On 8 October 2021, the Inclusive Framework (IF) announced a further agreement backed by 136 (out of 140) members of the Inclusive Framework on the two-pillar approach. In the last few days, a number of countries that initially opposed the reform are now also signing up for it (e.g. Hungary, Ireland and Estonia). With this, all EU Member States that are part of the IF are supporting the reform.
What is decided?
The further agreement is a political commitment that builds on the earlier agreement reached on 1 July 2021 and together it redesigns the international tax framework. The agreement does not provide a lot of details on how the reform will actually work out. It is likely that important aspects of the reform still need to be decided on. In this alert, we provide a brief overview of the current details already known today.
Not all members of the IF are supporting the agreement yet: the four current hold out countries are Sri Lanka, Kenya (fifth economy in Africa), Nigeria (Africa’s largest economy!) and Pakistan. Further, Cyprus, which is not an IF member, has previously indicated opposition.
The agreement takes into account also some concerns expressed by the developing countries. As an example, the agreement now gives more focus on the subject to tax rule (enabling to apply a withholding tax on certain payments) and some thresholds have been adjusted so they better match the situation of developing countries.
How does Europe react to the agreement?
The European Commission is supportive and has indicated to work on two directives to implement the agreement reached. The EC intends to publish the Directive covering pillar one in the third quarter of 2022. The publication of the Directive on pillar two is already foreseen for February 2022!
What are the next steps?
The G20 finance ministers will discuss the outcome of the IF’s meeting and the plan at their meeting on 15 – 16 October in Washington. The leaders of the G20 will address the agreement at their meeting in Rome on the 30th and 31st October.
The further agreement reached in the Inclusive Framework is a political commitment to potentially fundamental changes to the international corporate tax system. There remains, however, broader uncertainty around the effective implementation of the agreement, in particular, the (un)likelihood of speedy passage through the US Congress. The impact this may have on implementation by other countries, for example by deferring the implementation of the pillars, is unclear. In the next weeks, further work will be needed to flesh out the details of the agreement.
The time to simulate the impact of the Two Pillar approach is now! Now that the direction of travel becomes clearer, it is also time to model the impact this proposal could have on your group’s effective tax rate. This will allow you to determine whether actions are required before the actual implementation of these rules. As you know, PwC Belgium developed the PwC MARTA tool, which enables an easy way of modelling the impact. We would be happy to explain our approach to you.
What details do we know today?
Here is a summary of the main points of the latest agreement. Although the agreement contains information on some critical points, it still lacks a lot of technical detail.
Pillar One is intended to re-allocate the taxing rights of certain MNEs (multinational enterprises) across market countries, irrespective of whether the MNE has a physical presence there. Pillar One consists of several steps, including Amount A (new nexus and allocation rules), Amount B (fixed return for baseline marketing and distribution activities) as well as measures to avoid disputes and controversy.
Falling under the scope of Amount A are MNEs with a global turnover of more than 20 billion euros (this may be reduced to 10 billion after 8 years) and a profit before tax / revenue ratio of more than 10%. A nexus to the market state (even in the absence of physical presence) is created when the MNE derives at least 1 million euros in a market state; for countries with a GDP lower than 40 billion euros, the nexus is set at 250,000 euros. The statement indicates that compliance costs including the tracing of small amounts of sales will be limited to a minimum.
The level of profit to be reallocated to market states is 25 % of all profit in excess of 10% of the revenue. Revenue sourcing is linked to the end user or consumer country, based on detailed sourcing rules (yet to be determined). The tax base is determined on the basis of financial accounting income, with a limited number of adjustments and a carry-forward of losses. Segmentation is needed only when the segments disclosed in the financial accounts exceed the scope rules (more than 20 billion in turnover for the time being and PBT / revenue ratio of more than 10% for that segment);
The agreement provides for the introduction of a marketing and distribution safe harbour and further work is needed on its design. Double taxation will be relieved through the exemption or credit method. The surrendering entities will be selected from the group members that have residual profits.
The agreement calls for mandatory and binding dispute prevention and a resolution for tax certainty. An elective binding dispute resolution will be available for certain developing economies with no or low experience with regard to MAP.
Amount A will be implemented through a multilateral instrument, open for signature in 2022 and entering into effect in 2023. Digital services taxes (or equivalent) should be removed. Extractives and regulated financial services are excluded from Amount A.
Amount A will be implemented through a Multilateral Convention (MLC), and where necessary, through changes to domestic law, aiming at an effective implementation in 2023.
