The multilateral agreement envisaged under BEPS 2.0 took further steps forward on 1 July with a statement released by the OECD/G20 Inclusive Framework on the agreement of a two-pillar solution to address the tax challenges arising from the digitalization of the economy. An implementation plan is envisaged by October 2021, with enactment into law by 2022, anticipated to be effective in 2023.
1. Increased clarity on taxing rights to market countries (Pillar One)
The applicability, nexus and scope of the profit allocation to market jurisdictions (Amount A) was clarified, with Multinational enterprises (MNEs) with global turnover above EUR 20 billion1 and profitability before tax above 10% to be impacted. For these in-scope MNEs, 20-30% of residual profit (defined as profit in excess of 10% of revenue) (Amount A) will be allocated to relevant market jurisdictions, using a revenue-based allocation key. Losses will be carried forward. So far, the only industries to be explicitly excluded are extractives and regulated financial services.
Whilst this limits the MNEs in scope, they are likely to be heavily impacted since relatively low thresholds are used to define jurisdictions in scope of receiving an Amount A allocation (Nexus). These include end-market jurisdictions where goods or services are used or consumed, and where the in-scope MNE derives at least EUR 1 million2 in revenue. Where the residual profits of an in-scope MNE are already taxed in a market jurisdiction, a marketing and distribution profits safe harbor will cap the residual profits allocated to the market jurisdiction through Amount A. This cap is still to be defined.
Details on Amount B (application of the arm’s length principle to in-country baseline marketing and distribution activities) were less forthcoming, with the process anticipated to be completed by the end of 2022.
The Inclusive Framework also confirmed that the double taxation of profit allocated to market jurisdictions will be relieved using either the exemption or credit method. In-scope MNEs will benefit from dispute prevention and resolution mechanisms, and the tax compliance process is anticipated to be streamlined (including filing obligations), allowing MNEs to manage the process through a single entity.
This provides additional certainty that large and profitable Swiss headquartered groups, or MNEs operating with Swiss principal structures, will need to surrender a significant part of the residual profit - currently subject to taxation only in Switzerland - to the market jurisdictions; however, the tax impact on a group level may be offset to some extent by the removal of all Digital Service Taxes (DSTs) and other similar measures, that would otherwise have been applied.
2. Global minimum tax (Pillar Two)
The 15% minimum tax rate introduced in the June 5 communiqué from the G7 was upheld, along with further details on the computation of the tax rate and potential carve-outs.
Importantly, the Global anti-Base Erosion Rules (GloBE)3 rules will apply not only to MNEs that meet the EUR 750 million threshold as determined under Country by Country Reporting (CbCR), but countries may choose to apply the Income Inclusion Rule (IIR) to MNEs headquartered in their country even if they do not meet the threshold4.
The GloBE rules will operate to impose a top-up tax using an effective tax rate (ETR) test that is calculated on a jurisdictional basis, and that uses a common definition of covered taxes and a tax base determined by reference to financial accounting income. For now, the IF has not mentioned any taxes on corporate equity.
Regarding exclusions, the GloBE rules will provide for a formulaic substance carve-out that will exclude an amount of income that is at least 5%5 of the carrying value of tangible assets and payroll. The GloBE rules will also provide for a de minimis exclusion and furthermore for an exclusion for international shipping income as defined under the OECD Model Tax Convention.
Given the wide-reaching nature of these rules, the likelihood that countries may implement these also for MNEs below the CbCR threshold, and the limited availability of carve-outs, it is likely to affect many Swiss MNEs or Swiss companies. A key consideration will be whether Switzerland decides to (i) increase the tax burden to at least 15% (where relevant) and (ii) adopt the GloBE rules, in which case, Swiss parent companies would be subject to the IIR, or whether the UTPR would allow other countries to (indirectly) levy taxes on a Swiss company’s profits.
It is also still to be confirmed how the implementation framework will include safe harbors and/or other mechanisms in order to avoid compliance and administrative costs for MNEs.
1The turnover threshold could be reduced to EUR 10 billion, contingent on successful implementation including of tax certainty on Amount A, with the relevant review beginning 7 years after the agreement comes into force.
2For jurisdictions with GDP lower than EUR 40 billion, the threshold will be set at EUR 250,000.
3Income Inclusion Rule (IIR) imposes top-up tax on a parent entity in respect of the low taxed income of a constituent entity; Undertaxed Payment Rule (UTPR) denies deductions or requires an equivalent adjustment to the extent the low tax income of a constituent entity is not subject to tax under an IIR
4Government entities, international organizations, non-profit organizations, pension funds or investment funds that are Ultimate Parent Entities (UPE) of an MNE Group or any holding vehicles used by such entities, organizations or funds are not subject to the GloBE rules.
5In the transition period of 5 years, this is increased to at least 7.5%.
The following timeline is anticipated to determine the BEPS 2.0 agenda and implementation details:
With the increased clarity, companies can already start to assess how they will be impacted by Pillars 1 and 2 with KPMG’s proprietary tools, which can provide a cost effective and pragmatic viewpoint on the scenarios and impacts with CbCR data. The most significant unknowns are currently how individual jurisdictions will choose to implement Pillar 2, as well as some specifics on the implementation and approach. However, companies can already make assumptions on the extent to which they will be in scope (based on revenue and profitability thresholds), in order to assess risks.
More details on the BEPS 2.0 plans and on how companies can prepare for the changes can be found in our earlier publication.