The OECD-led effort to overhaul how and where multinationals are taxed still has technical details to address before companies understand the full impact of a pact announced last week.
After years of negotiations, officials from 136 jurisdictions last week signed a sweeping agreement that would change where a portion of the largest multinationals’ profits are taxed—known as Pillar One—and create a new global minimum corporate tax rate of 15%—known as Pillar Two.
The Group of 20 finance ministers will meet later this week to advance the agreement ahead of a G-20 leaders meeting at the end of the month, and countries have set an ambitious goal of implementing the plan in the next two years. But as the deal gets closer to the finish line, some key design questions are still being worked out.
“Quite a lot is undecided,” said Will Morris, deputy global tax policy leader at PwC. The deal “gives it political momentum to carry it forward, but this is not the end of the road.”
Countries have agreed that Pillar One will reallocate 25% of profits above a 10% margin for the roughly 100 largest and most profitable multinationals. But they still have to design the mechanics of how to avoid double-taxing companies, and spell out the details of when certain profits would be excluded from the reallocation rules. The architects of the plan also have yet to spell out how they’ll deal with timing differences under the minimum tax.
The outcome of the remaining questions could affect the success of the effort as countries move on to try to implement new rules and agreements by 2023, tax practitioners warn.
Double Tax Relief
Under Amount A—the profit reallocation portion of Pillar One—companies could end up paying tax twice on the same income if they aren’t getting a break from the country where the reallocation is coming from.
For example, a U.S. taxpayer who has an Amount A reallocation to France would need some form of tax relief in the U.S. to compensate for the Amount A tax it’s now paying in France.
The agreement said the double tax relief could either come from an exemption or a credit system—an open question because different countries use different systems.
That question could become political, said Ross Robertson, an international tax partner at BDO in London.
“In a world where double tax relief is given by exemption, that’s a much simpler mechanism in principle to apply, but it leaves open the prospects that some companies may actually end up paying less tax,” Robertson said.
Besides figuring out how the relief would be granted, the final deal must also determine which country the relief comes from.
The agreement said that would be the company’s entity or entities where there’s residual or excess profits. But the rules must still spell out what happens when a multinational has residual profits being drawn out of more than one jurisdiction.
Depending on the final design of the plan, more of the brunt of the revenue impact could fall on countries like the U.S., or on places where multinationals have regional headquarters, like Ireland or Singapore.
“It’s always been a critical issue, because it’s about who wins and who loses,” Morris said. “In Amount A, someone gives up tax base in order that others may gain.”
For the double tax relief system to work it must be well-coordinated, and countries must all sign on to an effective binding arbitration system, said Daniel Bunn, vice president of global projects at the Tax Foundation.
Excluding Routine Activities
The plan also said further work was needed on a safe harbor for marketing and distribution activities: an exception under Amount A for when a multinational is already paying routine rates of return to its own entities in other countries that are performing certain activities.
The measure is needed because the plan means for Amount A to be allocated to market jurisdictions that don’t have residual profit under existing rules—and not the ones that do, said Marcus Heyland, managing director of economic and valuation services at KPMG’s Washington National Tax.
“The marketing and distribution safe harbor delivers on this by capping the allocation of Amount A to jurisdictions that already have taxing rights over a group’s residual profit,” he said.
Officials must answer two big questions, Heyland said: Defining what how the plan defines “residual profit”—for example, whether it’s a return on local sales, local tangible assets, local costs like payroll, or some combination—and deciding the scope of activities covered. The safe harbor could be limited to marketing and distribution activities, or it could apply more broadly to residual profit related to all activities.
For companies, a broader scope would be helpful, letting them avoid “the line-drawing exercise of distinguishing marketing and distribution related profit from everything else,” he said.
Companies want to see more details to be assured the safe harbor will protect them from double tax, Morris said.
Minimum Tax Timing Differences
The OECD says it plans to release model rules for Pillar Two in November—legislation countries can adopt to enact the rules domestically.
One key question that will be answered in the final model legislation is how the rules will deal with timing differences. The minimum tax calculations will be based on the audited financial accounts. However, profits reported in financial accounts may be different from those reported for tax purposes, which often fall after the end of the accounting period.
The issue can be particularly problematic for capital intensive industries such as extractives that have big differences between their accounting and tax profits. The rules will need to provide methods for eliminating any double tax that could result from losses not taken into account.
A U.K. official said in late September that negotiators were contemplating a system known as deferred tax accounting, but that it wasn’t yet certain they would adopt it or what form the final rules would take. The agreement didn’t offer more clarity.
Deferred tax accounting can be used by companies to create either a future liability or an asset that can be used to offset taxes. This method can allow the companies to account for the timing differences, said Kate Barton, EY’s global vice-chair for tax.
“The statement does not conclude on the mechanism for managing timing differences, suggesting that there’s ongoing discussion as to the final approach, including potentially deferred tax accounting,” Heyland said.
Initially, there was some hesitation to consider deferred tax accounting, said Alexandra Readhead, lead for tax and extractives at the International Institute for Sustainable Development. “I think the concern is from some governments that there’s an element of judgment involved in deferred tax accounting, particularly when it comes to things like tax assessments or disputes.”