The deal, which aims to address the tax challenges of digitizing the economy, follows an agreement between G7 finance ministers in June, but is more detailed and includes outsourcing for specific sectors.
“This is a milestone forward,” said tax expert Eloise Walker of Pinsent Masons, the law firm behind Out-Law. “So far there has been a lot of talk and arguments, but not much agreement on a way forward, but it looks like this lengthy process is accelerating.”
The federal states have agreed on a two-pillar solution. Under the first pillar, multinational companies with a worldwide turnover of over 20 billion euros and a profitability of over 10% are taxed on part of their profits in the countries in which they operate. Sales of 20 billion euros will potentially drop to 10 billion euros after seven years.
Countries in which the multinational corporation generates revenues of at least € 1 million will benefit from the new tax law. For smaller jurisdictions with a GDP of less than EUR 40 billion, the threshold is set at EUR 250,000.
Regulated financial services and extractive industries are not subject to the first pillar rules. After the G7 agreement, the UK had advocated the exclusion of financial services, as banks in the countries in which they operate are forced by regulation to capitalize on capital so that they can already pay out profits there.
In return for taxing rights under the first pillar, part of the deal is that countries like the UK and France, which have unilateral taxes on digital services, will lower those taxes. The OECD statement stated that the package provides for “appropriate coordination between the application of the new international tax rules and the elimination of all taxes on digital services and other relevant similar measures for all businesses”.
Pillar two of the agreement are the Global Anti-Base Erosion Rules (GloBE), according to which multinational companies can be compelled to pay a minimum tax rate of 15% regardless of their headquarters or the legal system in which they operate.
Countries are not forced to apply the GloBE rules, but where they wish they must do so in accordance with the agreements. Countries that do not adopt the rules must accept the application of the rules by other countries.
“This will be an interesting aspect in practice, especially in Europe, where overarching rules like state aid are involved and clashes are likely to occur,” said Walker.
Under the GloBE rules, countries are not required to increase their corporate tax rate to at least 15%. Instead, parent companies in jurisdictions that choose to apply the rules are subject to a top-up tax, the income tax rule, if their subsidiaries in another jurisdiction have paid less than 15% tax or deductions on payments. Group members in low-tax areas can be refused.
There will also be a minimum tax rate based on a double taxation treaty of between 7.5% and 9% on interest, royalties and certain other payments between related persons subject to the tax regime. If the recipient of such a payment were to tax less than the established tax rate, the tax liability would allow the payer’s state to impose an “top-up” withholding tax.
Tax submission was an integral part of the agreement on the second pillar for developing countries. Under the agreement, countries that apply nominal corporate tax rates below the minimum taxable rate on interest, royalties and certain other payments undertake to include the taxable provisions in their bilateral agreements with developing countries upon request.
The GloBE rules apply to multinational companies that meet the € 750 million threshold for country-specific reporting. However, countries are free to apply the income inclusion rule to multinational companies based in their country, even if they do not meet the threshold.
In a further attempt to make the rules more acceptable to developing countries, it was agreed that the GloBE rules include a “substance” spin-off that excludes an income amount of at least 5%, or in the transition period of 5 years, at least 7.5 % of the book value of property, plant and equipment and payroll. Thus, the rules do not apply to incentives that countries offer for material investment in their countries, such as the construction of factories.
“As with all compromises,” said Walker, “the proposed way forward is a hodgepodge of new rules rather than a streamlined, easy-to-use one size fits all. That’s as expected, but as the OECD is overhauling a long-standing international tax system, we can expect a decade or two of chaos as each country has its own view of the complex proposals. “
Non-profit organizations, pension funds or mutual funds that are the ultimate parent company of a multinational corporation, or the holding vehicles they use, are not subject to the GloBE rules.
The OECD members Ireland, Estonia and Hungary have not signed the agreement. Barbados, Kenya, Nigeria, Sri Lanka and St. Vincent and the Grenadines were the other countries involved in the discussions that disagreed with the measures, with Peru abstaining.
The signatories of the agreement have set an ambitious timetable for the conclusion of the negotiations. This includes a deadline in October 2021 for the completion of the remaining technical work on the two-pillar approach, as well as a plan for its effective implementation in 2023.