Back on July 1, 2021, the OECD and G20 announced that 130 countries, led by the USA, had joined the Two Pillar tax reform package aimed to “ensure that multinational enterprises pay a fair share of tax wherever they operate”. That number now stands at 147 countries.

The OECD hopes to re-allocate a quarter of a trillion dollars of taxable profit (not tax) per year of the largest multinational groups to onshore countries.

If you think only the biggest tech groups are affected, think again. E-commerce operators of all sizes are affected by separate but related changes including:

• New VAT rules in the EU and UK;
• US sales rates at over 20,000 different rates in US states and cities, following a Supreme Court judgment in 2018 (the Wayfair Case);
• Online platform operators may now be compelled to collect these taxes from your sales;
• The OECD has tightened up the income tax nexus rules if you use an agent, warehouse or fulfillment house – via a complex super tax treaty known as the multilateral instrument (MLI).

For many smaller e-commerce firms, it will be like a loose- fitting shirt with hidden tax pockets.

What are the two Pillars?

The Two Pillars are an emerging tax reform package developed by the OECD. Many big digital operators  operate on an internet cloud located nowhere in particular but owned by an offshore subsidiary company. Those offshore companies have been accumulating tax free profits perfectly legitimately.

So Pillar One recommends allocating some profits to “market jurisdictions” where customers or users are located. Pillar one would contain Amount A and Amount B. Amount A would be excess profits above a certain level and amount B would relate to “baseline marketing and distribution” activities.

Pillar Two recommends to impose a minimum global tax rate to the ultimate parent entity (UPE). Of course, there are exceptions and loose ends.

Pillar Two is being adopted by many countries, Pillar One is still work in progress at the OECD.

More on Pillar One:

According to the G20, “in scope” multinationals for Pillar One would have global turnover (revenues) above EUR 20 billion, which may decrease to EUR 10 billion after 7 – 8 years. But “extractives” (mining companies apparently) and Regulated Financial Services would be excluded altogether from Pillar One. The latter was apparently a gift from the Biden Administration to the City of London provided the UK drops its 2% digital services tax which US tech giants dislike.

There would be a new nexus (linking) rule permitting Amount A to be allocated to a market jurisdiction when the multinational derives at least EUR 1 million in revenues there, or at least EUR 250,000 for jurisdictions with GDP under EUR 40 billion (the Israeli GDP is around EUR 340 billion…). Amount A allocated in this way would be 20%-30% of excess (“residual”) profit above 10% of revenue. Sourcing rules still need to be developed for allocating revenue to where goods or services are used or consumed. Profit would be according to financial accounts with a small number of adjustments. Losses (where?) will be carried forward. The taxpayer will be “drawn from” those entities that earn the excess (residual) profit.

Segmentation within a group “will occur only in exceptional circumstances. This matters because some segments of Amazon, say, make more than 10%, others under 10%.

Digital Service Taxes in some countries are to be removed in coordination with the application of this package. This is proving politically difficult.

Amount B will deal with “baseline marketing and distribution activities”.

Double taxation:

Any profit already taxed locally should not be allocated again via Amount A. And double taxation of profit allocated to market jurisdictions should be relieved using the exemption or credit method.

Disputes:

The G20 says there will be dispute prevention and resolution mechanisms which should avoid double taxation for Amount A in a mandatory and binding manner. Unfortunately, we still await details of how this will work.

More on Pillar Two:

Pillar two is also known as GloBE (Global Base Erosion Rules) and aims to achieve a 15% minimum global corporate tax rate. The GloBE/Pillar Two rules are aimed at multinationals with turnover of at least EUR 750 million. There are three elements:

• A top-up tax on a parent company – known as an income inclusion rule (IIR),
• Undertaxed Payment Rule (UTPR) which denies an expense deduction regarding low taxed income of a recipient not taxed under the IIR, but the methodology varies, and
• Subject To Tax Rule (STTR) in tax treaties allowing withholding tax of 7.5%-9% on certain related party payments taxed below the minimum rate.

