Global tax talks reach ‘critical mass’ for landmark deal by tweaking details

By Doug Connolly, MNE Tax

The historic October 8 agreement on a global minimum tax and new rules for allocating taxing rights for large multinationals both firms up issues left open in the initial July statement and reflects concessions that were made to bring into the deal a few new countries, including all the holdouts within the EU.

Negotiators secured the support of Estonia, Hungary, and Ireland – which before this week had refused to consent to the agreement to which 130-plus countries had already signed up. OECD tax director Pascal Saint-Amans and other advocates of the deal had contended well before the July agreement that the success of a deal would not require every country – just a “critical mass.” Garnering full support within the EU, along with the otherwise continued support of the G20, arguably reaches that goal.

On the other hand, Pakistan now joins Kenya, Nigeria, and Sri Lanka as the four countries out of 140 in the Inclusive Framework not to support the deal. Unlike the other three, which have consistently held out, Pakistan had previously signed on to the July statement.

The changes in the October deal include some refinements to the Pillar 1 terms for allocating a portion of profits of the largest multinational enterprises to market jurisdictions. It further specifies terms for the associated removal of unilateral measures.

Regarding the Pillar 2 global minimum tax, the amendments include concessionary expanded carve-outs and transition rules.

The October statement also adds as an annex a “detailed implementation plan.” The ambitious timelines for implementation are generally consistent with the July statement, other than transition rule amendments. There also remains the contingency for evaluating how changes to international tax laws in the US mesh with the deal.

Profit allocations under Pillar 1

The thresholds applicable to determine if a large multinational is in-scope for purposes of Pillar 1 are unchanged, although the new statement clarifies that the 10% profitability threshold will be calculated “using an averaging mechanism.” It is expected that the deal would apply to no more than about 100 of the largest multinationals.

The amount of residual profit to be reallocated is clarified in the October statement. The July statement had provided that between 20%–30% of residual profit in excess of 10% of revenue of in-scope entities would be allocated to market jurisdictions. The October statement specifies the relevant portion will be 25% of such residual profit.

The October statement confirms that there will be an elective binding dispute resolution mechanism “only for issues related to Amount A for developing economies that are eligible for deferral of their BEPS Action 14 peer review and have no or low levels of MAP disputes.” It adds the eligibility will be reviewed regularly, and once a jurisdiction is determined to be ineligible, it will remain so in future years.

Digital services taxes

Regarding unilateral measures like digital services taxes, the October statement provides that removal of such measures – and commitment not to introduce them in the future – will be secured by a multilateral convention.

Moreover, it specifies that no such new measures are to be introduced from the day of the agreement (October 8) until the earlier of when the multilateral convention comes into force or December 31, 2023. Transitional arrangements for existing measures are under discussion.

Global minimum tax under Pillar 2

The global minimum tax rate is set at 15% – no longer “at least 15%” – in a concession to Ireland and others that did not want to leave in place the open-ended option to push the rate further up.

The plan for the overall design of the global minimum tax is unchanged. The tax would be applied via the global anti-base erosion (GloBE) rules, consisting of the “income inclusion rule” and “undertaxed payments rule,” as well as the treaty-based “subject to tax rule.”

The October statement adds an exclusion from the undertaxed payments rule for multinational enterprises that are “in the initial phase of their international activity.” It defines this phase as having no more than EUR 50 million (approximately USD 58 million) in tangible assets abroad and operating in no more than five other jurisdictions. The exclusion is limited to five years.

The substance carve-out for 5% of the carrying value of tangible assets and payroll remains. However, in a likely concession to Hungary, the transitional rule, originally envisioned as a 7.5% carve-out for the first five years, is increased. The transition period will now last 10 years, and the exclusion will be 8% for tangible assets and 10% for payroll, “declining annually by 0.2 percentage points for the first five years, and by 0.4 percentage points for tangible assets and by 0.8 percentage points for payroll for the last five years.”

The October statement also specifies a de minimis exclusion for jurisdictions in which a multinational enterprise has revenues of less than EUR 10 million (approximately USD 11.6 million) and profits of less than EUR 1 million (USD 1.2 million).

In addition, the October statement defines the minimum rate for the subject to tax rule as 9%, settling at the high end of the 7.5%–9% range envisioned in the July statement.

The Pillar 2 rules are still planned to be brought into law in 2022 and become effective in 2023. However, the October statement adds that the undertaxed payment rule will not come into effect until 2024.

Detailed implementation plan

Regarding Pillar 1, “Amount A” – relating to the portion of profits to be reallocated to market jurisdictions – will be implemented through a multilateral convention, the October statement specifies, as expected. The plan remains for it to take effect in 2023.

The Pillar 1 multilateral convention will include rules for determining and allocating Amount A and eliminating double taxation, as well as processes for simplified administration, exchange of information, and dispute resolution. Other than for excepted jurisdictions, the dispute resolution mechanism will be mandatory and binding.

The Pillar 1 convention text is planned to be ready in early 2022 to be signed in “a high-level signing ceremony” in mid-2022. Model legislation is also planned to be developed by early 2022 for countries needing to make changes to domestic laws to implement the provisions.

Regarding Pillar 2, model GloBE rules are planned to be developed by next month (November). The model rules will define the scope and mechanics of the GloBE rules, the calculation of effective tax rate and the exclusions, and administrative provisions such as filing obligations. An implementation framework for the GloBE rules is also planned to be developed by the end of 2022 at the latest.

Also by next month, a model treaty provision to give effect to the subject to tax rule is planned to be developed. In addition, the Inclusive Framework will develop a multilateral instrument by mid-2022 to facilitate the implementation of the subject to tax rule into bilateral treaties.