The End Is Nigh: An Update On The OECD Tax Reform Plan

Tax Notes chief correspondent Stephanie Soong Johnston recaps the final agreement on the OECD’s two-pillar corporate tax reform plan approved in October by 136 countries of the inclusive framework.

This transcript has been edited for length and clarity.

David D. Stewart: Welcome to the podcast. I’m David Stewart, editor in chief of Tax Notes Today International. This week: nearly there?

We’ve been tracking the progress of the OECD inclusive framework’s efforts on updating international tax rules for quite some time. But for those just joining the saga, the OECD and the 140 members of the inclusive framework are pursuing a two-pillar solution to address the tax challenges of digitalization. It has proven to be quite tricky to find consensus on what can be done, but recently the OECD announced some significant progress.

Here to talk about the latest developments is Tax Notes chief correspondent Stephanie Soong Johnston. Stephanie, welcome back to the podcast.

Stephanie Soong Johnston: Thanks for having me again.

David D. Stewart: Why don’t you start us off with a brief refresher on the two pillars?

Stephanie Soong Johnston: For years, the OECD inclusive framework on base erosion and profit shifting has been working on a global corporate tax reform plan. That work builds on action 1, which is sort of a leftover of the original BEPS project from 2015.

Action 1 was supposed to address the tax challenges of digitalization of the economy. The main question there was, “How do you tax new business models that sell goods and services, often digital in nature, to another country and profit off consumers in those countries without physical presence under the existing rules?”

Over the years, the plan took shape and now it’s got two pillars. Pillar 1 would change profit allocation and nexus rules so that market countries where consumers are located will be able to have a new taxing right called amount A.

Amount A would allow those countries to tax companies on a portion of so-called residual or nonroutine profits earned from activities in those jurisdictions, even if they lack physical presence.

Pillar 1 also calls for amount B, which represents a fixed return for the baseline marketing and distribution activities and market jurisdictions in line with the arm’s-length standard. It also provides dispute prevention and resolution mechanisms to ensure tech certainty.

Pillar 2, meanwhile, would ensure that large multinationals would pay a minimum level of tax primarily through global antibase erosion rules, which are nicknamed the GLOBE. These are based on a minimum effective tax rate.

The GLOBE rules would contain the income inclusion role and the under-taxed payment rule, both of which were inspired by the global intangible low-taxed income regime and the base erosion and antiabuse tax of the Tax Cuts and Jobs Act, respectively.

The income inclusion rule would apply a top-up tax to an in-scope multinational enterprise’s income that is taxed below the agreed effective minimum tax rate, while the under-taxed payments rule would deny deductions for payments that are taxed under the minimum tax rate.

Pillar 2 also has the treaty-based subject to tax rule, which would let sourced jurisdictions apply limited source taxation to some related party payments that are taxed below a minimum rate.

David D. Stewart: What is the latest from the inclusive framework?

Stephanie Soong Johnston: A lot has happened since the last time I was on the podcast in July.

On July 1, 130 out of 139 countries in the inclusive framework on BEPS had reached a preliminary political agreement on several elements of pillars 1 and 2. But there were open questions that still needed to finalize things. The inclusive framework said that they’d work to finalize that agreement by October, which they did.

On October 8, the inclusive framework, which had increased its membership to 140 countries in that short period, had announced that 136 of those 140 countries had finalized the agreement.

David D. Stewart: What do we now know about pillar 1?

Stephanie Soong Johnston: There were two big outstanding issues that relate to amount A from the July agreement. That is the quantum, which is a fancy word for the percentage of the in-scope MNEs and residual profits that should be allocated to market countries. There’s also the tax certainty requirements for developing countries. Those are two big issues that needed to be addressed.

There’s also an open question about how countries would be expected to withdraw unilateral digital services taxes and other relevant measures, and how they would be prevented from introducing new ones in the future. There was no definition of what constituted relevant unilateral measure.

The October agreement confirms that companies in scope of amount A rules are MNEs with global turnover exceeding €20 billion with profitability of more than 10 percent. That turnover threshold would eventually decrease to €10 billion, if the amount A rules and tax certainty mechanisms are successfully implemented.

