Global tax reform for the largest multinationals new OECD draft proposals
23 February 2022
The OECD is drafting proposals which, if and when implemented, would allow certain of those countries in which large multinationals operate to an increased share of the group's global profits. In the first instance, those new rules, which are known as Pillar One, would only be relevant to the world's very largest multinationals1. There are further details and background in our previous update here. In short though, the issue is that current tax rules can result in multinationals paying little or no tax in countries where they have little or no physical presence, even if they have large amounts of revenue and/or customers there (so called "market jurisdictions"). That is felt to be increasingly difficult to support and the Pillar One proposals aim to redress that somewhat.
As part of that process, the OECD has just published draft rules providing for a consistent method of calculating the profits (or losses) of large multinational groups for the purposes of reallocating a portion of those profits to be taxed (potentially) in market jurisdictions. The basic position is that those calculations are performed largely on the basis of the consolidated group financial accounts, with limited book-to-tax adjustments.
There is an extremely tight timeframe for comment on these draft rules, with responses requested by 4 March 2022. This reflects the OECD's ambitious timetable to have the rules come into effect next year. Further 'building blocks' of Pillar One will be released for feedback in due course.
Pillar One
The OECD's Base Erosion and Profit Shifting (BEPS) project resulted in massive changes worldwide to domestic tax systems, ensuring minimum standards in areas such as interest deductions, hybrid mismatches and minimising tax treaty abuse. However, concerns remained that the global tax system has not kept pace with today's digitalised economy, and that the current meaning of "permanent establishment" allows companies to have a significant (non-physical) presence in a market jurisdiction without necessarily becoming liable to tax there.
The OECD's two pillar solution is designed to ensure that multinational enterprises pay a "fair share" of tax wherever they operate and generate profits. Together with Pillar Two's 15% global minimum tax rate for large multinationals, Pillar One of the rules provides for a new taxing right for market jurisdictions over certain profits of the largest multinationals.
Businesses within the scope of Pillar One (namely, those multinationals with global turnover of at least €20bn and where profit is at least 10% of total revenue) will see 25% of profits above that 10% profit margin (so called "Amount A") reallocated and then subjected to tax in the countries in which they operate and earn revenue of at least €1m per year (or €250,000 for smaller jurisdictions), rather than all taxing rights sitting where the business has physical presence.
Tax base rules
The OECD has now released a document containing draft rules for calculating the adjusted profit before tax figure upon which Amount A will be based.
The starting point will be the financial accounting profit (or loss) as found in the consolidated group financial accounts, provided these are prepared in accordance with one of the accounting standards qualifying as acceptable for these purposes. These will include IFRS and the accounting standards of Australia, Brazil, Canada, the EU and EEA, Hong Kong (China), Japan, Mexico, New Zealand, China, India, the Republic of Korea, Russia, Singapore, Switzerland, the UK, and the US. Given the size of the groups within scope, it is anticipated that most will be using one of these qualifying standards anyway.
All items within the consolidated P&L account must be taken into account, unless specifically excluded. As yet unpublished commentaries will elaborate further on the detail of applying these book-to-tax adjustments but, to limit complexity, they are to be kept to a minimum with the following to be excluded from the Amount A tax base:
- tax expenses (on the basis that income tax expenses are usually not deductible for corporate income tax purposes and there would otherwise be an element of double-counting);
- dividends (on the basis that dividends are excluded, in whole or in part, from the corporate income tax base in many jurisdictions, or alternatively, the recipient will benefit from tax relief);
- equity gains or losses (to ensure that the tax base does not include gains or losses derived from those generated by another entity); and
- expenses disallowed as a matter of policy (i.e. those related to behaviours considered by governments to be undesirable but which are treated as expenses under financial accounting rules).
Restatement adjustments in relation to prior periods will also be required. These will be attributed to the tax base of the group in the period that the restatement is identified and recognised, rather than going back and recalculating the tax base for prior closed periods.
The draft rules also include provisions for the carry-forward of losses. Broadly, these require that unrelieved losses be carried forward and set off against subsequent profit, following an 'earn out' mechanism. Specific rules will apply to pre-Pillar One implementation losses and losses following certain reorganisations and acquisitions, but the detail of these is still under discussion. There may be time limits set on the use of carry forward losses but, again, a final decision has yet to be made on this point.
Some Observations
This is one of 14 'building blocks' that are going to be needed to set out these Pillar One rules, and which will be consulted upon over the coming months. Whilst it is relatively short, it is a complex document.
It does answer some of our initial scoping questions though. In particular, since dividends and equity gains are reversed out of Amount A, that effectively preserves the sort of "participation exemption" for dividends and capital gains that most multinationals have come to expect. Other types of tax benefits, reductions, allowances etc. are generally unlikely to be reversed out of Amount A; indeed one suspects that the OECD would see that as undermining the basic design.
Next steps
As with the consultation on the nexus and sourcing aspects of Pillar One published earlier in February, it has been made clear that this draft is still very much a work-in-progress which does not, as yet, reflect consensus on the substance of the rules. Pillar One is due to come into effect from next year and, to meet that tight timetable, it is important to obtain public input early in order to help in further refining and finalising the rules.
The OECD is hoping for input to ensure that these rules correctly capture the profits that are intended to be reallocated to market jurisdictions, without overburdening in-scope businesses with excessive accounting and reporting obligations, or overcomplicating the rules.
Businesses within scope of Pillar One should consider responding to this consultation to ensure that the final version of the rules is workable from the point of view of their accounting processes and information. Comments should be sent electronically (in Word format) by email to tfde@oecd.org.
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