Tax systems are designed to raise the revenue that is needed to absorb the cost of government operations including the country’s infrastructure and military. On the other side, in most countries and jurisdictions, compliance to the tax system is generally voluntary and taxpayers are allowed to structure their business to minimize their tax bill. Some taxpayers have the opportunity to plan their tax internationally. A British music band for instance cut down its tax bill significantly by using offshore trusts and companies to obtain tax breaks and by moving to the Netherlands where there was no direct tax on royalties under Dutch law. Competition between countries and jurisdictions has enabled international tax planning: countries cut corporate tax rates to retain existing capital investment and to attract and retain new direct foreign investments. As a result, many corporations make big profits but pay no tax to support their country.

The Organization for Economic Cooperation and Development (OECD) has estimated that corporate tax avoidance costs countries between $100 and $240 billion annually. This is the equivalent of 4-10% of global corporate income tax revenue. In the United States, for instance, the Government Accountability Office (GAO) studies have shown that most U.S. corporations pay little to no federal income tax. And the federal government derives most of its revenue from individual income tax, payroll tax, and self-employment tax.

Monitoring compliance becomes a challenge when a taxpayer’s business dealing becomes global. And the digitalization of the economy with the rise of e-commerce has amplified corporate tax avoidance. Even if shoppers still prefer to buy in-store, more and more sales now take place online. For instance, three out of four B2B customers prefer to buy online instead of buying through a distributor’s sales team. Air transportation has helped make the world a global village and has contributed to the rise of e-commerce. End-to-end air transportation services are widely available for time-sensitive documents, small parcels, or high-value items. In addition, air cargo operators provide the export infrastructure that small and medium-sized businesses, especially e-commerce small businesses, need to grow internationally without investing in their own supply chain. In this context, there was a need to come up with a more suitable global corporation tax framework. The Organization for Economic Co-operation and Development (OECD) has designed a two-pillar framework which includes a partial reallocation of taxing rights and a global corporate minimum income tax. More than 130 countries and jurisdictions have agreed to implement the new framework.

The OECD has been working since 2013 on an action plan to address the tax challenges arising from the digitalization of the economy:

The Base Erosion and Profit Shifting (BEPS) project was initiated in 2013.

The BEPS project package of 15 actions to counter tax avoidance was adopted. Action 1 deals with the digitalization of the economy.

The BEPS 2.0 interim reports came out in 2019.

Blueprints for a two-pillar solution to address the tax challenges of the digitalization of the economy was released in October 2020.

In June 2021, the G7 agreed to the OECD framework. In July 2021, over 130 countries and jurisdictions join a new two-pillar plan to reform corporation international taxation rules and ensure that the largest and most profitable companies pay their fair share of corporate income tax in each of the countries and jurisdictions where they operate.

Pillar One aims to ensure a fairer distribution of profits and the right to tax multinational companies among countries. The OECD’s proposal is comparable to the multi-state revenue allocation and apportionment rules applicable in the United States.

The largest companies that fall under the OECD’s Pillar One guideline are the multinational companies (MNEs) with a global revenue of more than EUR20 billion and a ratio of profit before tax divided by revenue of more than 10%. The revenue threshold of EUR20 billion will be reduced to EUR10 billion upon successful implementation of the two-pillar plan by the Inclusive Framework’s 139 members countries and jurisdictions.

Multinational companies that fall under the OECD’s guideline will be deemed to have economic (revenue-based) nexus in any country or jurisdiction where they derive at least EUR1 million of their revenue if the country or jurisdiction’s GDP is at least EUR40 billion, or at least EUR250,000 of their revenue if the country or jurisdiction’s GDP is less than EUR40 billion.

Multinational companies that fall under the OECD’s guideline will be required to apportion between 20-30% of their profit in excess of 10% of their revenue to the country or jurisdiction where they have economic nexus.

To determine the percentage of their business’ profits subject to a given country or jurisdiction’s corporate income tax, the revenue derived from the country or jurisdiction will be the apportionment factor. The multinational company should source its revenue to the end-market country or jurisdictions where its products or services are used or consumed. The OECD will develop additional sourcing rules for specific categories of transactions. A multinational company may develop its own sourcing rules based on its specific facts and circumstances.

The taxpayer may determine its taxable income (or loss) by starting with its profit or loss per GAAP and by operating all necessary tax and books adjustments.

The entity (or entities) that earn the taxable income will be responsible for the tax due. Losses will be carried forward and will be offset against future taxable income.

