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OECD’s Pillar One and Pillar Two—A Question of Timing

June 14, 2022, 7:00 AM

A major discussion in the tax world concerns the timing of the introduction of Pillar One and Pillar Two of the second phase of the Organisation for Economic Co-operation and Development (OECD) Base Erosion and Profit Shifting program (BEPS 2.0).

Pillar One

Pillar One involves the reallocation to market jurisdictions of 25% of profit above 10% of very large multinationals with revenue exceeding 20 billion euros ($20.8 billion). There are exclusions for extractives and regulated financial services. It also involves changing existing tax treaties, which is proposed to be achieved through a multilateral Instrument of many countries signing up to the new rules through a streamlined mechanism.

The timetable for the introduction of Pillar One in the agreements made by the Inclusive Framework of more than 130 countries on July 1 and Oct. 8, 2021 proposed that the changes would take place from 2023. Given the complexity of Pillar One, this was always going to be an ambitious timetable.

At Davos, the Secretary-General of the OECD, Mathias Cormann, indicated that the implementation of Pillar One would be delayed until 2024. Questions have been raised as to the nature and prospects of the Pillar One rules passing the US Congress and, in particular, whether 50 votes (based on budget reconciliation processes) or 60 votes are required for the rules to pass through the US Senate. Recently, US Treasury Secretary Janet Yellen indicated that the ratification process clearly requires the approval of Congress, but the form this needs to take is yet to be determined.

An essential feature of the agreement in relation to Pillar One is that countries agree to withdraw, or not to introduce, digital services taxes. This is the Damocles Sword. If agreement is not reached, then the world is likely to see the proliferation of these taxes, and potentially counter-measures on tariffs. The OECD has estimated that this world—of no Pillar One, and with digital services taxes—could result in a significant reduction of global GDP. This is an important incentive to get Pillar One done.

Pillar Two

Pillar Two involves the introduction of a global minimum tax for multinationals with revenue greater than 750 million euros. The proposed rules seek to ensure that multinationals pay a minimum of 15% tax determined on a jurisdiction-by-jurisdiction basis by charging “top-up tax” if the Effective Tax Rate falls below 15%.

There are two important elements to note. The first is that the more than 130 countries that signed up to Pillar Two in the agreements of July 1 and Oct. 8, 2021, did not agree to introduce the rules in their own jurisdiction (although many will) but not to introduce inconsistent rules. Thus, Pillar Two does not rely on all countries agreeing to a minimum tax, but simply a sufficient number of countries agreeing to do so.

This raises the second important element. The top-up tax to ensure that a 15% rate is achieved on a jurisdictional basis can be levied at three levels. The first level is where a jurisdiction in which a multinational’s Constituent Entities are located introduces a domestic minimum top-up tax of 15%. Technically this is referred to as a Qualifying Domestic Minimum Top-up Tax, or QDMTT. This concept was introduced only in December 2021 and after the earlier Inclusive Framework agreements.

Jurisdictions will have a significant incentive to introduce a QDMTT because in the absence of such a tax, profits of multinationals from that jurisdiction could be taxed elsewhere under the other two levels.

The second level is the Income Inclusion Rule, or IIR. This rule is akin to a controlled foreign corporation rule and provides for top-up tax up the chain where a parent, including the ultimate parent or an intermediate parent, is located in a jurisdiction that has implemented the rule.

The third level is UTPR. This started off as an Undertaxed Payments Rule, but as it evolved such that the concept applies beyond payments, what used to be an acronym has become its actual name. It is the back-up policeman rule and can apply where a Constituent Entity of a multinational is located in a jurisdiction with such a rule, and there is unpaid top-up tax at the other two levels.

On Pillar Two the agreements of July 1 and Oct. 8, 2021 provided for the introduction of the IIR rule in 2023 and the UTPR rule in 2024.

However, discussions in the EU focused on converting the Inclusive Framework proposals into an EU directive reflected that this timing was too tight. At an Economic and Financial Affairs Council (Ecofin) meeting of April 5, 2022 it was agreed by 27 EU countries, except Poland, to implement the IIR from 2024 and not 2023, and the UTPR from 2025 and not 2024. There were further potential deferrals for EU countries with 12 or fewer in-scope multinationals—basically multinationals with revenue more than 750 million euros—whose ultimate parent entity was located in that jurisdiction. To date, Poland has taken the position that it will not sign up for Pillar Two unless Pillar One is fully agreed. Advice from the EU has suggested that such a linkage would be contrary to EU rules.

Going Forward—How Will Countries Proceed?

The French Presidency of the EU ends on June 30, with one more Ecofin meeting on June 17. The French Minister for Finance, Bruno Le Maire, has expressed confidence that all EU members will agree on the terms of a directive on June 17, although this would appear to be far from certain.

If no agreement is reached, it raises the question of whether other EU countries will introduce laws independently of the EU directive from 2024 or indeed from 2023, as this would not be inconsistent with an EU directive (if it were to come into being) which sets a minimum standard.

While the EU is broadly on a path of deferral for 12 months, it does not mean that other countries will follow suit. The position of the UK is not clear and the UK may well introduce an IIR in 2023 and the UTPR in 2024. While many UK businesses would prefer to see a deferral to 2024 and 2025 in line with the EU path, there is a Brexit narrative that the UK can do things faster outside the EU, and potentially a revenue-raising incentive to go in 2023 for the IIR rule.

There are other countries, such as Indonesia and Australia, and potentially Japan, that suggest that they will introduce an IIR rule with a 2023 commencement date. These countries may benefit from a first mover advantage, particularly if they have a UTPR rule in place in 2024 while others only introduce such a rule from 2025.

There is no reason why a country could not introduce an IIR and a UTPR in 2024. That is, the earliest a UTPR rule could be introduced is 2024, but it does not need to be introduced 12 months after the IIR rule.

The US position is different. They have rules in place currently, referred to as Global Intangible Low-Taxed Income (GILTI) rules, which require certain changes to ensure that they conform with the Pillar Two rules. In particular, GILTI is based on global blending rather than jurisdictional blending. If the EU and other countries have agreed to introduce global minimum tax rules, then this will assist in arguments for the US Congress to change their GILTI rules.

In Summary

For businesses, the potential complexity of different countries introducing QDMTT, IIR, and UTPR rules at different times is considerable. Such complexity feeds into accounting issues on recognition of top-up tax generally once rules are substantively enacted. This is further complicated where laws are passed with retrospective effect; for example, a law passed on Oct. 1, 2023 with effect from Jan. 1, 2023. Additional complexity arises where countries have straddle years, such as the UK and Japan, which are likely to commence Pillar Two rules from April 1.

Moreover, the compliance requirements for the global minimum tax are very significant, and it is likely that multinationals will need to prepare global returns for the 2023 year.

This article does not necessarily reflect the opinion of The Bureau of National Affairs, Inc., the publisher of Bloomberg Law and Bloomberg Tax, or its owners. 

Author Information

Grant Wardell-Johnson is KPMG Global Tax Policy Leader.

The author may be contacted at: grant.wardellJohnson@kpmg.co.uk