The OECD has released its consultation document for BEPS Pillar Two on GloBE (the global anti-base erosion tax) as promised when releasing the Unified Secretariat Proposal on Pillar One last month, see our Tax Brief here.

As readers will be aware, Pillar Two is all about a global minimum level of tax and is primarily directed at ensuring that income that is taxed at low rates (or a nil rate) is appropriately taxed at an agreed minimum level. That is why the OECD so often repeats that Pillar Two will successfully deal with remaining BEPS issues. There is considerable money on the table and at least two countries that can claim it. The OECD in reporting to the G20 in October 2019 indicated that while Pillar One will raise a modest amount of additional revenue it is mainly about reallocating revenue among countries. By contrast the OECD stated that Pillar Two will raise considerably more revenue.

Unlike the Pillar One Proposal issued last month, the new Pillar Two document simply discusses some of the design issues involved in Pillar Two and then seeks input from stakeholders on specific matters, reiterating that yet further consultation will occur on these issues (obviously in 2020, though that is not mentioned) before a high level consensus is reached. In other words, it appears that the progress on Pillar Two is lagging behind Pillar One, which seems to be targeting a high level consensus in early 2020.

Pillar Two involves four distinct elements:

  • Taxation in the parent jurisdiction of foreign subsidiary income at a fixed (lower than usual) rate of tax to the extent that the income is not taxed offshore at least at that rate, effectively acting as a minimum tax like the US GILTI regime.

  • Switch-over from exemption to credit (FITO) relief in the head office jurisdiction for income of foreign permanent establishments (PEs) not taxed offshore at the fixed minimum rate of tax, implying that the normal head office corporate tax will apply to such income.

  • Taxation in the source country of deductible related-party payments to the extent that such income is not taxed elsewhere at the fixed minimum rate of tax, either by denying deductions in whole or part, or by a separate tax (including possibly a withholding tax) generated by the payment.

  • Denying source country treaty benefits for at least interest and royalty payments to related parties if they are not subject to tax at the fixed minimum rate of tax, with the possibility of extension to business profits, dividends, capital gains and other income, and to structured/conduit arrangements, also implying tax at whatever the domestic rate in the source country is (e.g. 30% gross for royalty withholding tax in Australia).

The first two bullet points are effectively a parent/residence based tax on low taxed foreign income, if the country of source or the subsidiary levies no tax or tax below the agreed minimum. The second two bullet points are a similar tax at source if the residence/parent country has no or a low level of tax. Together - and this does not always seem to be understood – these two parts of the Pillar Two proposals work as a global minimum corporate tax with either the source or residence jurisdiction picking up the tax if the other does not.

No priority has currently been specified but in due course priority rules among potential taxing jurisdictions will be established similarly as for the hybrid mismatch rules, as well as rules on avoiding international double taxation. The issues of which country is first in line and the setting of the minimum rate of tax will only be resolved in the political argy-bargy at the end of the process. The consultation document uses (with disclaimers) a 15% minimum tax rate for illustration – this is usually thought of as being at the upper limit of likely outcomes (the range is probably 10% to 15%).

The consultation document is focused on just the first bullet point in the list above. To the extent it deals with calculating the required minimum tax, it may be relevant to the other bullet points, though whether the test is intended to be the same for all cases is yet to be specified. The elements on which input is specifically sought are the use of financial accounts for establishing the tax base for measuring the minimum tax rather than a country’s tax rules, whether one calculation only is required for all foreign taxes paid (a global measure) or more than one calculation (either jurisdiction by jurisdiction or entity by entity) and what carve-outs if any will be permitted.

In relation to the first issue it is acknowledged that existing rules (e.g. for CFCs and PEs) use the parent/head office jurisdiction rules for calculating the tax base for foreign income but this would have the consequence for large multinational enterprises (MNEs) of having to calculate global income under many different countries’ tax rules. The alternative is to use financial reports which will simplify and standardise the calculation, though not necessarily down to one size fits all, as the US currently uses FASB rules, much of the rest of the world IFRS rules and Japan its own modified version of IFRS (while often MNEs are not required to use any particular standards if not listed on the stock exchange).

If financial accounts are used the next question is around the adjustments that may be necessary to recognise book/tax differences. In relation to permanent differences between accounting and tax the consultation document is open-ended but for temporary differences it canvasses specific options: the carry-forward of excess taxes above the minimum tax, adoption of tax-effect accounting for this purpose with deferred tax assets and liabilities effecting the reconciliation over time, or multi-year averaging. Five very simple examples are given to illustrate the first two of these alternatives and some complications are mentioned such as the period over which temporary differences would be allowed and the effect of changes in corporate tax rates. So far as there is a “vibe” in the document it seems to be in favour of tax-effect accounting.

On the question of whether the minimum tax will be applied on a global, jurisdiction or entity basis, the document is relatively clear that the policy of Pillar Two of eliminating remaining BEPS risks points to a jurisdiction or entity approach, since the minimum tax is designed to encourage both taxpayers not to tax plan for very low tax, and jurisdictions not to offer very low rates to attract tax base (and the latter concern is not dealt with under a global approach). This policy direction needs to be balanced against the escalation of compliance and administration costs if a more granular approach is adopted. The document also discusses complexities caused by domestic consolidation and similar regimes, PEs and transparent entities for allocating tax paid among entities or jurisdictions. If the final outcome is for a global approach this will be a considerable victory for what the OECD now terms “hubs” (without naming anyone) like Ireland, Luxembourg, Netherlands, Singapore and Switzerland.

Finally on carve-outs, the tone is that while general exceptions based on relatively objective metrics like MNE size may be possible, more specific or facts-and-circumstances rules will again increase system costs and tax planning. While specific industry carve-outs are a feature of Pillar One, they seem much less likely for Pillar Two.

The fact that the OECD in the new consultation document is making only a slight dent in the many issues raised by Pillar Two suggests that there are too many different avenues being considered. It is not clear why the first bullet point above could not be extended directly to PEs without the need for the switch-over rule in the second bullet point. Similarly it is not clear why the insertion of a subject to tax rule in treaties dealt with in the fourth bullet point is considered necessary when the underpayments rule, which itself will require treaty modifications, seems largely to cover the source country issues.

Submissions to the OECD on the consultation document are due by 2 December and will be followed by a consultation meeting in Paris on 9 December 2019. It seems impossible now for the OECD to meet the October 2019 G20 Finance Ministers stress on “agreeing to the outlines of the architecture by January 2020” including “a determination of the nature of, and the interaction between, both Pillars”. But it can be expected that more BEPS 2.0 developments will occur in early 2020 as the political pressure is now really on.