A large number of countries in the World are trying to work out a twin pronged tax reform plan. According to the Organization for Economic Development and Cooperation (OECD),136 countries and jurisdictions representing more than 90% of global GDP have agreed to join an accord to impose this global tax reform plan. These constitute over 97 percent of the 140 countries and jurisdictions that OECD has involved in the process of negotiations concerning this issue.
Initially, there are plans to create a new taxing right in order to enable the participating countries to levy a slice of the profits generated by a handful of the world’s biggest firms, based on the sales generated within each country’s borders. According to the OECD more than $125bn (£92bn) of corporate profits from about 100 of the world’s largest and most profitable multinationals would be reallocated under the first pillar of the twin-pronged reforms. The second pillar will set a global minimum tax rate at 15% on large companies enabling the participating governments around the world to collect an extra $150bn for each year by taxing the large firms based on their local sales. Earlier, the G7 countries had agreed for these tax reforms in their meeting in June this year,
The blue print of this global tax reform charts out a move towards a fairer tax system, where large global players pay their fair share in countries where they do business. While some countries view it as a mode of higher degree of global cooperation, yet there are a few developing countries who have expressed apprehension that such a tax regime may disproportionately advantage large economies, while leaving smaller nations without a fair claim on large company profits. Yet OECD has made some efforts to design the tax rules in a way so as to accommodate the special requirements of the low-capacity economies as well.
The Dynamics of the Global Tax Reform
According to the OECD, the participating countries are expected to sign a multilateral convention next year, facilitating effective implementation of the tax reforms in 2023. The global tax reforms are considered as a logical step in order to align the international tax system with the modern digitalized and globalized world economy. The focus is now turned on how to ensure the effective implementation of this major reform as early and diligently as may be possible.
The Two-Pillar Solution comprises of Pillar One and Pillar Two. The thrust at Pillar One is to ensure a fairer distribution of profits and taxing rights among countries with respect to the largest MNEs, which are the winners of globalization. The idea is to foster tax certainty as the new rules even include a mandatory and binding dispute resolution process for Pillar One subject to the caveat that developing countries will be able to benefit from an elective mechanism in certain cases, ensuring that the rules are not too onerous for low-capacity countries.
The agreement at Pillar One includes the removal and standstill of Digital Services Taxes (DST) and other relevant, similar measures, which is likely to put an end to trade tensions resulting from the instability of the international tax system. It will also provide a simplified and streamlined approach to the application of the arm’s length principle in specific circumstances, with a particular focus on the needs of low-capacity countries.
Pillar Two puts a floor on tax competition on corporate income tax through the introduction of a global minimum corporate tax at a rate of 15% that the countries can use to protect their tax bases (the Global rules). Here, the tax competition is not eliminated completely, but fixing up a minimum applicable tax rate would certainly envisage multilaterally agreed limitations on it. There is provision to accommodate tax incentives provided to spur substantial economic activity through a carve-out. Pillar Two also protects the right of developing countries to tax certain base-eroding payments (like interest and royalties) when they are not taxed up to the minimum rate of 9%, through a “subject to tax rule” (STTR) provision.
Global Tax Reform Timeline
The OECD has worked out deadlines for implementation of the Global Tax Reforms in two phases as summarized in the Table below:
Thus, we clearly observe that the two pillars seem not only as complimentary but also they both lay the foundations for a common platform, i.e., to provide a level playing field to every participating country in the fast-globalizing world dominated by a league of large players, say top multinationals. The timelines are also drawn to facilitate dialogues, negotiations and consensus to evolve necessary framework for a well-coordinated implementation of the GloBE rules.
Benefits to Developing Countries
Although the OECD GloBE Rules are generally expected to bring revenue gains for every country whether they are low-, middle- and high-income countries as an outcome of Pillar One, yet the low-income jurisdictions are likely to benefit more even as Pillar Two is implemented. In a nutshell, the GloBE rules are expected to benefit the developing countries in more than one way:
- reduce some of the pressure on developing countries who are mostly compelled to provide excessively generous tax incentives to attract foreign investment.
- the Subject to tax rule (STTR) prevents companies from avoiding tax on their profit earned in developing countries by making deductible payments such as interest or royalties and protecting them from abuse through profit shifting to low tax jurisdictions under any tax treaties or arrangements.
- the simplified and streamlined approach to the application of the arm’s length principle to in-country baseline marketing and distribution activities through a formulaic approach in those cases, will immensely benefit the low-capacity countries as they generally face difficulties in the administration of transfer-pricing rules.
- a lower threshold provided for determining the re-allocation of profit under Pillar One to smaller economies.
- The OECD will provide the requisite technical assistance to support all aspects of implementation of the Two-Pillar Solution.
- Additional benefits will arise from the stabilisation of the international tax system and the increased tax certainty.
GloBE Tax Regime: A Balancing Act
The GloBE Rules not only make an attempt to accommodate the needs and concerns of the developing countries but also provide a level playing field for all countries to benefit from tax certainty and stability. This move will also benefit the in-scope large companies as GloBE Rules address issues like a uniform tax rate, avoidance of double taxation and exclusions for specific activities/entities which will not only give them ease of working out their tax liabilities more accurately but also avoid instances of tax dispute due to complex tax structures in certain countries. We may have to wait, though, till end 2022 to know how the participating countries finalize GloBE Rules for implementation from the year 2023.