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Achieving a Global Tax System—Next Steps

Nov. 25, 2021, 8:00 AM

Broad unanimity in the acceptance of changes to the global tax system doesn’t happen very often. This is partly because the compromises and negotiations needed to bring people on board take years to progress, but mostly because very few taxes, notably the base erosion and profit shifting (BEPS) project, have been practically implemented so far at such a scale, so changes are few and far between.

This is why the October agreement on the Organization for Economic Cooperation and Development’s (OECD) Pillar One and Pillar Two frameworks by the G-20, as part of the 136 countries subscribed to the proposals (recently increased to 137 by the signing of Mauritania), deserves applause, as a product of diplomatic, patient efforts by many people over many years.

The OECD now looks more likely than ever to reach a global consensus regarding (i) how multinationals pay their “fair share” of tax across the network of jurisdictions they operate in—whether or not having a physical presence in each of them—and (ii) the introduction of a global minimum corporate tax at the rate of 15%.

Further, Pillar One will most likely stop the proliferation of unilateral tax measures such as digital services taxes, and will enhance multilateral assessments on transfer pricing that hopefully will become easier, as well as less expensive, to manage.

Questions to be Resolved—the Technicalities

Are there still technicalities to be resolved? Yes, of course there are. There will likely be long discussions in the future. Also, the nations subscribed to the Inclusive Framework (IF) now need to turn their attention to enticing the outliers, Pakistan, Nigeria, Sri Lanka and Kenya.

An important consideration for these countries is that being part of the negotiations can help model the new rules according to their needs and timing expectations. Indeed, the system and IF participants are open to compromise under the right circumstances when they meet resistance.

This is what happened, for example, with the discussions with Ireland: Before signing up to the two-Pillar OECD agreement, Ireland’s focus was on securing the necessary changes to provide certainty and stability to the revised international tax framework, in particular around the minimum effective rate.

Securing consensus that the minimum effective rate will be 15% for businesses with a turnover in excess of 750 million euros ($840 million) and the guarantee that Ireland can continue to offer a 12.5% trading rate for all other companies was an important result that it was able to achieve, thanks to the negotiations.

Being party to the agreement means that Ireland can also have input as the rules on Pillar One and Pillar Two develop. There are numerous technical details to consider in implementing these fundamental changes to the international tax system.

According to Sonya Manzor, Head of Tax at William Fry Tax Advisors, Taxand Ireland:

“The predominant view of international business in Ireland was that it was better for Ireland to sign up to the OECD deal, even if that meant an increase in the 12.5% corporate tax rate. It provided certainty, predictability and stability for business. The fact is that the R&D tax credit will remain under the agreement and changes made to the substance based carve-out were also positive for businesses operating in Ireland.

“The interplay of any changes to the U.S. tax rules with the new OECD international tax framework will be closely monitored by Ireland, and their potential impact on companies operating there.”

The point that both Irish politicians and their resident corporates recognize the benefit of being part of Pillar One and Pillar Two (even if in the short term they face an increase in tax) by having a seat at the table of future negotiations, is a powerful one. It shows maturity and a proof point that so much more than sheer tax efficiency is what boardrooms around the world are prioritizing.

Developing Countries

However, not all countries are in the same position, especially if we compare developed and developing countries. One of the most challenging tasks at the OECD is strengthening engagement with developing countries in the BEPS project, mainly with direct participation in the Committee on Fiscal Affairs and its technical working parties to reach unanimous consensus. After all, that’s the point.

Africa presents perhaps one of the most complicated landscapes politically and practically in finding that uniformity of acceptance, for several reasons. According to Jens Brodbeck, Executive at ENSafrica, Taxand South Africa:

“From an African perspective, the agreement reached on the new Pillar One and Pillar Two rules is regarded as an important milestone to address the needs of African countries in the process of bridging the gap between the existing tax rules that have been skewed in favor of developed countries and a more simple and equitable set of rules. While a number of the concerns raised by ATAF (African Tax Administration Forum) and the African countries were taken into account in the negotiation process, the agreement now reached is not expected to be the end of the discussions around a fair and equitable international tax system. This doesn’t take away from the main underlying issues still facing African countries, such as the urgent need to build capacity to deal with illicit financial flows or to implement the Pillar One and Pillar Two rules.”

This sentiment that signing up to the two pillars offers the power to change longstanding disadvantages in the system, despite needing to make what might feel like an initial compromise, feels similar to that of Ireland’s “seat at the table” argument. Perhaps this is what will change the minds of Nigeria and Kenya on the African Continent.

It can be said that the tax systems in a number of the countries yet to sign up are less developed than many systems in the West, and the rollout of Pillar One and Pillar Two also presents the opportunity to offer support to these nations in advancing their existing frameworks, even if the offer is initially declined. Regardless, it is unlikely that these countries do not see the benefit of one day joining this global movement. In not doing so, they will risk losing influence and control over their own international tax diplomacy.

The U.S.

Despite it being at the forefront of the implementation and negotiations around Pillars One and Two, there remains some uncertainty associated with the U.S.

Although an important achievement in the efforts to combat global tax base erosion, the effects of these measures (Pillars One and Two) could extend well beyond the targeted multinationals, because their responses could trigger issues for the suppliers and customers of the U.S., which are generally smaller businesses.

Marc Alms, Managing Director of Alvarez & Marsal Taxand, comments:

“A challenging road lies ahead with many technical and implementation issues that need to be resolved to accomplish the ambitious goal of implementing Pillar One and Pillar Two in 2023. In the U.S. for example, the legislative path to fully implement the two-pillar system, including modification to tax treaties, is currently unclear.”

One thing is certain, while the fanfare of October’s success was fully deserved, we are still a long way from the finish line.

This column does not necessarily reflect the opinion of The Bureau of National Affairs, Inc. or its owners.

Paolo Ruggiero is a Partner with LED Taxand.

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