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Pillar One and Pillar Two: Overview and updates

September 5, 2023  /  By
Two ancient stone columns, known as Pillar One and Pillar Two, with weathered surfaces stand under a clear blue sky.

By ATLEGANG MATJILA

The Organisation for Economic Co-operation and Development’s (OECD) Two-Pillar solution (Pillar One and Pillar Two) originated from a need to align taxing rights of jurisdictions to the way business has rapidly progressed (and continues to progress) from the traditional bricks and mortar business to more digitalised business models. Today’s digitalised economy has created various tax challenges, especially regarding Multinational Enterprises (MNEs). This led to the introduction of Pillar One and Pillar Two. In this article, we’ll recap both Pillars and look at the latest updates.

Pillar One and Pillar Two overview

Pillar One stemmed from highly digitalised businesses operating in jurisdictions that were not able to tax the income ‘arising’ within these jurisdictions. Pillar One therefore introduced the identification of market jurisdictions i.e., jurisdictions in which goods or services are supplied or consumers are located. The composition of Pillar One is as follows:

  • Amount A: To fall within the scope of Amount A, the MNE’s revenue will need to exceed the scope threshold of Euro 20 billion and have profitability exceeding 10%. Using a formulaic approach, Amount A aims to reallocate a portion of the profits of the largest MNE Groups to jurisdictions they operate in, noting that physical presence is not required due to the application of the term market jurisdictions which creates a profit nexus. In doing so, Amount A effectively creates a new taxing right.
  • An overview of Amount A’s formulaic approach is detailed below for in-scope MNE Groups:
    • Nexus and revenue sourcing: A market jurisdiction will be eligible to tax Amount A if the MNE derives more than Euro 1 million revenue from that jurisdiction, or, alternatively, Euro 250 thousand if that jurisdiction’s GDP is lower than Euro 40 billion. Amount A’s revenue sourcing rules would need to be applied to determine how much revenue is derived from each jurisdiction.
    • Tax base determination: The tax base rules provide that the MNE’s total profit (or loss) in its consolidated financial statements is to be used as a starting point. Thereafter, certain book-to-tax adjustments would be made to arrive at a standardised adjusted profit before tax figure, taking into account losses will be carried-forward subject to certain time limitations.
    • Allocation of Amount A: The Amount A profit allocated to an eligible market jurisdiction is determined as follows:
      • First apply 25% of the adjusted profit before tax in excess of 10% of the Group’s revenues to determine the total Amount A profit; and
      • Allocate the Amount A profit to the market jurisdiction in proportion to the amount of revenues the Group derives from that jurisdiction
    • Importantly, the Amount A profit allocated to a market jurisdiction is adjusted and reduced by the marketing and distribution profits safe harbour where that jurisdiction already has taxing rights over the Group’s residual profits.
    • Elimination of double taxation: Double taxation arising from the application of Amount A as an overlay to the existing profit allocation system will be eliminated through the relevant mechanisms. The mechanisms to eliminate double taxation will apply on a quantitative and jurisdictional basis and serves to identify which jurisdictions will be responsible for eliminating double taxation and in what amounts.
  • Amount B: Focuses on streamlining the application of the arm’s length principle to certain in-country baseline marketing and distribution activities. This will be achieved by determining a fixed return for these activities to the extent possible.

Pillar Two provides rules that ensure that MNEs pay a minimum level of tax on their global profits. The composition of Pillar Two is as follows:

