The Two-Pillar Solution, often referred to as “BEPS 2.0”, was agreed at the OECD/G20 Inclusive Framework on Base Erosion and Profit Shifting (BEPS) in October 2021 to address the tax challenges arising from the digitalisation of the economy as OECD’s BEPS Action 1. Involving more than 135 countries, Pillar One will reallocate some taxing rights for large MNEs from their home countries to the jurisdictions where their users and customers are located, while Pillar Two will ensure that certain MNEs will be subject to a minimum 15% tax rate.
According to the OECD’s October 2021 brochure, the key elements of Pillar One are as follows:
- To reallocate taxing rights over 25% of the residual profit of large MNEs to “market jurisdictions”, where the customers and users of those MNEs are located (referred to as Amount A)
- To provide mandatory and binding dispute resolution for issues involving Amount A, with an elective regime to accommodate certain low-capacity jurisdictions (LCJs)
- To remove Digital Services Taxes (DSTs) and similar measures with respect to all companies, and ensure no similar measure would be adopted in the future, and
- To establish a simplified and streamlined approach to the application of the arm’s length principle in specific circumstances, with a particular focus on the needs of LCJs (referred to as Amount B).
Amount A and the removal of DSTs will be implemented through a multilateral convention (MLC).
The amount of taxing rights to be redistributed under Pillar One is known as Amount A. Redistribution would apply where an MNE has global revenues exceeding €20 billion per annum, as well as a profit-before-tax to revenue ratio exceeding 10%. However, revenues and profits related to extractives and regulated financial services will be excluded.
Amount A would be equal to 25% of the MNE’s global residual profits. Global residual profit is defined as all profits above a 10% (profit before tax/revenue) profitability threshold. These Amount A profits would be reallocated among market jurisdictions, based on the share of revenue sourced from each of those jurisdictions. The market jurisdiction would then apply their domestic corporate tax system to tax the allocated residual profits, while another ‘relieving jurisdiction’ would relinquish their taxing rights over these profits. There will also be a ‘marketing and distribution profits safe harbour’ to cap the amount of profits reallocated to a market jurisdiction that is already able to tax the MNE’s residual profits.
An OECD factsheet lists the following 5 main steps for deriving Amount A from its draft domestic model rules contained in the OECD’s July 2022 progress report. References in the Steps below are to the articles and Schedules of the draft domestic model rules.
Step 1. Determine whether the MNE is in scope of Amount A.
- A “Covered Group” is an MNE that has more than €20 billion in revenues per annum and has profitability exceeding 10% (art 1(2))
- Where the MNE does not meet these thresholds, but one of its “Disclosed Segments” does on a standalone basis, the Disclosed Segment will be subject to Amount A (as per Sch D), and
- Revenues and profits related to extractives and regulated financial services will be excluded.
Step 2: Determine which market jurisdictions are eligible to tax a portion of the MNE’s residual profit under Amount A.
- A market jurisdiction will be eligible to tax Amount A if the Covered Group derives more than €1 million in revenues from that jurisdiction or €250,000, if that jurisdiction’s GDP is lower than €40 billion (art 3), and
- To determine how much revenue is derived from each jurisdiction, the Covered Group will apply the revenue sourcing rules in art 4 and Sch E.
Step 3: Determine the relevant measure of profit of the Covered Group
- The tax base rules will take the Covered Group’s total profit or loss in its consolidated financial statements as a starting point (art 5(1))
- A limited amount of book-to-tax adjustments will be made to arrive at a standardised “Adjusted Profit Before Tax” amount (art 5(2)), and
- Losses will be carried forward, subject to certain time limitations (art 5(3)).
Step 4: Allocate Amount A to eligible market jurisdictions.
