Global Tax Reform – Pillars One & Two
You may have asked yourself, “What is this global minimum tax I hear about?” There are many pieces to this proposed tax idea, and the best place to start is the beginning. Pillars One and Two actually have roots in the Base Erosion and Profit Shifting (BEPS) project the Organisation for Economic Co-operation and Development (OECD) completed in 2015. One BEPS action item was related to how to tax the digital economy, but at the completion of BEPS, it was essentially left unresolved. Pillars One and Two aim to resolve this unfinished BEPS action item. In October 2020, the OECD issued its blueprints on the details of Pillar One and Pillar Two. Without a global agreement, Pillars One and Two will be hard, if not impossible, to implement.
Pillar One aims to reach a global agreement on adapting the allocation of taxing rights on business profits in such a way to expand the taxing rights of the market jurisdiction, i.e., the country where the products are being sold, regardless of the existence of an entity. The economic idea behind Pillar One is that the local consumers drive the value of the company and, therefore, the countries where the consumers are located should receive their “fair share” of taxable revenue. The blueprint outlines a two-part plan to accomplish this. The first part is to give each market jurisdiction a routine profit for the activities it performs. The second part is to then allocate the residual profit among all jurisdictions where sales occur. The methodology for allocating the residual profit is yet to be determined. A significant change that Pillar One brings is the OECD recommending to tax authorities to tax income generated in their countries, regardless of the existence of an entity or permanent establishment in their jurisdiction. Pillar One would lead to companies that sell internationally having increased tax reporting compliance and potentially a higher tax burden.
Pillar Two is where the idea of a global minimum tax begins, and it is supposed to be independent of Pillar One. The idea behind a global minimum tax is to set a minimum threshold on effective tax rates. The tax rate most commonly reported is 15 percent or 21 percent. This is intended to stop the “race to the bottom” for corporate income tax rates and to identify companies that push profits to low-tax jurisdictions and eliminate that advantage. For example, if Company A pays a tax rate of 3 percent in a certain jurisdiction, and the global minimum tax rate is decided to be 15 percent, then a mechanism would be in place to ensure that Company A’s profits in that jurisdiction ultimately have an effective tax rate of 15 percent. There are other proposed mechanisms that Pillar Two would have to achieve the mandated global minimum tax rate. These include income inclusion rules and eliminating treaty-based exemptions in certain situations. Ultimately, a global minimum tax would limit tax planning and structuring to only be able to achieve an effective tax rate of the global minimum tax rate.
As of October 8, 2021, Pillars One and Two had been agreed to by 136 of the 140 countries in discussion. This will change the international tax landscape in a major way. This change will lessen tax competition and the autonomy of individual countries and tax authorities. The four countries that did not agree to the idea of Pillars One and Two are Kenya, Nigeria, Sri Lanka, and Pakistan.
For additional thoughts, commentary, and current tax planning in regard to Pillars One and Two, please contact your BKD Trusted Advisor™ or submit the Contact Us form below.