Pillar Two Exceptions:

Countries need not adopt the GloBE/Pillar Two rules, but it’s all or nothing if they do.

There are Pillar Two carve-outs (exemptions) for:

• 5%- 7.5% of the carrying value of tangible assets and payroll (“substance carve=out”)
• If earnings are distributed within 3-4 years and taxed above the minimum level (15%).
• Shipping income,
• Pension funds or investment funds that are ultimate parent entities,
• Government entities
• International organizations
• Safe harbors (at least temporarily).

US entities continue to be governed by GILTI rules.

Countries may apply the IIR to multinationals headquartered in their country even if they turnover is below EUR 750 million.

Implementation:

Pillar 2 is being adopted by many countries in 2024-2026. Pillar 1 is still being sorted out at the OECD level.

Comments:

We predict chaos for large and small international businesses. Here is a dirty dozen for starters.

1. What About VAT and Sales Taxes? The G20 ignored VAT and sales taxes around the world. The EU introduced tough new B2C VAT rules on the same day as the G20 announcement – July 1, 2021. And in 2018, the US Supreme Court in the Wayfair Case allowed US states to start taxing large and small out-of-state sellers with sales above certain levels (e.g. $100,000) in that state.
2. What About Existing Income Tax Rules? The MLI is aimed at international businesses of any size, but is complex to apply. Countries have to sign up to each Article and sub-Article. The MLI applies where two countries sign up to the same sub-Article(s). Where applicable, the MLI imposes stricter “permanent establishment” income tax liabilities for suppliers that use warehouses, fulfillment houses or many types of agent, for large and small suppliers.
3. Too Many Collectors: There will be multiple tax collectors. The USA, the EU and the UK all collect VAT/Sales Tax from B2C online sellers and online platforms and other countries are following suit. The Two Pillar package proposes collecting income tax from excess profit earners, parent companies, subsidiary companies and expense payors.
4. Disorderly: We expect complexity and multiple taxation of the same income, in the 147 participating countries. In simulations we have run using an offshore supply company, we foresee 40%-60% taxation in some cases if no action is taken.
5. Not Ready: Many countries are not ready or only partially ready.
6. Who Pays The Price?  The allocation rules will tell us where to allocate taxable income to, but not where from. Imagine customers in the UK of goods supplied from a website in China. Will China readily surrender Amount A profit to the UK?
7. Who’s In Charge? No body is yet charged with coordinating it all in each of the 147 participating countries. For example, will the USA let the OECD run the show?
8. Appeals: There is no mention of local appeal procedures, that will be up to each country.
9. Disputes: International dispute procedures are not yet agreed. Many are skeptical of the OECD’s ability to deliver a fast efficient international tax tribunal/arbitration system.
10. Cat and Mouse: We predict many loop-holes, for example different supply routes, splitting up private groups, R&D credits, territorial tax systems and passing on taxes where possible to consumers. Not to mention conservative financial accounting, conservative exchange rate translations, brokerage rather than buy-sell, employing not subcontracting, investing appropriately, etc.
11. DAC6 is Scary:  The EU and UK have also implemented in 2021 a Directive called DAC6. This requires many types of cross border arrangement, innocent or not, to be disclosed in detail and may trigger a tax audit. E-commerce operators need to check this out.
12. Existential Threat: Last but not least, the environment took a back seat. There is no mention of adapting the tax reform to penalize polluters and carbon emitters.

Next Steps:

Please monitor developments and contact us for assistance with ABCDEF:

• A:   Automation of analysis and reporting.
• B:   Business nexus review.
• C:   Comprehensive structural planning.
• D:   Double/multiple tax relief steps.
• E:   Expected developments preparation.
• F:   Further significant points, including transfer pricing planning and amended intercompany agreements.

Next Steps:
Please contact us if you need to discuss the above or any other business matter.

Always consult experienced professional advisors in each country concerned – we can help arrange this.

[email protected]

© November 18, 2024