On October 8, 2021, the Organisation for Economic Co-operation and Development (OECD) announced that 136 countries (out of 140 members of the OECD/G20 Inclusive Framework on BEPS) have agreed to a global minimum tax rate of 15% for multinational enterprises (MNEs).
The announcement is part of the OECD's two-pillar solution to ensure that that MNEs pay their fair share of tax wherever they operate, largely in response to concerns about the taxation of the digital economy and about base erosion and profit shifting.
In some cases, the adoption of these measures will reallocate profits between jurisdictions and in other cases could potentially increase the incidence of tax paid. Either way, this will be a significant change for large MNE companies.
In this article, we break down the key details that MNEs need to know about the new two-pillar solution, and how they can prepare their organization for the changes.
Pillar One: fair distribution of profits and reallocation of taxing rights
According to the OECD website, Pillar One will ensure a fair distribution of profits by reallocating some taxing rights over an MNE's home country to markets where they have business activities and profits, regardless of whether firms have a physical presence there.
At its core, Pillar One does not impose any additional tax on MNEs but instead is a redistribution of profits. It applies to MNEs with global revenues above EUR€20 billion and profit above 10% (profit is determined based on accounting income). A new special-purpose nexus rule will be introduced to reallocate profit where value is created via user participation. There are also exemption, credit, and dispute resolution mechanisms to eliminate double taxation.
Perhaps one of the most significant developments is related to the digital services tax (DST).
Many countries, including Canada, have introduced a DST. The OECD has called for a pause on the introduction of new DST measures from October 8, 2021 until December 31, 2023. This will be accomplished through a multilateral convention (MLC) and supplemented by explanatory notes. While no additional details have been provided in the OECD release, it's expected that changes to domestic law will be required. The MLC and the explanatory notes are expected to be available in 2022 and in effect starting in 2023.
What remains to be seen is whether digital services taxes will be abolished all together. Chrystia Freeland, Canada's Deputy Prime Minister and Minister of Finance, said the following as part of her statement on the new agreement:
“To ensure that Canadians' interests are protected in any circumstance, we intend to move ahead with legislation finalizing the enactment of a DST, by January 1, 2022, in keeping with Budget 2021. The DST would be imposed as of January 1, 2024, but only if the treaty implementing the tax regime under this global agreement has not come into force. In that event, the DST would be payable as of 2024 in respect of revenues earned as of January 1, 2022.”
Pillar Two: a global minimum tax rate
Pillar Two has garnered the most attention, as it introduces a global minimum tax rate of 15%.
Unlike Pillar One, which redistributes profits, Pillar Two is expected to generate US$150 billion of additional revenues for governments. The new minimum tax rate applies to companies with revenue above EUR€750 million, which is the same threshold under the country-by-country reporting rules. The rules propose carve-out for certain entities (such as certain international organizations, governments, non-profits, pension funds, and investment funds) and certain income (5% of the carrying value of assets and payroll).
While certain countries with tax rates lower than 15% were not originally supportive of the global minimum tax rate, the agreement has now received support from all of the G20 countries.
How can multinational enterprises prepare for the global minimum tax rate?
The OECD has made significant progress in its attempt to have a unified approach to the tax challenges arising from digitalization. However, the organization has a very ambitious timeline to implement Pillars One and Two, with many technical details still to be worked out.
MNEs should prepare for these proposals by:
- Reviewing their global operations to determine if de minimis thresholds are met in order for the new rules to apply.
- Modelling out the impact of Pillar One, including the redistribution of profits under the proposed rules. For example, MNEs that have significant user or customer bases in countries where they currently do not have a physical presence could be impacted by these rules.
- Reviewing whether Pillar One causes any incidence of double taxation.
- Monitoring the application of the new Canadian DST on their business.
- Reviewing the impact of changes to Canadian domestic laws in order to implement the MLC to repeal the DST.
- Modelling the impact of Pillar Two on the company's global effective tax rate based on income that will be subject to the new minimum tax. For example, if MNEs operate in jurisdictions that are below the 15% global minimum tax rates, they may be impacted by these rules. MNEs will also need to understand whether they can obtain foreign tax credits under the new proposed rules based on local country laws.
Reach out to your BDO advisor to learn more about how these international tax developments affect your business, and how we can help you manage the impact.