Implementing the OECD’s two-pillar solution for international taxation


This article was first published in Lexis Nexis, October 2021.

What is the background to the publication of the two-pillar solution?

The OECD’s ‘two pillars’ are ambitious proposals that seek to fairly determine both the tax base and method of taxing multi-national enterprises (‘MNEs’) in a ‘digital world’ where the traditional tax concept of a physical presence is outdated.

The broad aim of the ‘two pillars’ is to ensure that MNEs, who, thanks to digitalisation, can access global markets with relative ease, pay a fair amount of tax in the ‘right place’. The two pillars build on the progress achieved through the BEPS project (tackling attempts to artificially reduce taxable profits) and also alter where the resulting tax should be paid.

After many international debates and compromises, 136 OECD member jurisdictions agreed to the two pillar solution and an implementation plan on 8 October 2021, progressing the OECD statement issued on 1 July. The plans were formally endorsed by the G20 at the summit in Rome on 31 October 2021. The new measures are intended to be effective from 2023.

What are the two pillars?

Pillar One proposes that ‘market jurisdictions’ should be entitled to tax some of the profits generated in that country. This will be achieved by new nexus and profit allocation rules based on where goods or services are used or consumed. The aim is for MNEs to pay some tax in the countries in which they do business, not just where they have their headquarters or establish corporate entities.

Pillar Two is designed to ensure MNEs pay a minimum level of tax. After much debate, the minimum level has been set at 15%. It will be achieved via:

  1. two related domestic rules:
    1. an ‘income inclusion rule’ imposing top-up taxation in a parent entity where income is undertaxed in a subsidiary; and
    2. an ‘undertaxed payments rule’ denying tax deductions or requiring other tax adjustments where undertaxed income has not been subject to top-up taxation under the income inclusion rule; and
  2. a tax treaty-based rule (the ‘subject to tax rule’) allowing jurisdictions from which payments are made (source jurisdictions) to impose withholding tax of 9% on certain related party payments that are not subject to this minimum tax rate in the recipient jurisdiction.
Which companies are within the scope of the new rules?

Pillar One
MNEs will be in-scope if they have global turnover above €20 billion and a profit margin (profit before tax/revenue) above 10%. This will be calculated using an averaging mechanism. If the implementation is successful, the turnover threshold may be reduced to €10 billion euros in the future.

Extractive industries (e.g. mining) and regulated financial services will be excluded from the rules.

Pillar Two
The income inclusion and undertaxed payments rules will apply to MNEs with over €750 million revenue.  In addition, countries can choose to apply the income inclusion rule to MNEs headquartered in that country, regardless of whether the threshold is met. This €750 million threshold does not apply to the treaty-based subject to tax rule.

Certain entities will not be subject to the income inclusion and undertaxed payments rules, such as government entities, non-profit organisations, pension funds or investment funds that are ultimate parent entities of an MNE group. There will also be a de minimis exclusion for income generated in jurisdictions where an MNE has revenues of less than €10 million and profits of less than €1 million.

What has changed since the previous OECD statement in July?

The October statement clarifies and expands on certain points in the July statement. The key changes are:

Pillar One

  • introducing the concept of an averaging mechanism to determine the €20 billion revenue and the 10% profit margin thresholds to identify in-scope MNEs;
  • setting the amount of residual profit to be allocated to market jurisdictions at 25% (the July framework referred to a range of 20-30%);
  • providing a dispute resolution process for certain developing economies;
  • adding detail to the mandated withdrawal of unilateral digital services taxes and prohibiting the introduction of any new ones;

Pillar Two

  • setting the minimum tax rate at 15% (the July framework stated ‘at least’ 15%);
  • introducing an exclusion from the undertaxed payments rule for MNEs in the initial phase of their international activity;
  • detail on certain income that will be excluded from the income inclusion and under taxed payments rules, including the introduction of the de minimis rules for countries in which an MNE has low revenues and profits; and
  • setting the minimum rate of tax for the subject to tax rule at 9%.

Another key change from July is that the October statement has the support of 3 further jurisdictions (Estonia, Hungary and Ireland). The statement is supported by all G20 countries and 136 of the 140 jurisdictions in the Inclusive Framework. The four dissenting Inclusive Framework members are Kenya, Nigeria, Pakistan and Sri Lanka but it does not seem likely that their lack of support will delay the process.

What were the most controversial aspects of the deal?

The features regarded as controversial vary from country to country. Ireland, for example, currently has a corporation tax rate of 12.5% and voiced concerns that the July statement referred to a Pillar Two minimum rate of ‘at least 15%’. When rates of 21% were on the table, countries such as Ireland had legitimate concerns about the flight of MNEs. Ireland has now signed off on the deal following the removal of the words ‘at least’, to provide certainty as to the 15% rate.

Many are expressing positive sentiments on the deal, including UK Chancellor Rishi Sunak who has said the deal will “upgrade the global tax system for the modern age”. However, others have criticised the measures on the basis that they will do little to help developing countries. Some consider that the 15% minimum rate is too low, especially when compared to the corporate tax rate in industrialised countries (which averages at 23.5%).

Some economists expect the deal to incentivise MNEs to repatriate capital to the country in which their headquarters are based (after years of trying to do the opposite). If that turns out to be correct then there will inevitably be a resulting boost for those economies. Given the threshold requirements, we are actually only talking about a handful of in-scope MNEs who, given their size are likely to be headquartered in the world’s richest countries – Canada, France, Germany, Italy, Japan, the UK and the US. It’s therefore understandable that developing nations may have concerns as to whether these measures really will yield fair results.

What are the next steps for the OECD?

The Annex to the October statement purports to set out a ‘detailed’ implementation plan but in reality it is little more than a skeleton – significant technical details still need to be resolved.

A substantial element of Pillar One will be implemented through a multilateral convention (‘MLC’). Work on the MLC will require, amongst other things, ‘residual profit’ to be properly defined and the mechanisms eliminating double taxation to be clearly established. The MLC and accompanying explanatory materials are to be finalised by early 2022.

The model rules under Pillar Two are to be developed quickly – by the end of November 2021. This will include a model treaty provision to give effect to the subject to tax rule, which will be implemented in relevant bilateral treaties by a multilateral instrument (‘MLI’) to be developed by mid-2022.

At the recent Rome summit, G20 leaders expressed their desire for the OECD to swiftly develop these model rules and the MLI.

What are the next steps for individual countries?

In addition to the MLC and MLI, changes may be needed to domestic law (e.g. to implement the new taxing rights over the residual profit allocation). Some domestic processes may be more complex than others. The US approval process is creating an air of uncertainty: Biden’s administration has shown its support for the measures, but the deal still needs to go through US Congress – potentially problematic given the level of Republican opposition.

Individual countries will also need to address the mandate to withdraw their existing digital services tax measures. On 21 October, the UK, Austria, France, Italy, Spain and the US issued a joint statement setting out a digital services tax credit type system with the aim of bridging the gap between the existing digital services taxes and the new OECD measures. In a compromise, the US has agreed not to levy tariffs or impose trade actions in response to existing digital services taxes.

Julia Cockroft


Rachel Arnison

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