Pillar one – redistribution of taxation rights – the new dualistic system
The deal brokered by the Organization for Economic Co-operation and Development (OECD) is a two-pillar solution. Under the first pillar, multinational companies operating in every sector, with a few exceptions, with a worldwide turnover of over 20 billion euros and a profitability of over 10% on part of their profits in the countries in which they operate , taxed. It is believed that these thresholds will initially bring about 100 of the world’s most profitable multinationals within the scope of the new tax system, but the agreement provides for the threshold to be lowered to € 10 billion after seven years. When this happens, many more groups will fall within the scope.
Countries in which the multinational group generates revenues of at least € 1 million will benefit from the new tax law. So that less developed countries can share in the revenue, the threshold for jurisdictions with a GDP of less than 40 billion euros is set at 250,000 euros.
In return for taxing rights under the first pillar, part of the deal is that countries like the UK and France, which have unilateral taxes on digital services, will lower those taxes. However, it is not yet clear when this will be the case, so a period of double or additional taxation in these countries is likely in the short term.
When the first pillar was originally developed, it should only apply to digital companies. This was extended to other consumer-oriented companies as the proposals were drawn up and now applies to all companies except financial services and extractive industries. It also includes business-to-business deliveries as well as business-to-consumer deliveries. This means that there will be greater challenges in figuring out which country is the market for the goods or services and therefore which country will receive taxation rights.
For example, if a multinational company supplies goods or services to another company, is the market jurisdiction where the receiving company is located or where the end users of the goods or services are located? In the technology sector, this could be relevant in several areas, for example if cloud services are sold to a business customer who uses them to supply their customers.
The new tax law will be more than a percentage of the so-called “amount A”. This is the top tier of corporate profit before tax – any profit that exceeds 10% of sales. Of this, 20-30% will be shifted to market jurisdictions – the exact percentage has not yet been determined. It is divided among the market jurisdictions based on their local revenue. However, the amount allocated to a country is capped if marketing and sales profits are already taxed in that country.
The first pillar will mean that the largest multinationals – and particularly in the technology and telecommunications sectors – will tax part of their profits in the jurisdictions in which they operate, whether or not they have a permanent establishment there. The deal is intended to increase tax revenue, not just reallocate it so that more taxes are likely to be paid overall. If the new system works, however, once the inevitable teething problems are resolved, it could bring more security than the current position. Currently, multinational corporations are subject to a multitude of unilateral DSTs, all of which are slightly different, based on revenue rather than profits, and where there is a significant chance that two jurisdictions will attempt to tax the same profits due to the different approaches used by the country with DST.
However, the detailed proposals for determining which profits can be taxed where are complex. Everything is not yet worked out – especially the hotly debated revenue-based allocation key that divides the “Amount A” between market jurisdictions with Nexus, and the source rules for certain categories of transactions. Such a major change in the international tax system will inevitably create a degree of uncertainty and significant additional administrative costs for multinational corporations. Additional tax costs are also likely to lead to increased consumer costs. There will be arrangements to settle disputes between countries over taxation rights, but while the OECD strives to generally minimize double taxation, in practice, at least in the short term, double or additional taxation will inevitably occur.
The new taxation rights effectively transform the previous tax pie, in which countries fight for their share under double taxation treaties and existing international principles, into a two-tier pie in which the new division of the amount A comes first between the countries on the new basis. The lowest level will continue to be largely calculated and divided according to the existing tax rules, although another aspect of the agreement relating to the first pillar, which could apply to all multinational companies, not just those above the € 20 billion threshold, simplified a new one The rule is to calculate the profit allocation within a group for basic marketing and sales activities. This is known as “Amount B”.
While the OECD is interested in keeping the compliance process as lean as possible, it cannot be denied that the first pillar means a fundamental change in international tax regulations for the largest multinational technology and telecommunications companies. This will entail a significant administrative burden as well as additional tax bills and, most likely, a decade of new tax disputes with the market areas until the rules are settled.