Taxation
OECD two-pillar global tax framework at risk
The OECD/G20 Inclusive Framework on Base Erosion and Profit Shifting (IF) represents a significant overhaul of international tax rules, aimed at addressing the tax challenges arising from the digitalisation of the economy. The global tax solution seeks to ensure that multinational enterprises (MNEs) pay a fair share of tax wherever they operate. Over 130 countries were signatories to the initial deal in 2021. The final deal included several concessions, including by Ireland to cap the minimum tax threshold at 15%, instead of the initial wording that would have allowed tax rates under these rules to exceed it.
The framework is based on two separate pillars. Pillar One focuses on the reallocation of taxing rights over MNEs to the countries where their goods or services are consumed, regardless of the MNEs’ physical presence there. The Pillar’s scope covers MNEs with global turnover exceeding €20 billion and profitability above 10%. This pillar introduces a new nexus rule not tied to physical presence and allocates taxing rights through a formula that considers the revenue generated in each market jurisdiction.
Pillar Two, on the other hand, introduces a Global Minimum Tax (GMT) rate of 15%. The scope includes MNEs with a global turnover exceeding €750 million. This aims to put a floor on tax competition among countries over attracting MNEs by offering low corporate tax rates. It consists of two interrelated rules: the Income Inclusion Rule (IIR) and the Undertaxed Payments Rule (UTPR), which aim to ensure that MNEs pay at least a 15% tax rate on their income in each jurisdiction they operate. If the effective tax rate paid by an MNE in a jurisdiction is below the minimum, the IIR allows the parent entity’s country to collect the top-up tax, while the UTPR addresses any remaining low-taxed income through denial of deductions or other adjustments.
The OECD estimates the GMT to reduce global low-taxed profit by about 80%, from 36% of all global profit to around 7%. Furthermore, the OECD expects significantly decreased incentives to shift profits to lower-taxed jurisdictions.
On 1 January 2024, the global minimum tax went into effect in several jurisdictions, with OECD estimating annual tax revenue increases up to 9%, or $220 billion. These include the EU, UK, Norway, Australia, South Korea, Japan, and Canada. Conspicuously absent from the first countries to implement it are the United States and China. Given that the implementation of the OECD’s two-pillar solution requires significant changes to domestic tax laws and international tax treaties, questions have persisted whether countries such as the United States will actually commit to it.
However, there has been increasing opposition towards the two-pillar framework from two different angles. The US political climate and their upcoming elections however have complicated and potentially even killed any further progress on, at the very least, the first pillar, if not also for the second. The country has decades-long examples of acting belligerently towards any sort of international framework that impose obligations, most notably the International Court of Justice. In addition, it has previously pushed back on any sort of taxation outside of the country that are targeting US businesses, most notably in the digital realm. The bipartisan requirement to ratify the treaty would imply that, given the political environment the country currently is in, any sort of setbacks on agreeing to global taxation rules would be hard to overcome.
Furthermore, a large number or developing countries have sought to shift global tax discussions to the UN instead, where they see potential to them having more influence on forming rules benefiting their country-specific objectives better. This has further divided progress on the OECD framework.
Given that the EU and several high-economy countries have already implemented the GMT, this can be a signal for an increase in disputes and tensions between countries. Since part of the objective why the EU has been pushing for the OECD framework has been to address the deficiencies in taxing companies that offer digital products or services, the largest of which are all US-based, a failure to implement the two-pillar solution globally could indicate a comprehensive EU-wide digital tax as a supplementary mechanism. This in turn would increase tensions and would give rise to a potential trade war in the near future. For the EU, several recently implemented regulations such as the DMA and the DSA, there is a clear signal to target MNEs that have so far used various profit-shifting mechanisms to minimise their tax obligations.