Pillar Two aims to level up the corporate income tax competition between countries or jurisdictions by requiring each country or jurisdiction to impose a minimum global corporate income tax of 15%. Pillar Two thus set multilaterally agreed limitations on tax competition between countries and jurisdictions through the following rules:

The Global anti-Base Erosion (GloBE) rules, which consist of (i) an Income Inclusion Rule (IIR) and (ii) an Undertaxed Payment Rule (UTPR). The Income Inclusion Rule imposes a tax at the parent company level in respect of the low taxed income of a related entity. The Undertaxed Payment Rule denies deductions or requires an equivalent adjustment to the extent the low tax income of a related entity is not subject to tax under an Income Inclusion Rule.

The Subject to Tax Rule (STTR) is a treaty-based rule that allows source jurisdictions to impose limited source taxation on a certain related party payments subject to tax below a minimum rate. The tax thus paid is creditable as a covered tax under the GloBE rules.

Scope

The GloBE rules will apply to multinational companies with consolidated group revenue reported on the applicable financial statement of EUR750 million or more. All the consolidated revenue that is or would be reflected in the consolidated financial statements should be accounted for.

Countries are free to apply the Income Inclusion Rule (IIR) to multinational companies headquartered in their country even if they do not meet the EUR750 million consolidated group revenue threshold.

Government entities, international organizations, non-profit organizations, pensions funds or investment funds that are Ultimate Parent Entities (UPE) of a multinational company group or any holdings vehicle used by such entities, organizations or funds are not subject to the GloBE rules.

Other Tax Considerations

The minimum tax rate used for purposes of the IIR and the Undertaxed Payment Rule will be at least 15%.

Because Pillar Two will apply a minimum rate on a jurisdictional basis, consideration will be given to the conditions under which the U.S. GILTI regime will co-exist with the GloBE rules, to ensure a level playing field.

The Subject to Tax Rule (STTR) minimum rate will be between 7.5% and 9%. Inclusive Framework’s 139 member countries and jurisdictions that apply nominal corporate income tax rates below the STTR minimum rate to interest, royalties, and a defined set of other payments would implement the STTR into their bilateral treaties with developing Inclusive Framework members when requested to do so. The taxing right will be limited to the difference between the minimum rate and the tax rate on the payment.

How the Framework Should Be Implemented

The GloBE rules are a common approach. As such, their adoption is optional. However, the OECD/G20 Inclusive Framework on Base Erosion and Profit Shifting (IF) members should agree and release an implementation plan that will contemplate that Pillar Two should be brought into law in 2022, to be effective in 2023.

The OECD/G20 IF members should agree and release an implementation plan once the OECD finalizes Pillar One.

What’s the U.S. Approach?

The Biden Administration is hoping to have incorporated in the coming budget resolution and reconciliation bill (the Build Back Better Act) the changes that are necessary to put Pillar Two, the minimum tax rate, into effect.

Build Back Better proposed, for tax years beginning after December 31, 2022, to impose, on U.S.-owned corporations with an aggregated global financial statement income that exceeds $1 billion on average over any consecutive three-tax-year period preceding the tax year, a 15% minimum tax on their worldwide book income after certain adjustments. The adjusted aggregated book income threshold is $100 million for U.S. corporations that are owned by a foreign company.

Because the taxable amount is determined in accordance with accounting rules, the American Institute of Certified Public Accountants (AICPA) believes that, if enacted, the proposed legislation will add complexity to the tax system and create disparities.

Build Back Better also proposed, for tax years beginning after December 31, 2022, to reduce the deduction for the Global Intangible Low-Taxed Income (GILTI) of controlled foreign corporations to 5%, resulting in a tax rate of 15%. This allows the GILTI regime to co-exist with the OCDE’s GloBE rules and ensures a level playing field with the other countries and jurisdictions. It also proposed to calculate the GILTI on a country-by-country basis.

The Administration will work with Congress when Pillar One is ready for adoption.

Conclusion

The OECD believes that Pillar One should apply to approximately 100 companies and taxing rights on more than $100 billion of profit are expected to be reallocated to market jurisdiction each year.

In addition, hundreds multinational companies fall under Pillar Two guidelines. The global minimum tax is expected to generate $150 billion in additional global tax revenue per year and lead to the demise of tax havens. Approximately 200 companies fall under the U.S. Corporate Profit Minimum Tax; the Administration is hoping to raise hundreds of billions in revenue over 10 years to absorb the cost of its programs.

The two-pillar package provides for the standstill and rollback of unilateral measures such as digital services taxes (DSTs). The DSTs would have impacted U.S. tech giants the most.

Mathieu Aimlon, CPA, Expert-comptable diplômé, France (non inscrit), is a principal at Aimlon CPA P.C., a CPA firm that provides comprehensive accounting, auditing, and tax services to businesses and nonprofit organizations throughout the United States and in France.