There’s also a new special purpose nexus rule that would allocate amount A to market countries if an in-scope MNE has at least €1 million in revenue in those countries. Smaller market countries with GDP of less than 40 billion would have a lower nexus of €250,000.

The October agreement also confirmed the quantum of amount A. Countries agreed that 25 percent of in-scope MNE residual profits will be allocated to market jurisdictions with a nexus based on an allocation key tied to revenue. This is a development from the July agreement, which had given a range of 20-25 percent for the quantum. This is more precise.

The inclusive framework also agreed that there would be a multilateral convention, or MLC, which will be developed to implement amount A rules, which countries will be able to sign in 2022. Amount A rules will take effect in 2023.

Countries that joined the multilateral convention will also be required to withdraw all DSTs and other relevant, similar measures. They are barred from introducing new DSTs on any companies, not just those in scope of amount A, from October 8 to either December 31, 2023, or the date when the MLC comes into force, whichever comes first.

According to the agreement, the definition of relevant similar measures will be included as part of the MLC and its explanatory statements. Again, we don’t have a definition of what constitutes relevant similar measures. That’s very weird because if countries are not supposed to introduce new measures in the interim, how are they supposed to know which ones are off limits besides DSTs? I don’t know if there’s an answer, but we’ll see.

The October agreement also confirms that in-scope MNEs would have a mandatory and binding dispute prevention and resolution mechanism for amount A issues only. But developing economies that meet certain conditions, like if they have no or low mutual agreement procedure cases, are allowed an elective binding dispute resolution mechanism. This is to respond to several developing countries’ concerns that their sovereignty would be impugned on if they had to agree to these rules.

One thing I did notice from the October statement is that it said nothing more about segmentation. The inclusive framework agreed that there would be a need for singling out business lines of a company to subject it to amount A rules only in exceptional circumstances.

The segmentation issue was put in there to address concerns from countries that certain companies — like Amazon — would not actually get taxed because their profit margins are too low to qualify for amount A rules. This segmentation element of pillar 1 was supposed to address those concerns, so that there were profitable business lines would fall under scope of the Amount A rules.

David D. Stewart: That’s a lot of new information about pillar 1. Did we get anything similar about pillar 2?

Stephanie Soong Johnston: The biggest issue that everyone kept talking about pillar 2 was, “What is the effective tax rate that countries will agree to for the purposes of the income inclusion rule and the under-taxed payment rule?”

Originally, in July, countries agreed that this rate would be at least 15 percent. That’s sort of in line with what the United States had suggested to kick-start the negotiations when the Biden administration took over. After a lot of haggling with several countries, especially Ireland, which was concerned about how pillar 2 would affect its headline corporate tax rate of 12.5 percent, we’ve got an answer: an effective tax rate of 15 percent.

The October agreement also confirms that MNEs that are just starting to branch out with international activities will be temporarily excluded from the under-taxed payments rule. So now, MNEs with a maximum of €50 million in tangible assets abroad and operations in a maximum of five other countries will be exempt for five years after the first time an MNE falls under the scope of the GLOBE rules.

The GLOBE rules also have a formulaic substance carveout that will exclude an amount of income that is 5 percent of the carrying value of tangible assets and payroll. We see there’s a 10-year transition period where the amount of income to be excluded will be 8 percent of the carrying value of tangible assets and 10 percent of payroll.

These percentages would decrease annually by 0.2 percentage points for the first five years and by 0.4 percentage points for tangible assets, and by 0.8 percent of points for payroll in the last five years.

The pillar 2 agreement also provides a concession for countries with distribution tax systems. The agreement now says that there will be no top-up tax liability if earnings are distributed within four years and taxed at or above the minimal level.

There’s also a de minimis exclusion for jurisdictions where MNEs have revenues of less than €10 million and profits of less than €1 million. The agreement also confirms that the subject to tax rule rate will be 9 percent.

David D. Stewart: Turning back to what you mentioned earlier, as of July, there were 130 countries that had signed onto the agreement as it was at the time. Now we’re up to 136 out of 140. Which reluctant countries have signed on? Who is still holding out?

