pillar Two, which is for shipping, where profits are difficult to measure owing to the presence of shipping in international waters.
In Pillar One there are exceptions for financial services and for extractive industries. The exception for extractive industries was necessary because the rent is attached to the land where the minerals are located. In the case of financial services, the nature of the international markets means that it would be too complex to attempt to re-allocate the profits to the market jurisdictions.
Implementation
Remaining issues will be worked out this year, including the precise percentage to be allocated to the market jurisdictions under Pillar One and the level of the minimum tax under Pillar Two. A multilateral convention will be required to implement the agreement and a model for domestic legislation will also be drafted. The process will be completed by the end of 2021 or early 2022. Relevant legislation can then be enacted by countries in 2022 ready for implementation in 2023.