In summary

In January 2020, the OECD Inclusive Framework (139 countries) met to push BEPS 2.0 forward.

The January meetings were set against the backdrop of the political “hand grenade” that the US tossed into the mix in late 2019 when it suggested that Pillar One should be optional.

Although much of the discussion at the January meetings was focussed on this development, the OECD side stepped the issue for now by agreeing to consider the proposal as part of the ongoing work on BEPS 2.0.

Following these meetings, the OECD released their latest paper on BEPS 2.0 – the January 2020 “Statement by the OECD/G20 Inclusive Framework on BEPS on the Two-Pillar Approach to Address the Tax Challenges Arising from the Digitalisation of the Economy” (the Statement). The Statement provides further insights in relation to the development of BEPS 2.0.

In detail

Background - the US proposal

In December 2019, the exchange of letters between the US Secretary of the Treasury and the OECD Secretary General looked like a stalemate for Pillar One with the US proposing that whatever emerges should be a safe harbour at the election of the taxpayer.

The US proposal mystified many members of the Inclusive Framework as it was seen as undoing the work to date.

Rather than alienating the US, the Inclusive Framework agreed at the January meetings to include the issue of “optionality” in the program of work that will take place over the next few months.

It will be fascinating to see how this issue plays out over this period. It is difficult to see how Pillar One can work on an elective basis or indeed whether it would get political support from anyone (other than the US). 

Although other countries will certainly be looking to change the US position on this issue, one possibility is that a significant group of countries may be willing to move forward even without the US.

The January 2020 Statement

The January 2020 Statement provides greater details on the approach to both Pillar One and Pillar Two.

As you will recall, Pillar One is primarily about re-allocating taxing rights to the country where the consumer is located, regardless of the existence of a physical presence in that jurisdiction (Amount A). The second element of Pillar One is concerned with providing greater definition on the amount of tax that can be collected in the consumer country where a physical presence existed (Amounts B and C) – i.e. moving away from a transfer pricing methodology to, at least partly, an agreed rate of return for certain activities.

One of the great uncertainties with the Pillar One proposals was precisely what was within scope – in particular, what was a consumer facing business. Greater clarity is provided on this in the January 2020 Statement. It is recognised in the Statement that there are in fact two different types of businesses that will be caught by Pillar One - both depending in different ways on profiting from economic (monopoly-type) rents. All technology companies above a revenue threshold will be in as they benefit from “powerful network effects” (creating de facto monopolies for the winners, with the losers probably making at most routine returns). Businesses with marketing intangibles attracting consumers will also be in as they benefit from pricing power arising from their brands. The same policy is also used to explain the exclusions from Pillar One. The two most important exclusions being (i) resource (and likely commodity producing) companies - excluded on the basis that the economic rents belong to the country of production, not sale) and (ii) banks - excluded as their customers are typically based in the same country as where the bank is located.

The exclusion of resource companies and banks is likely to be of great comfort to the Australian Government with these companies making a significant contribution to the Australian corporate tax base.

The January 2020 Statement also offers greater insights on other areas of Pillar One. Two other notable developments are:

  • the Statement appears to have a far greater focus on Amount A than previous documents – it appears that the amount of tax that will be collected under Amount A may be greater than we originally expected; and
  • the Statement appears to indicate that transfer pricing will have a greater role to play in determining Amounts B and C than we had originally understood – previously the “vibe’ had been that Amount B would simply be a politically agreed rate of return and would be de-linked from transfer pricing principles

Pillar Two is concerned with achieving a global minimum tax through various specific rules. The January 2020 Statement moves Pillar Two forward to a much lesser extent than Pillar One. One interesting point to note in relation to Pillar Two is that the Statement recognises but does not resolve the priority between the measures giving revenue to the residence country (the CFC-type measure and switchover for low taxed branch profits) or the source country (the deduction denial and withholding tax proposals). Separately, in recent webcasts OECD officials have suggested that the residence country will have the priority right.

Financial modelling

One of the great unknown questions with BEPS 2.0 has been what are the dollars at stake?

In February 2020, the OECD tried to partly answer this question – they estimated additional revenue of up to USD 100 billion per year from BEPS 2.0 with gains broadly similar as a percentage of corporate revenue across developed and developing countries (note that for developing countries corporate tax is a much greater share of tax revenue than for developed countries). By far the greatest proportion of the revenue increase comes from Pillar Two.

The OECD financial analysis has many caveats both as to the difficulty of obtaining relevant data and in relation to the parameters used in the modelling, which have to second guess the outcomes of the final package for BEPS 2.0. More detail is promised in coming months and the temptation to accept the numbers as real must, in the meantime be resisted.

Where to from here?

Notwithstanding the ongoing political uncertainty, the clear message is that BEPS 2.0 will continue to move quickly in 2020. The OECD has set out an aggressive program of works over the next 4-6 months.

Although it is difficult for taxpayers to do much at this stage, it will be important for all multinationals to continue to monitor developments in the coming months.

The Statement was endorsed by the G20 Finance Ministers in late February 2020 who stressed the importance of “agreeing on the key policy features of a global and consensus-based solution by July 2020.”