Tax Insight: BEPS 2.0 Grinds On

By Toby Eggleston, Ryan Leslie, Nick Heggart and Graeme Cooper

The OECD’s 2 Pillar project to redesign the architecture of the international tax system continues its slow and faltering progress. This Tax Insight summarises some of the recent developments, and their implications for Australian groups.

Pillar One

Pillar One involves two unrelated components:

• a regime for reallocating a portion of profits of the largest multinationals to the countries where their goods and services are consumed (so-called Amount A), and
• a proposal for a simpler way of determining the arm’s length price of certain marketing and distribution activities occurring in a country (so-called Amount B).

Australian taxpayers seem to have concluded that Amount A of Pillar One will have little impact on their tax position, an impression supported by the tentative conclusion in Treasury’s October Consultation Paper, that “no Australian headquartered multinationals currently fall into the scope of Amount A.” This view is driven by the combination of the high monetary threshold needed to trigger Amount A (annual group turnover greater than €20bn) and the exclusion of companies in the extractives and financial sectors.

Amount B of Pillar One, on the other hand, will be relevant for Australian companies because it is not limited by the same monetary threshold. It involves the pricing of marketing and distribution activities undertaken in Australia by the local subsidiaries of multinational groups, and undertaken offshore by the foreign subsidiaries of Australian groups. As part of the negotiations at the OECD’s Inclusive Framework, developing countries in particular wanted to simplify the transfer pricing process for local subsidiaries undertaking marketing and distribution activities in their jurisdictions; this became Amount B. But the proposed changes are not limited to developing countries, and it is clear from Australian cases such as Roche and SNF that even Australian taxpayers and revenue authorities have difficulties agreeing appropriate prices for marketing and distribution functions.

On 8 December 2022, the OECD released a Public Consultation Document seeking submissions on 3 key design elements of Amount B:

• the scope of the activities which will fall within Amount B and the preconditions which will have to be met in order to attract the simpler computation. So far, the Paper proposes more than a dozen preconditions which will have to be met. Among the more important conditions are a proposal to limit Amount B to distributors of tangible goods only (not intangibles or services), and to exclude distributors of minerals and agricultural commodities. There is also specific reference to excluding “centralised marketing hubs” from the Amount B pricing mechanism;
• the pricing methodology – whether this is to be a profit-based calculation or calculated as a return on assets or sales or some other computation, and whether the simpler method is still available if there is sufficient local information to allow traditional methods to be administered; and
• the implementation framework – is Amount B to be inserted as an option inside the Transfer Pricing Guidelines or given effect in some other way, is it mandatory or is it optional (and if optional, at whose election), does it supplant entirely traditional arm’s length methodologies, or is it a safe harbour?

Depending on how the proposal develops, Amount B may change quite significantly the transfer pricing for Australian subsidiaries undertaking marketing and distribution activities of goods manufactured offshore by related entities, and the offshore marketing subsidiaries of Australian entities (outside the extractives and agricultural sectors).

Pillar Two

Pillar Two is intended to ensure that multinational groups pay a minimum tax of 15% on accounting profit in the jurisdictions in which they operate. This outcome is accomplished through a series of interlocking rules:

• a qualified domestic minimum tax: a second corporate tax designed to impose top-up tax on any low-taxed profits being earned in the jurisdiction,
• the income inclusion rule: a second CFC regime to attribute the profits of low-taxed subsidiaries to their parent entities,
• the under taxed payment rule: a regime which denies deductions claimed by a low-taxed subsidiary, and
• the subject to tax rule: a treaty rule allowing the imposition of (higher) withholding tax by source countries on dividends, interest and royalties paid to low-taxed entities offshore.

In October 2021, the Australian Government signed the Statement on a Two-Pillar Solution to Address the Tax Challenges Arising from the Digitalisation of the Economy committing to implementing both pillars, and in October 2022 Treasury released its Consultation Paper on some of the issues that will need to be resolved to implement these measures in Australian domestic law. The consultation period closed on 1 November 2022, and we await the next announcement.

A 70-page model of domestic rules (along with 200 pages of Commentary and Examples) to give effect to Pillar Two had been released by the OECD by March 2022, and several countries have now started their preliminary steps toward introducing a version of Pillar Two in their domestic law. For example,

• the UK released draft legislation to enact Pillar Two in June 2022 and in the November 2022 Budget, Chancellor Jeremy Hunt re-confirmed that the UK will be proceeding with the legislation;
• in July 2022, the Korean Ministry of Strategy and Finance released draft domestic legislation to enact Pillar Two;
• in August 2022, the Swiss Federal Council released for consultation a draft ordinance to implement Pillar Two in Swiss law;
• in October 2022, the Netherlands released for public consultation a draft bill to enact Pillar Two in Dutch law;
• in December 2021, the European Commission issued a proposal for a council Directive which would require EU member states to enact a version of Pillar Two in their domestic law. For some time, Poland and Hungary expressed reservations about the Directive which prompted France, Spain, Germany and the Netherlands in September to announce their intention to move ahead, alone if need be. On 12 December 2022, the Council of the EC issued a media release saying the ambassadors of all the Member States had given their unanimous support to the proposed Directive. While the media release has not been withdrawn, rumours now circulating suggest the announcement of unanimity may have been premature. If an EU-wide agreement has not been reached, it seems likely that France, Spain and Germany will act anyway; and
• of course, the United States had already implemented its Global Intangible Low-Taxed Income (GILTI) regime in 2018. GILTI is the model from which the Pillar Two proposal is derived (though the US would need to amend GILTI if it is to align closely with the Pillar Two design).

Draft legislation can be expected to emerge from Australia and other countries, and very soon – Treasury has said it expects, “a critical mass of countries will implement [Pillar Two] in 2024” which probably means countries will start enacting their legislation during 2023.