  • Global Anti-Base Erosion (GloBE) Rules: This applies a global minimum tax rate of 15% falling within a specified scope. Determined on a jurisdictional basis, where such MNE’s minimum tax rate is below 15%, a “Top-Up Tax” is to be applied on such profits to account for the difference.
  • Below is an overview of the GloBE Rules:
  • MNE Group’s and constituent entities within scope: MNE Group’s fall within scope of the GloBE rules if their consolidated revenue exceeds Euro 750 million – tested based on two of the four fiscal years immediately preceding the tested fiscal year.
    • The constituent entities of an MNE Group include all the entities within the Group with any Permanent Establishment (PE) of a group entity being treated as a separate constituent entity. Excluded entities are, however, not within scope and excluded from the operation of the GloBE rules. Additionally, the location of each constituent entity is determined based on its local tax treatment.
  • GloBE Income: The amount of a GloBE income or loss of a constituent entity is determined by taking the financial accounting net income or loss for the constituent entity for the fiscal year and adjusting the amount in accordance with the relevant GloBE rules and provisions to arrive at that entity’s GloBE income or loss. The GloBE income or loss is then allocated between a PE and the main entity or to owners of a flow-through entity in accordance with local tax treatment.
  • Covered Taxes: The amount of a constituent entity’s covered taxes is determined by taking the constituent entity’s current taxes for the fiscal year, adjusted to reflect certain timing differences. Covered taxes are allocated from one constituent entity to another in certain cases. To the extent there are changes in tax liability after filing, additions or reductions to taxes are identified and allocated to a particular jurisdiction and time period.
  • Effective tax rate and top-up tax: The Top-Up Tax of each low-taxed constituent entity is determined as follows:
    • Calculating the Top-Up Tax percentage for each low-tax Jurisdiction;
    • Applying the Top-Up Tax percentage to the excess profits of the jurisdiction;
    • Deducting the amount of Top-Up Tax imposed under a qualified domestic minimum tax; and
    • Allocating the jurisdictional Top-Up Tax to the constituent entities in the jurisdiction in proportion to their GloBE income.
  • Income Inclusion Rule (IIR) and Undertaxed Payment Rule (UTPR): The Top-up Tax is first imposed under the IIR on a parent entity with an ownership interest in the low-taxed constituent entity.
    • If there is any residual amount of Top-up Tax that remains unallocated after the IIR applies, the UTPR allocation mechanism results in a liability to Top-Up Tax in the jurisdictions that introduced the UTPR.

On 17 July 2023 the OECD published a comprehensive list of Agreed Administrative Guidance on the application of Pillar Two GloBE Rules, this document is to be referred for a detailed understanding of GloBE Rules.

Subject To Tax Rule (STTR): The STTR allows source jurisdictions to “tax back” where defined categories of intra-group covered income are subject to nominal corporate income tax rates below the STTR minimum rate, and domestic taxing rights over that income have been ceded under a treaty. The STTR takes priority over the GloBE Rules (STTR tax is creditable under those rules) and is designed to help developing Inclusive Framework members to protect their tax base.

The STTR is a model treaty provision that allows jurisdictions to impose limited additional taxation on certain cross-border payments between connected companies where the recipient is subject to a nominal corporate income tax rate below 9%. The STTR applies to interest, royalties and a specified list of other payments (Covered Income), including all intra-group service payments. Where the STTR applies, the payor jurisdiction can impose additional tax on the gross amount of Covered Income up to 9% of the income. This 9% figure is reduced by (a) the nominal tax rate in the recipient jurisdiction and (b) any existing taxing right of the payor jurisdiction under the applicable tax treaty.

The STTR does not itself impose a tax obligation but allows jurisdictions to impose a tax where they otherwise would be unable to do so under the other provisions of the treaty. Where no bilateral income tax treaty applies, source jurisdictions are already able to impose tax on these payments and the STTR has no work to do. For the same reason, the STTR does not apply to a category of Covered Income (for example, interest or royalties) where the source state can already impose an amount of tax that is greater than the STTR rate of 9% on the relevant category under another treaty provision.

11 July 2023 OECD outcome statement highlights

On 11 July 2023, the OECD released an outcome statement reflecting the agreement reached by 138 of the 143 Inclusive Framework member jurisdictions on the Base Erosion Profit Shifting (BEPS) 2.0 project. The July release provides insight on the following:

  1. Amount A and the Multilateral Convention (MLC);
  2. Amount B of Pillar One (Amount B);
  3. Subject To Tax Rule (STTR) under Pillar Two, and
  4. Plans for implementation support for countries.

An overview of each topic covered in the 11 July 2023 release has been summarised below.

Pillar One 

Amount A and the MLC

The scope of Amount A has changed materially since its introduction i.e., it was previously intended to apply to MNEs providing automated digital services or where they were consumer-facing businesses to now applying to any MNE falling within the defined scope.

