After months of behind the scenes negotiations, 136 countries announced the latest version of their two-pillar global tax agreement on Friday. And while steady pressure from taxpayers and other stakeholders has won some concessions to clarity, the agreement text adds just a few pages and a few details to a five-page July agreement. U.S. policymakers at the Treasury Department and in Congress will need, and should continue to seek, many more assurances before they even begin to implement the accord.
As a refresher, this agreement has come about because the Organisation for Economic Co-operation and Development (OECD) is leading negotiations among 130-plus countries on two-pronged global tax reform. At times, the process has looked more like a hunt for additional revenue than any quest for genuine reform.
The first prong, Pillar One, would reallocate a portion of the profits earned by multinational tech companies on the digital goods and services they provide, with profits directed to potentially dozens of countries where those companies earn a minimum amount of revenue. The second prong, Pillar Two, would require multinational companies to pay a minimum amount of tax on their foreign earnings, with countries that host those companies having the right to levy a ‘top-up’ tax where the effective tax rate falls below the minimum.
More on the basic details of both Pillar One and Pillar Two below, but here are a few basic takeaways that U.S. policymakers and U.S. taxpayers should be concerned about.
There's not enough substance on the removal of discriminatory digital services taxes (DSTs). Here's what the agreement language says:
"No newly enacted Digital Services Taxes or other relevant similar measures will be imposed on any company from 8 October 2021 and until the earlier of 31 December 2023 or the coming into force of the MLC. The modality for the removal of existing Digital Services Taxes and other relevant similar measures will be appropriately coordinated. The IF notes reports from some members that transitional arrangements are being discussed expeditiously."
This is encouraging news for NTU and other voices that have called for a genuine commitment from participating countries to stop unilateral DST proliferation and begin reversing it. As of yet, however, there are few assurances for U.S. companies and workers that are uniquely affected by DSTs in Europe and elsewhere. The agreement says the removal of existing DSTs "will be appropriately coordinated." It also says that transitional arrangements for existing DSTs "are being discussed." We have yet to see sorely needed guarantees for U.S. companies and U.S. policymakers that existing DSTs will be swiftly and completely removed. While global negotiators should be commended for establishing an effective moratorium, through 2023, on the imposition of new DSTs, negotiators owe U.S. companies and taxpayers answers on how existing DSTs will be handled.
The OECD is contemplating giving 140-plus countries just six months to ratify the multilateral agreement that serves as the foundation for Pillar One. The agreement says:
"The [Task Force on the Digital Economy] will seek to conclude the text of the [multilateral convention, or MLC] and its Explanatory Statement by early 2022, so that the MLC is quickly open to signature and a high-level signing ceremony can be organised by mid-2022. Following its signature, jurisdictions will be expected to ratify the MLC as soon as possible, with the objective of enabling it to enter into force and effect in 2023 once a critical mass of jurisdictions as defined by the MLC have ratified it."
Even proponents of an aggressive global tax agreement have pointed out that it has taken years to partially implement far less ambitious elements of anti-base erosion and anti-profit shifting tax measures at the OECD. It seems extraordinarily ambitious at best, and naive at worst, to assume that 140 countries can implement major elements of Pillar One in just a few months, for an effective date in 2023.
The OECD is contemplating giving 140-plus countries potentially no time to implement Pillar Two. The agreement says:
"At the latest by the end of 2022 an implementation framework will be developed that facilitates the coordinated implementation of the GloBE rules."
However, Pillar Two is supposed to be effective in 2023. How can U.S. policymakers -- and, policymakers around the globe -- be confident in attempting to implement Pillar Two in 2022, for an effective date in 2023, when the framework may not even be completed until the end of 2022? This should give Congressional Democrats pause on their efforts to implement international tax changes as part of the multi trillion-dollar reconciliation package.