Stephanie Soong Johnston: Between the July and October agreements, there were essentially six holdouts. Three EU countries — Ireland, Estonia, and Hungary — and three developing countries — Nigeria, Kenya, and Sri Lanka.

There was a lot of press coverage, including Tax Notes, about Ireland, because Ireland was really worried about the “at least 15 percent” language in the July agreement. Ireland was worried that the effective tax rate under pillar 2 would basically undercut their ability to attract multinationals to Ireland.

They worked really hard to get that “at least” language pulled out of that agreement. You can see in the final agreement that Ireland got its way and is now part of the agreement.

Estonia also had some concerns about how pillar 2 would treat its distribution tax system, which has been addressed. Hungary had concerns about the formulaic substance carveout for the GLOBE rules, and they managed to get a lot of concessions, which is probably why that language in the agreement on the substance carveout is so complicated. You can see that the inclusive framework has accommodated a lot of these concerns that Estonia, Hungary, and other countries have.

The fact that there was a lot of attention on Ireland, Hungary and Estonia not joining the agreement has a lot to do with the EU’s ability to pass legislation to implement these rules. The EU requires unanimity to pass any directive involving taxation. If Estonia, Hungary, and Ireland weren’t on board with the agreement, then the EU would have a very hard time trying to get those rules implemented. Now that Ireland, Estonia, and Hungary are now on board, it’s not a problem for the EU.

Kenya, Nigeria, and Sri Lanka were the three holdouts that continued to hold out. They did not sign the October agreement.

In fact, Pakistan, which was part of the July agreement, withdrew that support and is now out. So now we’ve got four holdouts: Kenya, Nigeria, Sri Lanka, and Pakistan.

I have to admit that I’m not 100 percent sure what Pakistan’s deal is. I would imagine that the reason why Kenya and Nigeria did not want to join was that Kenya imposes a DST and Nigeria has a significant economic presence provision in its tax laws. I’d imagine they want to hang on to those to raise more revenues from digital activity.

Sri Lanka, I would imagine, has concerns with pillar 2 and special economic zones. Sri Lanka has special economic zones that they use to attract international investment. I assume that’s what their problem was on pillar 2. I hope to report back to find out more about what Pakistan’s position is. Stay tuned.

David D. Stewart: Beyond the countries, the holdouts, and the joiners, what other reactions have we heard to this latest announcement?

Stephanie Soong Johnston: I think reactions kind of fall into two camps. One is: “Hey, thank God we have some certainty finally.” There are some major blanks that are fulfilled. But at the same time, there are a lot of outstanding issues that need to be addressed.

It was interesting to cover this story because as you follow the negotiations you find that developing countries, even within the inclusive framework and the G-20, were raising concerns about whether this deal will actually help developing countries.

I covered an event where the Finance Minister of Argentina, who is a member of G-20, said, “This deal is a bad deal, but what’s worse is nothing. So we have to sign up to this.” He actually acknowledged that this is not what they want, but they’re signing up anyway, which kind of makes you wonder how strong this agreement really is, how solid it is among developing countries.

You’ve heard civil society really criticized this deal. That it doesn’t do enough to help developing countries. It’s asking too much of them. They’re asking too much to give up in exchange for too little. There’s that voice in the debate.

Companies, I think, are just happy that there is some certainty going forward about what these new rules might look like. So far, I’ve seen a lot of statements from businesses in that regard.

I think a lot of tech companies are still worried about what the rollback and standstill provisions are under pillar 2 regarding DSTs. There is more language about the standstill and rollback of DSTs and relevant unilateral measures, but the language did provide a sunset clause for countries that have digital services taxes to phase them out.

But at the same time, countries will still be allowed to have these taxes for two years. In the meantime, the Office of the U.S. Trade Representative is poised to impose 25 percent tariffs on millions of dollars of imports from several countries that have DSTs, including Italy, France, India, Spain, and Turkey.

What’s going to happen to those tariffs? The USTR had suspended those tariffs until the end of November. Now that this agreement is in place, what happens to those tariffs? Are they going to be put off or what? We don’t know.