Creating taxing rights, the purpose of Amount A is to tax the largest and most profitable MNEs operating in their markets, prevent the proliferation of Digital Service Taxes (DSTs) and relevant similar measures, avoid double taxation and excessive compliance burdens, and enhance stability and certainty in the international tax system. To accompany the application of Amount A, the MLC sets out the substantive features necessary for it to be prepared for signature, including the scope and operation of the permissible taxing rights, the mechanisms for relieving double taxation, a process for ensuring tax certainty, the conditions for the removal of existing DSTs and relevant similar measures upon its entry into effect, and the commitment as of the same time not to enact new DSTs and relevant similar measures. The MLC will be published for signature in the second half of 2023 and a signing ceremony will be organised by year-end. The proposed date for the MLC to enter into force is 2025, subject to (amongst others) at least 30 jurisdictions accounting for at least 60% of the ultimate parent entities of in-scope MNEs signing the MLC. The aforementioned regarding the MLC may be recognised as a progress in the implementation of Amount A.

Amount B

Members of the OECD/G20 Inclusive Framework on BEPS (Inclusive Framework) acknowledge that to ensure the appropriateness of the scope and pricing framework of Amount B, further work will be undertaken on the following aspects:

  1. Ensuring an appropriate balance between a quantitative and qualitative approach in identifying baseline distribution activities;
  2. The appropriateness of:
    1. the pricing framework, including in light of the final agreement on scope;
    2. the application of the framework to the wholesale distribution of digital goods;
    3. country uplifts within geographic markets; and
    4. the criteria to apply Amount B utilising a local database in certain jurisdictions

The Inclusive Framework invites members of the public to provide suggestions and/or recommendations to the above aspects by 1 September 2023. An OECD consultation document on Amount B was released on 17 July 2023 in this regard. It is aimed for the abovementioned aspects to be fully addressed by the end of 2023 as the Inclusive Framework will approve and publish a final Amount B report, content from which will be incorporated into the OECD Transfer Pricing Guidelines by January 2024.

Implementation support

The Inclusive Framework also calls upon the Secretariat to prepare a comprehensive action plan to support the swift and co-ordinated implementation of the Two-Pillar Solution. In particular, the plan should offer additional support and technical assistance to enhance the capacity necessary for the implementation of the Two-Pillar solution by developing countries. In this regard, the OECD should co-ordinate with relevant regional and international organisations. Plans for implementation support for Pillar One include:

  • Ensuring understanding of the MLC including the process for signing and ratifying.
  • In relation to Amount B, support is required for factors to consider when making submissions during the validation phase. Once finalised, existing 34 technical assistance programmes on transfer pricing will include Amount B implementation.
  • Support to be provided through various partner initiatives, such as the OECD Forum of Tax Administration Capacity Building Network – Pillars Knowledge Sharing Network led by HMRC.

Pillar Two 

STTR

To facilitate the implementation of the STTR, a Multilateral Instrument (MLI) will amend the treaties that it covers. An Explanatory Statement will also be published, detailing the agreed understanding of the negotiators on the approach taken in the MLI. Additionally, the Inclusive Framework has agreed a process to assist developing Inclusive Framework members in implementing the STTR.

The MLI implementing the STTR will be open for signature from 2 October 2023. Inclusive Framework members can elect to implement the STTR by signing the MLI, or bilaterally amending their treaties to include the STTR when requested by developing Inclusive Framework members.

Implementation support

The following support is to be provided regarding the implementation of GloBE Rules:

  • Providing adequate training material; establishing regional workshops; and bilateral assistance will be expanded beyond current 10 pilot countries on GloBE and Tax Incentives; and
  • Determining the niche role of OECD/United Nations Development Programme Tax Inspectors Without Borders.

In relation to implementing the STTR, support in this regard would include facilitating a process to determine which tax treaties might be affected by STTR and facilitating the process for signing and ratifying the STTR MLI.

Conclusion 

July was a busy month regarding Pillar One and Pillar Two. As much as the recent publications are appreciated and show continuous progress, there are still various aspects of the Pillars that require further work and understanding.

Sources:

  • OECD Fact Sheet: Amount A (Progress report on Amount A of Pillar One)
  • OECD overview of the key operating provisions of the GloBE Rules
  • OECD/G20 Base Erosion and Profit Shifting Project: Outcome Statement on the Two-Pillar Solution to Address the Tax Challenges Arising from the Digitalisation of the Economy – 11 July 2023
  • OECD Tax Talks: Centre for tax policy and administration (19 July)

 

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