BEPS 2.0 Developments: Impact on International Tax Trends | Pillar One & Pillar Two Explained


  • QUESTION POSTED BY: Student
  • PROGRAMME: Postgraduate Diploma in International Taxation
  • TOPIC: Introduction to International Taxation (WEEKS 1 & 2)
  • LECTURER: Dr Daniel N Erasmus

FULL QUESTION

In terms of the latest developments (eg. BEPS 2.0), what are some things that we should bear in mind and how are they expected to impact international taxation trends?

ADDITIONAL WRITTEN ANSWER

In the context of international taxation, BEPS 2.0 (Base Erosion and Profit Shifting) represents a significant shift in the global tax landscape. It seeks to address the tax challenges arising from digitalization and globalization by introducing Pillar One and Pillar Two, which aim to reallocate taxing rights and establish a global minimum tax, respectively. Here’s a breakdown of key developments and their expected impact on international taxation trends:

1. Pillar One: Reallocating Profits to Market Jurisdictions

Pillar One focuses on reallocating taxing rights to countries where businesses have significant customer bases, even if they do not have a physical presence there. It targets large multinational enterprises (MNEs), particularly those that engage in the digital economy, like tech companies, which can generate substantial user revenues without being taxed in those jurisdictions.

Key Elements of Pillar One:

  • Scope: Applies to MNEs with global revenues exceeding €20 billion and profitability above 10%, with a focus on digital services and consumer-facing businesses.
  • Amount A: A portion of residual profits (exceeding 10%) will be reallocated to market jurisdictions based on a formula, typically 25% of the residual profit.
  • Amount B: Simplifies the application of transfer pricing rules for baseline marketing and distribution activities.

Impact of Pillar One:

  • Increased Taxing Rights for Market Jurisdictions: Countries, where users and consumers are located, will be entitled to tax a share of profits, shifting some taxing rights away from traditional residence countries.
  • Global Consensus Challenge: Achieving broad consensus on the allocation of profits across jurisdictions is difficult, with ongoing negotiations on implementation details.
  • Potential for Double Taxation: With the reallocation of profits, ensuring that MNEs don’t face double taxation becomes critical, which may necessitate more significant reliance on mutual agreement procedures (MAPs) and dispute resolution mechanisms.

2. Pillar Two: Global Minimum Tax

Pillar Two introduces a Global Anti-Base Erosion (GloBE) rule, establishing a minimum tax rate to reduce the incentives for profit shifting to low-tax jurisdictions. The objective is to ensure that all large MNEs pay at least a minimum level of tax, regardless of where they operate.

Key Elements of Pillar Two:

  • Minimum Tax Rate: A global minimum effective tax rate (ETR) of 15% is proposed, applicable to MNEs with revenues exceeding €750 million.
  • Income Inclusion Rule (IIR): The parent company is taxed on the income of foreign subsidiaries if the latter’s effective tax rate is below the minimum threshold.
  • Undertaxed Payments Rule (UTPR): Denies deductions or requires withholding on payments made to entities that are taxed below the minimum rate.
  • Subject to Tax Rule (STTR): Allows source countries to impose additional taxes on certain intra-group payments, like interest and royalties, if they are taxed below the minimum rate in the recipient jurisdiction.

Impact of Pillar Two:

  • Reduction of Tax Havens’ Appeal: The 15% minimum tax rate reduces the incentive for companies to shift profits to low-tax jurisdictions, curbing base erosion.
  • Complexity in Implementation: Countries must coordinate to implement GloBE rules without causing overlapping or double taxation, which could increase administrative complexity for businesses and tax authorities.
  • New Compliance Burdens: MNEs will face increased reporting requirements to demonstrate compliance with the global minimum tax rules, which will likely demand substantial investment in tax risk management and compliance systems.

3. Wider Implications of BEPS 2.0

  • Shift from Physical Presence to Digital Nexus: Traditional rules on permanent establishments (PEs) are evolving. BEPS 2.0 addresses the challenge of digital businesses earning profits without a significant physical presence. This redefinition of nexus broadens the tax base for market jurisdictions.
  • Harmonization and Coordination Challenges: While BEPS 2.0 seeks to harmonize tax systems globally, countries will have to amend domestic laws to incorporate these changes. For example, the United States’ Global Intangible Low-Taxed Income (GILTI) regime will have to align with Pillar Two’s minimum tax requirements, leading to changes in U.S. tax policy.
  • Dispute Resolution and Tax Certainty: With the potential for double taxation and overlapping jurisdictions, Pillars One and Two may trigger more tax disputes. Effective dispute resolution mechanisms, including the OECD’s MAP process, will be essential for maintaining tax certainty.
  • Impact on Developing Economies: Developing countries, particularly those in Africa and Latin America, stand to benefit from Pillar One’s reallocation of taxing rights, as they host large user bases for digital services but previously saw minimal tax revenue from such businesses. However, these economies may also face challenges in implementing and enforcing these rules due to capacity constraints.

4. Unilateral Measures and Future Tax Trends

  • Digital Services Taxes (DSTs): Several countries (e.g., France, UK, India) have implemented DSTs as temporary measures until Pillar One is fully operational. These taxes target revenues generated from digital services, and there is a push to phase them out once global consensus is reached.
  • Increased Focus on Transparency and Compliance: The implementation of both Pillars will likely enhance transparency, requiring MNEs to disclose detailed financial and tax information on a country-by-country basis. This could lead to increased scrutiny from tax authorities and higher compliance costs.

5. Future Outlook

BEPS 2.0 represents a monumental shift in international taxation, with Pillar One reshaping how profits are allocated across countries and Pillar Two ensuring a global minimum tax rate to combat profit shifting. As countries move towards implementing these measures, multinational businesses will need to adapt their tax structures, manage increased compliance obligations, and prepare for a more complex global tax environment.

The key takeaway is that international tax trends are increasingly leaning towards greater tax fairness—targeting both profit reallocation and the reduction of tax avoidance strategies—while introducing new challenges in terms of coordination, compliance, and dispute resolution.

These trends are likely to shape the tax strategies of MNEs, encouraging a more transparent, compliant, and equitable approach to global taxation.