Hockey legend Wayne Gretzky’s admonition to “skate to where the puck is going to be” has become one of the most tired cliches in business. But for multinational companies that will be affected by OECD’s BEPS framework—a global tax regime that is simultaneously being drafted into law by multiple countries even as it continues to change and evolve—the Great One’s advice with respect to understanding the impact on their effective tax rate in various jurisdictions is actually pretty … great.
BEPS took a big step closer to becoming a reality in the last few months by releasing draft model rules for both Pillar I and Pillar II. The Pillar Two draft model rules were issued in December, followed by two draft rules for Pillar One in February: one that lays out how companies should determine the jurisdictional source of revenue and one that describes how they should determine their tax base.
While the model rules—"model” because they are meant to serve as a template for domestic legislation in the more than 100 countries in the BEPS Inclusive Framework—contained few surprises, the sheer breadth of the guidance underscores the enormous scope of the project. The nearly simultaneous promulgation of a proposed directive by the European Commission just two days after the release of the Pillar Two model rules showed just how quickly the initiative is moving.
What the Model Rules Do: Pillar One
Pillar One includes certain nexus and profit allocation rules regarding the reallocation of global taxing rights from low-taxed to market jurisdictions.
The draft nexus rules include a test to determine whether a certain jurisdiction qualifies for profit reallocation based on revenue arising in that jurisdiction. The nexus test is satisfied if the revenue of the covered group in a jurisdiction is equal to or greater than $1.10 million (€1.0 million) for jurisdictions with annual GDP equal to or greater than $44.0 billion (€40 billion), and $275,000 (€250,000) for jurisdictions with annual GDP of less than $44.0 billion (€40 billion).
Revenue is sourced on a transactional basis using a reliable indicator or specific allocation key based on a particular revenue category. The draft model rules include different revenue categories such as the sale of finished goods, provision of services, license or sale of intangible property, or sale or lease of real property that are further broken down into sub-categories.
The draft model rules provide specific indicators for each category and sub-category for certain revenue sources. Certain allocation keys could be applied in the absence of a reliable indicator. If there aren’t any reliable indicators and no allocation key is provided in the relevant revenue sourcing rules, a global allocation key could be applied based on specific ratios subject to further development.
If multiple categories of goods or services are covered under a single invoice or contract, the allocation of revenue must be proportionate to the revenue earned in each market under that invoice or contract, with any jurisdictional pricing differences also considered. A transaction is categorized based on its ordinary or predominant character if it includes multiple elements from different categories. Transactions that don’t fit into any categories are categorized based on the most analogous type. Supplementary transactions may be categorized based on the primary transaction.
In addition to the nexus rules, the OECD also issued draft rules regarding determining the appropriate tax base to which the profit allocation formula should be applied under Amount A of Pillar One.
The starting point for the tax base is financial accounting profit or loss derived from the consolidated financial statements under a qualifying financial accounting standard, with certain adjustments such as tax income and expense adjustments, dividends and distributions, equity gain and losses, policy disallowed expenses, and restatements.
What the Model Rules Do: Pillar Two
The draft Pillar Two model rules add copious detail to one key leg of the BEPS project, the effort to create a global minimum tax rate of 15% for large multinational enterprises, or MNEs, starting in 2023. Generally, the rules apply to MNEs with annual revenue of $825.0 million (€750 million) or more, excluding certain investment entities and organizations with special status.
The model rules delineate precisely which multinationals will be affected and how to compute their tax base—GloBE income or loss—and covered taxes. They detail how their effective tax rate should be calculated in a given jurisdiction. They create a mechanism for top-up taxes to be paid by companies to bring their effective tax rate up to the 15% minimum along with certain adjustments and exclusions.
The first step of the effective tax rate calculation involves computing GloBE income or loss for each constituent entity. Similar to the Pillar One model rules, financial accounting income or loss under an acceptable accounting standard is the starting point, with certain adjustments and eliminations. The second step of the effective tax rate calculation is the computation of covered taxes based on current tax expenses accrued in financial accounting subject to certain adjustments.
The effective tax rate is calculated by aggregating each constituent entity’s GloBE income or loss and covered taxes for each jurisdiction and dividing covered taxes by GloBE income or loss.
Once the effective tax rate is established for each jurisdiction, low tax jurisdictions with an effective tax rate below the 15% minimum tax rate are identified and a top-up tax percentage is calculated for each low-tax jurisdiction equal to the difference between the 15% minimum tax rate and the effective tax rate in each jurisdiction. The top-up is based on certain substance-based income exclusion rules and the determination of excess profits in the low-tax jurisdictions.
The top-up taxes are allocated to the constituent entities in low-tax jurisdictions through certain top-up tax mechanisms. The income inclusion rule imposes a top-up tax on a parent entity by paying its allocable share of the top-up tax concerning its low-taxed subsidiary. The undertaxed payments rule imposes top-up tax by denying certain tax deductions and corresponding adjustments resulting in additional cash tax expense.
How Fast is BEPS Moving?
The OECD set an ambitious goal of implementing both pillars in 2023. Lawmakers in several major jurisdictions have already begun drafting and circulating legislative responses, even as further guidance is pending from the OECD, and individual countries continue to raise objections to various provisions. Here are some examples:
The European Commission took the lead by floating a proposed directive in late December, less than a week after the OECD released the model Pillar Two rules. That measure, almost certain to be revised, will be considered by the European Council and ultimately the European Parliament. France has stated it would like to get Council approval in the first half of 2022.
While Switzerland was one of the noisiest objectors to certain provisions in the BEPS project, the Swiss Federal Council in January announced a framework for implementing Pillar Two through a constitutional amendment that would bring the measure into force on Jan. 1, 2024, a year later than the OECD target.
In the U.K, the government opened a consultation on implementing the new rules with an eye toward passing legislation implementing the main Pillar Two income inclusion rule in 2023.
The United States, with its narrowly divided Congress, may be the biggest wild card of all. Provisions for many elements of Pillar Two were included in the Build Back Better Act, including changes to the GILTI regime. But the act stalled in Congress late last year, and many observers rate the chances of its resurrection in an election year as low.
This is just a sampling of implementations worldwide, with new updates and new legislative initiatives seemingly being announced every week.
Bigger Ledgers, New Structures
With BEPS moving at such a rapid clip toward at least partial implantation next year, MNEs that will be affected may want to start planning with their advisers for the potential impacts of the new regime. The aforementioned model rules constitute the first set of documents expected to be released by the OECD in the coming months, including model rules around Amount B of Pillar One.
Companies should monitor these developments closely, as they may need new mechanisms for local notification, information sharing, and profit allocation between jurisdictions to determine their effective tax rates. Certain companies may also elect to implement structural changes to optimize operations in light of the new regime, such as shifting from centralized operating structures to multi-hub models through business restructurings and reorganizations, which may result in increased valuation needs from business, financial reporting, and tax perspectives.
No one can say exactly where the puck is going to be a year from now, but it’s time for MNEs to sharpen their blades and start skating to where the tax rules appear to be headed.
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.
Tom Gottfried is a managing director at Valuation Research Corporation, specializing in global tax matters. He has over 15 years of experience in planning, facilitating and leading engagements related to corporate reorganizations, mergers & acquisitions and restructurings.
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