Since 2013, concerted efforts have been made to promote international collaboration in taxation concerns, eliminate harmful practises, and combat tax avoidance by multinational corporations or MNEs.
The G20 charged the Organisation for Economic Co-operation and Development (OECD) with studying and addressing the Base Erosion and Profit Shifting (BEPS) issue involving multinational enterprises.
What is the Base Erosion and Profit Shifting (BEPS) Programme of the OECD and G20?
In 2013, the OECD released a research and action plan as a result. BEPS refers to tax planning tactics that use loopholes and inconsistencies in tax legislation to artificially shift earnings to locations with no/low tax rates and no/little economic activity.
In order to ensure an uniform and coordinated implementation of the BEPS recommendations and to make the initiative more inclusive, the OECD/G20 expanded its BEPS debate to include more than 140 jurisdictions through a platform known as the Inclusive Framework (IF) on BEPS.
In October 2021, the IF agreed on a Two-Pillar approach, often known as BEPS 2.0, to meet the tax difficulties posed by the digitalisation of the economy.
The Two-Pillar approach was approved by more than 135 IF member states.
What are the two pillars of the BEPS 2.0 framework?
Presently, countries where MNEs undertake their activities (e.g., manufacturing, strategic decision making) have the authority to completely tax MNEs on earnings due to these activities.
The design of the proposed tax framework incentivises profits that are distributed entirely to the jurisdiction in which the economic activities that generate them are done.
To guarantee that cross-border transactions between related firms in MNE groups are not subject to tax planning, such transactions are subject to stringent transfer pricing restrictions. Several jurisdictions, including enforce transfer pricing regulations.
MNEs pay variable effective tax rates (ETRs) in the various jurisdictions in which they operate, based on the economic activities pursued and the domestic corporation tax structure.
BEPS 2.0 Pillar One
Pillar One entails a new taxation approach geared at digitised businesses and consumer-serving organisations that engage in digital commerce or digital communication with clients.
Regardless of whether an organisation has a physical presence in a jurisdiction, revenues derived from customers in that country or from consumer data acquired from that country will be liable to tax.
The objective of Pillar 1 is to reallocate certain profits and, consequently, taxes from where economic activities are undertaken to where markets (i.e. customers) are located. Even though earnings are now dispersed in accordance with transfer pricing regulations, this is still the situation.
Pillar 1 compels impacted MNE groups to re-allocate 25% of their profits in excess of 10% of their global sales (i.e., 25% of their residual profits) to the markets in which they operate. Governments are currently discussing how to determine which jurisdictions must forfeit their profits and how much each must surrender.
Certain jurisdictions may be required to relinquish their taxes rights over more than 25 percent of their residual profits. This is possible due to the fact that the mechanism employed to determine the amount to be redistributed may result in some jurisdictions having to surrender more.
As Pillar One has evolved, its original scope has been modified, and while regulated financial services are not expected to be included, the majority of other industries will be.
In a nutshell, Pillar One signifies that taxing rights will reside in the country where the company's customers are located. The new regulations will apply to organisations with revenues over €20 billion and profit margins above 10%. Over time, the inclusion criterion will decrease to €10 billion in yearly revenue.
Profit distributions across nations will be governed by a formula, a considerable departure from the present transfer pricing norms.
BEPS 2.0 Pillar Two
Equally comprehensive, Pillar Two offers global tax reforms with the objective of ending the competition between nations to give the lowest feasible corporate tax rates in order to attract foreign investment. GloBE regulations are the most important component of Pillar Two (Global anti-Base Erosion).
Via the Global Anti-Base Erosion (GloBE) Model Regulations, Pillar 2 mandates a minimum ETR of 15% for affected MNE groups. If an impacted MNE's ETR is less than 15% at the group level, other jurisdictions may collect up to 15% of the difference.
In addition, Pillar 2 contains a Subject-to-Tax Regulation (STTR). STTR permits a jurisdiction A to apply an extra tax of up to 9% on certain payments (such as interest and royalties) made by a company in A to related businesses in another jurisdiction B, if the payment is taxed at a rate lower than 9% in B.
According to these regulations, multinational corporations with annual revenues above €750 million must pay a minimum effective tax rate of 15% in each trading country.
Governments will be authorised to impose additional tax rates on multinational corporations that are taxed below the minimal threshold. There are few exceptions to GloBE, including:
countries where a multinational group generates less than €10 million in revenue and
less than €1 million in profit (according to the GloBE calculations).
Organizations launching an international expansion with less than €50 million in abroad physical assets and a presence in no more than five more countries.
Investment institutions, governmental and multilateral organisations, and pension funds.
To establish the top-up tax owed, GloBE will examine the effective tax rate in each country, define the additional tax owed to reach 15%, and allocate that amount via a top-up tax.
Although the OECD does not aim to legislate a minimum tax rate, the premise is that a multinational group's international income received through its branches or foreign subsidiaries will be subject to a minimum tax rate.
In addition to additional parent company tax charges for low-taxed overseas income, Pillar Two permits low-tax paying organisations to be taxed at the source.
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