The Amount A profit allocated to an eligible market jurisdiction (as per Step 2) is determined by the following formula (art 6(2)):
- First, take 25% of the Adjusted Profit Before Tax (as per Step 3) in excess of 10% of the Covered Group’s revenues, to determine the total Amount A profit
- Then allocate the Amount A profit to the market jurisdiction in proportion to the amount of revenues the Covered Group derives from that jurisdiction (as per Step 2)
The Amount A profit allocated to a market jurisdiction is adjusted and reduced by the “Marketing and Distribution Profits Safe Harbour” where that jurisdiction already has taxing rights over the Covered Group’s residual profits (art 6(3) – (6)).
Step 5: Eliminate double taxation.
Double taxation arising from the application of Amount A, as an overlay to the existing profit allocation system, will be eliminated. The mechanism in arts 7 – 11 will apply on a quantitative and jurisdictional basis, to identify which jurisdictions will be responsible for eliminating double taxation and in what amounts.
In addition, draft rules for the MLC and procedures on Amount A in an October 2022 progress report cover:
- The administration process for Amount A, ie how affected MNEs will comply with the Amount A rules, from the filing of the relevant information to the payment of tax and access to timely relief from double taxation
- A tax certainty framework for Amount A, which guarantees certainty for impacted MNEs over all aspects of the rules, including the elimination of double taxation. The framework contains the following 3 mechanisms, which will be supported by a binding Determination Panel process to resolve any disagreements:
- A scope certainty review, to provide an “out-of-scope” MNE with certainty that it is not subject to the rules for Amount A for a period
- An advance certainty review, to provide certainty over an MNE’s methodology for applying rules that are specific to Amount A and relevant aspects of its internal control framework. This would be available for a group’s methodology for revenue sourcing, as well as its categorisation of revenues and costs that would be relevant when determining the exclusions from Amount A (ie extractives and regulated financial services)
- A comprehensive certainty review, to provide an MNE with binding multilateral certainty over its application of all aspects of the rules for a period that has ended, based on a standardised Common Documentation Package and building on the outcomes of any advance certainty applicable for the period
- Tax certainty for issues related to Amount A, which benefit Covered Groups for mandatory and binding dispute prevention and resolution mechanisms to avoid double taxation for all issues related to Amount A, including transfer pricing and business profits disputes. However, an elective binding dispute resolution mechanism will be available for issues related to Amount A for LCJs that are eligible for deferral of peer review of their BEPS Action 14 (on mutual agreement procedure (MAP)) and have no or low levels of MAP disputes.
Removal of DSTs
In addition, draft MLC articles require all parties to remove all DSTs and other relevant similar measures with respect to all companies, and to commit not to introduce such measures in the future. However, the commitment would not include value-added taxes, transaction taxes, withholding taxes treated as covered taxes under tax treaties, or rules addressing abuse of the existing tax standards. There is also a mechanism that will eliminate Amount A allocations if the commitment is breached.
Amount B is intended as a simplification and streamlining of the process for pricing baseline marketing and distribution activities in accordance with the arm’s length principle, based on the guidance provided in the OECD Transfer Pricing Guidelines.
In addition, Amount B should address the needs of LCJs. A particular concern of LCJs has been the relative unavailability of appropriate local market comparables through which arm’s length prices can be established. Amount B aims to specifically address this issue by providing a basis to establish an arm’s length price in all cases using suitable comparables, wherever they are geographically drawn from.
Consultation on Amount B took place between 8 December 2022 and 25 January 2023. The consultation document outlines the main design elements of Amount B, ie the scope, the pricing methodology and the current status of discussions concerning an implementation framework. The document seeks to outline the progress made in defining what in-country baseline marketing and distribution arrangements are, how they may be identified in practice, and subsequently how in-scope arrangements may be priced in a simplified and streamlined manner, in accordance with the arm’s length principle.
The MLC for Amount A and the removal of DSTs was scheduled to be finalised by mid-2023 for entry into force in 2024 under a revised timeline, and the final Amount B deliverable is also expected to be available by mid-2023. Meanwhile, Australia issued a consultation paper on the Two Pillars on 4 October 2022 and will continue to work with the OECD to finalise the outstanding details.