The Statement contains language that no new unilateral digital services taxes can be imposed between 8 October 2021 and 31 December 2023 or the entry into force of the MLC. The MLC will require that unilateral digital services taxes must be removed. Transitional measures will be developed.
Amount B is intended to simplify and streamline the arm’s length principle for baseline marketing and distribution activities and will be completed by the end of 2022. No further details were released in the communication by the IF.
Pillar two will allow
- residence countries of the ultimate parent entity to top up tax if a certain minimum tax rate is not met through the income inclusion rule (domestic rule) and /or the switch over rule (treaty application rule);
- source countries can deny deductions or adjust the low-taxed income of the recipient when that recipient is not subject to a minimum tax rate through the undertaxed payment rule (domestic rule) and / or the subject to tax rule (treaty application rule).
- Although this is a major step in the international tax reform, a lot of details are still unclear and this suggests that these details are likely still not yet finally agreed. Over the next months, important work will be needed to explore these details.
The minimum effective tax rate (on a jurisdictional basis) is now set at 15% (but individual countries may decide to apply a higher rate) for MNEs that meet the 750 million euros threshold (as determined under BEPS 13 on Country-by-country reporting). Ireland has accepted to join the agreement because the OECD text now no longer mentions to collect “at least” 15 percent from the groups in scope of PIllar two. There is no certainty yet on potential changes to the definition of tax under Pillar 2 (e.g. changes to include certain deferred tax elements).
The rules are not applicable to international shipping income as defined under article 8 of the OECD Model Tax Convention. A formulaic carve-out 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. A de minimis rule will be provided for jurisdictions where the MNE has revenues of less than 10 million EUR and profits of less than 1 million EUR
The UTPR will not apply to MNEs in the initial phase of their international activity. The agreement defines those ‘start-up’ MNEs as follows: a maximum of EUR 50 million tangible assets abroad and operate in no more than 5 other jurisdictions. This exclusion is limited to a period of 5 years after the MNE comes into the scope of the GloBE rules for the first time. For those MNEs that are in scope of the pillar 2 rules when the UTPR rules enter into effect, the period of 5 years will start when the UTPR rules come into effect.
Pillar Two will include safe harbours or other simplification mechanisms, the details of which are not yet decided. With regard to the Subject to Tax Rule (STTR), the taxing rights will be limited to the difference between the minimum rate and the tax rate on the payment. The minimum rate for the STTR will be 9%.
Pillar Two should be transposed into law over the course of 2022, so as to be effective in 2023, with the UTPR coming into effect in 2024.
Pillar one Implementation through a Multilateral convention
The statement indicates that a MLC will be developed to create a multilateral framework for all countries that join the two-pillar approach, irrespective of whether a tax treaty exists. The MLC will address how to determine and allocate amount A, eliminate double taxation, exchange information and prevent and resolve disputes in a mandatory and binding manner. The MLC will be accompanied by an explanatory statement describing its purpose, operation and processes.
Existing tax treaties will remain in force and govern treaty issues outside amount A, but the MLC will address inconsistencies with the treaties and will also address interactions with future treaties. When no treaty is in place between countries, the MLC will create the necessary relationships to implement amount A.
It is expected that the MLC and its explanatory statement will be developed by early 2022 and open for signature by mid 2022, with a possible entry into force in 2023 by a critical mass of countries (yet to be determined).
Pillar two implementation through model rules and a multilateral instrument
Model rules will be developed to define the scope and mechanics of the GloBE rules by end of November 2021 and will include ETR determination, exclusions such as the formulaic substance based carve-out, filing obligations, safe harbours and transition rules. Commentaries on the purpose and operation of the rules will be developed.
A treaty provision to give effect to the STTR, and its commentary, will be developed by the end of 2021. Further, a multilateral instrument will be developed by mid 2022 to organize a swift and consistent transfer of the STTR into the bilateral treaties.
At the latest by the end of 2022, the IF will develop an implementation framework facilitating a coordinated implementation of the GloBE rules such as administrative procedures, safe harbours and the possible development of a multilateral convention to ensure coordination and consistent application of the GloBE rules.
For more insights on the two-pillar approach or the PwC Marta impact assessment, reach out to Isabel Verlinden, Jonas Van de Gucht, Evi Geerts, Pieter Deré, Jean-Philippe Van West, Stefaan De Baets, Gilles Franssens, Jens Kiekens or your usual contact.
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