Tax Insight: Signs of BEPS Life

The Inclusive Framework of the OECD/G20 has released an “Outcome Statement” on developments in the long-running BEPS project. The Statement is evidence of life for the BEPS project. It focuses on work done but not yet public, rather than announcing significant progress on achieving milestones, new developments or major departures from what was already in the public domain. But, importantly, it also hints at problems in finalising the BEPS project.

1.     Some of the lead up

July 2021. After some false starts in earlier documents, the principal design features of the “Two Pillar” BEPS plan had been largely settled by mid-2021.

The Statement on a Two-Pillar Solution to Address the Tax Challenges Arising from the Digitalisation of the Economy (1 July 2021) laid out the key design features of the 2-pillar BEPS plan:

• Pillar One would comprise of two elements:
  • Amount A: a portion (between 20-30%) of the surplus profits (profitability above 10% of revenue) of MNEs with global turnover above € 20 bn would be taxable in each market jurisdiction where the MNE earns at least €1 m in revenue (or €250,000 for smaller countries) based on the amount of revenue earned in the jurisdiction;
  • Amount B: calculating the profit from baseline marketing and distribution activities occurring in a country would be simplified and streamlined;
  • Digital Services Taxes: part of the package for developed countries agreeing to Amount A is that countries would agree remove all Digital Service Taxes and similar taxes;
• Pillar 2 would involve three elements:
  • Income Inclusion Rule: a parent entity would be required to pay top-up tax on the profits of low-taxed members of the group (effective tax rate <15%);
  • Undertaxed Payment Rule: other members of the group would be denied deductions sufficient to collect the top-up tax on the low-taxed income of other group members if the IIR had not been enlivened;
  • Subject to Tax Rule: a treaty-override rule allowing source jurisdictions to impose additional tax (between 7.5% and 9%) on certain classes of payments being made to related low-taxed entities.

The original timetable envisioned Amount A of Pillar One and Pillar Two would both become operative during 2023.

October 2021. The subsequent Statement on a Two-Pillar Solution to Address the Tax Challenges Arising from the Digitalisation of the Economy (8 October 2021) did not fundamentally change that design although it did flesh out some details and tweak a few others:

• the share of revenue available to market jurisdictions under Amount A of Pillar One was fixed at 25% of residual profit;
• the amount of low-taxed income immune from being taxed under the IIR and UTPR was increased;
• a de minimis exemption from the UTPR would operate for the first 5 years for MNEs that have modest tangible assets abroad and operate in fewer than 5 other jurisdictions;
• source jurisdictions would be allowed to collect up to 9% on payments caught by the Subject to Tax Rule;
• as well the existing commitment to repeal existing DSTs, countries also agreed not to enforce any new DSTs enacted after 8 October until 31 December 2023 (or the coming into force of the expected Multilateral Convention). This latter commitment would become important in 2023.

December 2021 to March 2022. It was not until December 2022 that a major change to the design emerged with the release of three technical documents on Pillar Two: the Model Rules (20 December 2021), the Commentary (14 March 2022) and Illustrative Examples (14 March 2022).

The Model Rules contained provisions recognising a “Qualified Domestic Minimum Top-up Tax”: a domestic tax on the low-taxed profits of members of a MNE group, collecting any additional tax for the benefit of the source country rather than the country of the parent (under the IIR) or other countries in which the MNE group operates (under the UTPR). This was a significant development, effectively supplanting the IIR and UTPR as the main means of ensuring the global minimum 15% tax rate.

Australian developments. In Australia, the Government has been working toward implementing the basic design:

• the ALP announced its policy for the May 2022 election which included a promise to implement “a global 15 per cent minimum tax [Pillar Two], and ensuring some of the profits of the largest multinationals – particularly digital firms – are taxed where the products or services are sold [Pillar One]” (22 April 2022);
• Treasury released a consultation paper, Global agreement on corporate taxation: Addressing the tax challenges arising from the digitalisation of the economy (4 October 2022) seeking submissions on implementation issues; and
• in the 2023 Budget (9 May 2023), the Government announced the timetable for implementing Pillar Two in Australian law:
  • the Income Inclusion Rule would apply for income years starting on or after 1 January 2024;
  • the Undertaxed Profits Rule would apply for income years starting on or after 1 January 2025; and
  • the 15% domestic minimum top-up tax would apply for income years starting on or after 1 January 2024.

2.     The Outcome Statement

The Inclusive Framework has released its Outcome Statement on the Two-Pillar Solution to Address the Tax Challenges Arising from the Digitalisation of the Economy (11 July 2023) reporting signs of BEPS life in anticipation of the meeting of G20 Finance Ministers and Central Bank Governors’ meeting in India later this month. The Statement was agreed to by 138 members of the Inclusive Framework. There are currently 143 members; Canada was a notable absentee for reasons discussed below. Yes, Canada!

