The 137 jurisdictions of the Inclusive Framework on BEPS (IF) have released documents showing substantial progress on a new international tax architecture. The business community have an opportunity to participate in a public consultation on tax rules that will affect all large internationally operating enterprises, their corporate structures and their accounting and tax management systems.
On 12 October 2020 documents approved by the IF at their meeting on 8-9 October were posted to the OECD website. These included two blueprint documents, totalling 480 pages and setting out highly detailed proposals for the two “Pillars” of the new international tax architecture. This is the product of intense work by the OECD Secretariat and working parties of tax officials from IF member countries under the IF’s 2019 programme of work (see China Tax Alert 2020 Issue 10). This was accompanied by an economic analysis on the effects of the proposals, a public consultation document, as well as a covering statement setting out the state of play on progress towards IF political agreement. This commits IF jurisdictions to resolving remaining issues and finalize agreement on the new rules by mid-2021. The G20 Finance Ministers meeting on 14 October is expected to endorse the progress so far.
The blueprint documents set out highly complex new international tax rules, the details of which will be explored in greater detail in future KPMG publications. As explained in the cover statement, each of the two Pillars looks to address deficiencies of the international tax system that have become increasingly evident in recent years:
The cover statement is clear that the IF countries have not yet achieved agreement on either of the Pillars. However, the IF countries identify the aspects of the new rules on which they have achieved ‘convergent’ views, and state that the blueprints offer a solid basis for future agreement. As such, the IF countries have advanced significantly on their position in January 2020, at which stage the proposals were just a ‘basis for negotiation’ and they had solely committed to ‘explore’ pillar rule development.
The new international tax rules being developed within the two pillars are frequently referred to as BEPS 2.0. The original 2013-15 international tax reform is now referred to as BEPS 1.0. In the five years since the BEPS 1.0 deliverables were released, countries around the world have updated their transfer pricing rules, their tax treaties, and their domestic anti-avoidance rules in line with these, and preferential and zero tax regimes have adopted ‘substance’ requirements to prevent abuse. BEPS 1.0 had at its core the concept that taxing rights should be aligned with the place of ‘value creation’. Countries in which value was considered to be created, under a framework that emphasized corporate decision-making and control functions, could tax the allocated profits as they wished. The IF countries, in endorsing the direction of the BEPS 2.0 work in the cover statement, might be viewed as moving beyond the BEPS 1.0 value creation framework. The Pillar 1 rules allocate taxing rights using a new concept of nexus, and formulary allocation provisions, that make no reference to the BEPS 1.0 functions, assets and risks value creation framework. Pillar 2 might also be viewed as overriding taxing outcomes under the BEPS 1.0 value creation framework where this results in low tax outcomes. MNEs around the world have spent the last five years busily modifying their corporate and operating structures, and tax management arrangements, to comply with the BEPS 1.0 requirements. In future, under BEPS 2.0, they may have to revisit some of these efforts.
The two Pillars are at different stages of development. Pillar 1, which as designed impacts consumer facing businesses and digital service businesses, has left many of the key features open to further negotiation, and this is reflected in the broad scope of the public consultation. Work on the Pillar 2 rules (which affect all large enterprises) is highly advanced. This is reflected in the granularity of the rules set out in the blueprint, the clear enumeration of technical design matters that are flagged as “remaining issues”, and relative narrowness of the public consultation questions. While there are several important points on which political negotiation is needed, enterprises reading the blueprint may be able to form a view of how the rules will impact their overall tax burden, and assess the need for group restructuring and new tax and accounting systems development. Pillar 2-affected enterprises will have a major systems upgrade undertaking on their hands (Pillar 1 will also require additional systems work).
Chinese MNEs within the scope of the rules (likely those above the CBCR revenue threshold) will need to make significant investments in upgrading their accounting and tax management systems to deal with these requirements. They may also find that some existing structures (e.g. aspects of offshore listing arrangements) produce unfavorable tax results and call for restructuring. While the Pillar 2 rules are not yet agreed, the direction of travel is increasingly clear, and some MNEs may choose to start their planning now. Submissions to the public consultation on Pillar 1 and 2 are due by 14 December, with the consultation scheduled for mid-January 2021, and China MNEs should consider points they wish to raise.