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Pillars One and Two: How We Got Here and What May Happen Next

Aug. 5, 2022, 7:00 AM

Hungary’s recent decision to block the progress of the EU’s directive to implement a global minimum corporate tax has attracted significant attention across the financial and political worlds. Last month, Mihály Varga, Hungary’s Minister of Finance, announced his country’s decision to effectively prevent the measure’s implementation at a bloc level.

Although Hungary’s opposition has caused political disruption and frustration within the EU, this article does not intend to unpick the political machinations behind Hungary’s stance, but rather to outline the debates surrounding the existing international tax system, and the perceived efficacy of Pillars One and Two.

How We Got Here

It is helpful to begin by understanding why and how such a transformative and highly complicated tax reform proposal came into being.

The minimum corporation tax formed part of a global deal achieved last year at the Organization for Economic Cooperation and Development (OECD) and endorsed by 137 countries representing more than 90% of global GDP. This represented a truly historic global tax deal that would introduce a global minimum tax rate of at least 15% on the profits of the world’s largest businesses. Discussions surrounding the implementation of a levy of this global magnitude developed out of the financial crisis of 2008-2009 and from multiple international cases of tax evasion and aggressive tax planning.

The OECD and G-20, to their credit, recognized that the international tax rules were simply no longer fit for purpose and, arguably, were archaic in both their nature and implementation. Stories proliferated about large multinationals earning significant income in a country but not paying a minimum level of corporate income tax in that or any other country. Regardless of whether or not that was true in all cases, there was no doubt that advances in technological innovation and the creation of new business models were challenging the rules for taxing international business income.

Accordingly, the OECD decided to take measures against the erosion of the tax base and shifting of profits to ensure that there was some form of a level playing field on the global stage.

At the beginning of 2022, even more momentum was injected into the talks to reform the global tax system as the coronavirus pandemic forced governments around the world to scramble for ways to boost their fiscal revenues and finance costly recoveries. The EU decided to transpose the OECD deal into EU law through a directive that would apply across the bloc. However, as tax matters in the EU require unanimity among member states, a single country can paralyze an entire agreement. Hence, the current impasse—Hungary’s decision to impede any further steps towards a minimum effective tax rate for the global activities of large multinational groups.

A System No Longer Fit for Purpose

Some of the fundamental rules on which current tax legislation is based were conceived several decades ago. Since then, we have seen a profound transformation occur, introducing myriad economic models and innovations that current tax policies struggle to deal with. One such innovation is the digital economy. For a system of taxation to capture the digital economy’s revenue potential, it must recognize the core characteristics of e-commerce spaces—namely, mobility of consumers and traders, data-driven capabilities to drive sales, and the mass socialization of e-commerce spaces. These characteristics, amongst many others, form a significant part of the economy that is currently regulated by an outdated system.

One challenge experienced by businesses and governments is the practice of “base erosion and profit shifting” (BEPS), whereby tax planning strategies exploit gaps and mismatches in different countries’ tax systems. BEPS often results in the perpetuation of existing economic inequalities as developing countries, which rely mostly on corporate income tax, lose a considerable proportion of their tax revenue.

Arguably, the digital economy in itself does not generate BEPS issues in the same way as traditional business. However, it does exacerbate aspects of traditional BEPS risks. These findings are outlined in the OECD’s 2015 report “Addressing the Tax Challenges of the Digital Economy”, an authoritative report on the challenges facing tax systems as a result of digitalization. It is worth noting that the report is now seven years old, during which time the digital economy has evolved considerably and, therefore, has raised even more complications for the relationship between digitalization and international taxation. It is the area of the digital economy that best encapsulates the need for reform of the international tax system.

Pillars One and Two

At its core, the current international tax system is a series of agreements and bilateral treaties that consider taxation to be an issue of residency or the presence of assets within a particular place. The proposals found in the two pillars of the OECD’s framework, particularly Pillar One, consider the notion of presence. Pillar One aims to change the existing tax allocation rules, accounting, in particular, for the rise of the digital economy.

As stated in the OECD’s report: “Because the digital economy is increasingly becoming the economy itself, it would be difficult, if not impossible, to ring-fence the digital economy from the rest of the economy for tax purposes.”

The crucial suggestion underlying this point is that the notion of presence, whether of things or people, is no longer the benchmark for whether a business or individual ought to pay taxes. The digitalization of the economy has forced us to reconsider what the operative criteria driving tax allocation should be.

Pillar One tackles the notion of digitalization directly. Its scope extends further than Big Tech as it includes other consumer-facing digital businesses as well. The inclusion, supported by the United States, in Pillar One of consumer-facing digital businesses ensures that a greater portion of the digital economy is captured by applying two mechanisms to ensure fair taxation.

Pillar Two is even more expansive in that it puts a floor on corporate income tax competition through the introduction of a global minimum corporate tax rate of 15%. These minimum taxation rules would apply to all multinational enterprises with an annual revenue over 750 million euros ($766 million).

It is clear that the Pillar Two rules are rather complex. They basically allow the country where the ultimate parent company is located (in Italy, for example, in the case of an Italian multinational) to directly tax this parent company on income produced in another jurisdiction insofar as this foreign income was taxed at an effective tax rate lower than 15%.

Naturally, this is likely to drive changes in the wider rules and rates within individual countries, especially in those states that may lose tax income or business. If a global agreement were achieved, it would subsequently involve repealing national tax measures introduced to ensure taxation of the digital economy (i.e., digital services taxes). For the reasons already addressed, this is by no means an easy task.

Are the OECD and EU being too ambitious? Without getting into all the details of the proposals and certain specific provisions (such as the Undertaxed Payments Rule), the sheer complexity surrounding the implementation of the proposed new tax regime across multiple jurisdictions casts serious doubt on whether it can be achieved, at least in its current version. If it can’t be implemented then, according to a senior EU tax official, an EU-wide digital levy would be firmly back on the table.

Given this scenario, the OECD’s hard deadline of the middle of 2023 to reach an agreement can be seen as an attempt to put pressure on countries to move ahead. This includes not just EU countries but also the US, whose most recent behavior seems to suggest a certain degree of hesitation in taking the final step.

If It All Fails

Should Pillar One not materialize, there certainly would be wide discussions once again on whether to have a digital levy. It is worth noting that the EU’s strategy was shrewd because, if nothing happens globally, it has a blocwide digital levy to fall back on—even if the final form of such a tax is not yet clear.

However, the US originally saw the EU digital levy as a specific attack on US tech giants and, consequently, an economic attack on the US. If the levy is resurrected, the US may well raise this issue again, claiming that it amounts to unfair discrimination. The EU had previously been adamant that the levy as envisaged wouldn’t discriminate against American companies. Nevertheless, if Pillar One isn’t implemented, this bone of contention may well be revisited.


Clearly, implementing Pillars One and Two is by no means an easy task and it could lead to two equally complex situations and broader geopolitical tensions. Given the current state of global affairs, this is perhaps one headache that the world could do without right now.

Even if a solution can be found to the current political deadlock on implementation, the question of how to enforce an inherently complex global tax regime will still need an answer. No single party has the definitive solution and thus now, more than ever, full cooperation, collaboration and analysis between politicians and tax and legal experts is clearly needed.

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

Stefano Giuliano is a Partner with CMS Italy.

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