I think companies are worried that we’ll still have some trade wars happening while the multilateral convention is being developed.

I covered a press briefing with Treasury recently, and officials there said that they were having conversations with a lot of these countries that have DSTs to figure out a way to compromise. They didn’t really say what that meant. I suspect it means that they’re trying to find a way for these countries to withdraw their DSTs early, or at least say publicly that, “We are going to phase these out.” We were told to look out for some more information to be publicized in the coming weeks, so I’m looking out for that.

Another concern is that what’s going to happen with the U.S. on pillar 2? And pillar 1? Will the U.S. be able to push legislation to implement pillars 1 and 2 through Congress? The Biden administration has a pretty thin majority in the Senate and in the House of Representatives, so it’s an open question now. Will the U.S. be able to make good on its promises that it can deliver on implementing pillars 1 and 2? As everyone knows, the U.S. is pretty important to have on board to ensure the effective implementation of both pillars.

To that end, another reaction was from the Republicans here in the States. Reps. Kevin Brady, R-Texas, and Mike Crapo, R-Idaho, who are the top Republican tax writers in Congress, have been very vocal about the Biden administration and Treasury not being that forthcoming with their plan to get these two pillars implemented. Treasury Secretary Janet Yellen recently indicated that there could be another way around the need to have a multilateral convention pass in the Senate, which requires two thirds majority vote.

Since pillar 1 will require a multilateral convention, there are questions now like will the Senate be willing to push through this convention? Given our track record so far on treaties and treaty ratification, it’s very doubtful that Treasury will be able to pull that off, really.

The Republicans are worried that Treasury is trying to get around Senate treaty ratification application process, which is also an open question. What are they planning? We don’t know.

The Treasury officials told reporters that they’re working to get bipartisan support for pillar 1. There’s a lot to like about pillar 1. It gets rid of DSTs that both Democrats and Republicans hate. They basically said, “We can’t think about that now. It’s too early to think about that.” But the rest of us were thinking, “Well, it’s kind of important question.”

David D. Stewart: As I understand it, one of the big outstanding issues for pillar 2 was how it would work with the U.S. GILTI regime. What are the remaining questions there?

Stephanie Soong Johnston: It was a little disappointing to see in the October 8 agreement that there really wasn’t much to add on the GILTI coexistence. Treasury officials have told us that basically countries accept that the GILTI coexistence would happen.

Countries really only had two issues: the rate and the country-by-country determination for the GLOBE rules. The GILTI regime as it exists now differs in that it’s not on a country-by-country basis. But Treasury is trying to reform the TCJA so that the GILTI regime is on a country-by-country basis.

Now that the U.S. is making moves to better align the GILTI regime with the GlOBE rules, it remains to be seen how exactly the GILTI coexistence will be spelled out in the future.

David D. Stewart: What are the next steps for this agreement?

Stephanie Soong Johnston: The G-20 finance ministers approved the agreement on October 13 at their meeting on the sidelines of the IMF-World Bank meeting. That is one milestone.

The next milestone is to have the G-20 leaders approve the agreement at their October 30-31 meeting.

After that, we can expect model rules for pillar 2 to define the scope and mechanics of the GLOBE rules, as well as model treaty provisions to give effect to the subject to tax rule in November 2021.

In mid-2022, we can expect a multilateral instrument for the implementation of the subject to tax rules in bilateral treaties.

At the end of 2022, the OECD expects to have implementation framework to facilitate the coordinated implementation of the GLOBE rules.

That’s pillar 2, which we’d always known that the work on pillar 2 was more advanced than pillar 1.

Meanwhile, for pillar 1, in early 2022, we can expect the text of a multilateral convention and explanatory statement to implement amount A. Also model rules for domestic legislation that’s needed for implementing pillar 1. Also mid-2022, for pillar 1, we can expect a high-level signing ceremony for the MLC.

By the end of 2022, the inclusive framework expects to finalize its work on amount B for pillar 1. 2023 is the target implementation timeframe for both pillars.

David D. Stewart: I anticipate that we’re going to be having you back several more times before this is finished out. But thank you for being here this week.

Stephanie Soong Johnston: Thanks for having me.