There are a few silver linings in here for U.S. taxpayers. First, countries have received some increasingly solid assurances that the minimum rate in Pillar Two will not be higher than 15 percent. Second, the substance-based carve-out for multinationals’ foreign profits under Pillar Two is much more generous during the transition period than envisioned in July (and Congressional Democrats should make changes to their carve-out proposals to account for the transition period). Third, the de minimis revenue/profit threshold of €10 million/€1 million ($11.6M/$1.2M) is a win for compliance and administrative simplification (though more certainty is needed on other simplification measures; for more see here). Fourth, the envisioned effective date for the undertaxed payments rule (UTPR) ‘backstop’ has been pushed back one year, from 2023 to 2024, giving countries more time to implement a potentially complicated rule.
Overall, the October agreement speaks to the need for additional important conversations on transition issues, dispute resolution between countries and companies, and common definitions of policy. This latest revision of the framework isn't merely missing a few girders and fasteners -- it still lacks several key structural beams anchored into a well-set foundation.
Here are the basic details of Pillar One:
Pillar One Details, October 2021 | ||
| Details | Updates From July? |
Scope (i.e., who’s subject to profit reallocation) | -Multinational companies (MNCs) with annual revenues of more than €20B ($23.15B) and profitability above 10%
-Extractives (i.e., oil and gas) and financial services excluded | No |
Nexus (i.e., who’s eligible to tax profits under reallocation) | -Countries where the MNCs derive at least €1M ($1.16M) in revenue
-For countries with GDP <€40B ($46.3B), that revenue threshold drops to €250K ($289.4K) | No |
Quantum (i.e., how much profit will be reallocated) | 25% of profit in excess of 10% of revenue | Yes; July envisioned between 20% and 30% of profit in excess of 10% of revenue, so 25% is the middle of that range |
Removal of Digital Services Taxes? (DSTs) | A multilateral convention (MLC) will require the removal of existing DSTs, and a prohibition on new DSTs; however, details about how existing DSTs will be removed is TBD, as is whether a “transitional” period will be allowed for existing DSTs to remain in place in whole or in part | Yes; there are a few additional details on the removal of DSTs compared to July; unfortunately, most of the technical details have still been kicked down the road |
Implementation Timeline | -MLC text released by early 2022
-MLC signed by participating countries in mid-2022
-Pillar One effective in 2023 | Yes, there are more details about the release and implementation of Pillar One compared to July; however, the implementation timeline is still very ambitious |
And here are the basic details on Pillar Two:
Pillar Two Details, October 2021 | ||
| Details | Updates From July? |
Scope (i.e., companies subject to the minimum tax rules) | MNCs with annual revenue of more than €750M ($868.1M) | No |
Minimum rate (i.e., the minimum effective tax rate in-scope MNCs must pay) | 15% | Yes, the July agreement called for a rate of “at least” 15%, but the new agreement locks in 15% |
How effective tax rates are determined | -Country-by-country basis
-Common definition of covered taxes and common definition of tax base, based on financial accounting (i.e., book income)
-Unspecified “adjustments” will be made to account for policy objectives and timing differences | No |
Carve-out (i.e., amount of profits excluded from taxation) | -For the first year, 8% of the value of tangible assets plus 10% of payroll
-Transition period of 10 years, with amounts slowly declining
-After 10 years, 5% of the value of tangible assets plus 5% of payroll | Yes, the July agreement envisioned a five-year transition period at 7.5% of the value of tangible assets plus 7.5% of payroll |
Undertaxed payment rule (UTPR)? (i.e., a backstop for countries that host companies that still have low-taxed income in countries that are not party to the agreement?) | -Yes, and the minimum tax rate for the UTPR is also 15%
-There’s an exclusion from the UTPR for MNCs in their first 5 years, with a maximum of no more than €50M ($57.9M) in tangible assets abroad and operating in no more than five foreign countries | Yes, the exclusion is new and was not in the July agreement |
Implementation Timeline | -“Framework” by end of 2022
-Expectation that countries will implement Pillar Two into their tax laws in 2022
-Pillar Two effective in 2023 | Yes, the agreement envisioning a “framework” by the end of 2022 is new; this makes implementation for an effective date of 2023 more challenging |