The Outcome Statement is largely a progress report:

• Pillar One Amount A: the Multilateral Convention allowing countries to claim in domestic law tax on a portion of the residual profits of in-scope MNEs has been prepared for signature: the Statement says “the Inclusive Framework has delivered a text of a Multilateral Convention …” But the Multilateral Convention has not been signed, nor even opened for signing because “a few jurisdictions have expressed concerns with some specific items in the Multilateral Convention. Efforts to resolve these issues are underway with a view to prepare the Multilateral Convention for signature expeditiously.” Just what the text says remains secret as it has not been publicly released (although a small extract, dealing with removal of digital services taxes, was released in December 2022). The new timetable is that the convention should be open for signature in the second half of 2023 “with the objective of enabling the Multilateral Convention to enter into force in 2025”;
• Pillar One Amount B: the Outcome Statement reports no new developments saying, “further work will be undertaken” on various aspects of the proposal “to be completed by year end” leading to new “content … which will be incorporated into the OECD Transfer Pricing Guidelines by January 2024”;
• Pillar One Digital Services Taxes: the stand-still agreement on enforcing Digital Services Taxes introduced after October 2021 was conditionally extended from 31 December 2023 to 31 December 2024 (and possibly 31 December 2025). Interestingly, the agreement to delay implementation is conditional on “at least 30 jurisdictions accounting for at least 60 percent of the Ultimate Parent Entities … of in-scope MNEs signing the MLC before the end of 2023”; and
• Pillar Two Subject to Tax Rule: the drafters have apparently decided that a two-pronged attack is needed:
  • they have “completed and delivered” a model provision (and commentary) to add the STTR to existing bilateral treaties; and
  • they have also prepared a Multilateral Instrument and Explanatory Statement (presumably along the lines of the 2018 Multilateral Instrument) allowing signatories to amend existing bilateral tax treaties in bulk. The new Multilateral Instrument will be open for signature from 2 October 2023.

Neither text was released for scrutiny.

3.     Some observations

It is notable that the Outcome Statement focuses on the BEPS topics of most concern to developing countries, notably Amounts A and B of Pillar One and the Subject to Tax Rule element of Pillar Two: the Statement refers to special provisions which will be in the MLC “designed to address the unique circumstances of developing Inclusive Framework members”, how advancing Amount B “is a critical component of the broader agreement on Pillar One” and how “the STTR is an integral part of achieving consensus on Pillar Two for developing Inclusive Framework members.”

But the Statement hints at problems in finalising several key components of the BEPS project, especially with regard to Pillar One.

The first sign of trouble is with the 2021 compromise – to defer implementing new DSTs until 31 December 2023, in the expectation that the Multilateral Convention would be in place. The hold-outs with regard to the Multilateral Convention (the “few jurisdictions [which] have expressed concerns with some specific items in the MLC…”) are prolonging delivery of the Multilateral Convention. The majority of the members of the Inclusive Framework were willing to prolong the negotiations and extend the moratorium on implementing new DSTs for a further year, but this was too much for Canada. Its DST is scheduled to start on 1 January 2024 in accordance with the original timetable. The Finance Minister was unwilling to accept further delays noting there was still no “firm and binding multilateral timeline to implement Pillar One” and without that, “Canada [was] at a disadvantage relative to countries which have continued collecting revenue under their pre-existing DSTs”. (It is not clear whether the hold-outs are developing countries, who were expecting Amount A to deliver more revenue to them, or the developed countries since their companies are the most affected).

No doubt, Canada is right to be skeptical, but there must be a high chance that the extension of the moratorium will not actually happen because of the conditions attached to the extension. The extension is conditional on “at least 30 jurisdictions … signing the MLC before the end of 2023 …” and those 30 jurisdictions must represent “at least 60 percent of the Ultimate Parent Entities (UPEs) of in-scope MNEs …” Some researchers have concluded this second condition means the US must sign the Multilateral Convention. Their estimate is that more than 40% of the groups likely to be affected by Amount A of Pillar One are US-based, making the US indispensable. The prospects of the US Senate consenting to the Multilateral Convention are by no means assured.

The second sign of trouble is evident the decision to conduct yet more consultation on Amount B of Pillar One. Amount B has been relatively neglected in the prior BEPS work and this omission now seems to be causing delays, hindering the finalising of the work.

And in the same vein, the two-pronged approach to the STTR hints at disagreement. The invitation to developed countries to implement the STTR through amending bilateral treaties, rather than wait for the Multilateral Instrument, points to some doubts about the prospects for landing the Multilateral Instrument.

The Outcome Statement adds no new details or changes to the other components of Pillar Two: the domestic minimum top-up tax, the income inclusion rule or the under-taxed profits rule. These happen to be of most concern to the developed world and are apparently on track for implementation: the Statement notes, the “global minimum tax framework under Pillar Two is already a reality, with over 50 jurisdictions taking steps towards implementation.”