David D. Stewart: Welcome to the podcast. I'm David Stewart, editor in chief of Tax Notes Today International. This week: nearly there?
We've been tracking the progress of the OECD inclusive framework's efforts on updating international tax rules for quite some time. And we'll link to a number of those episodes down in the show notes. But for those just joining the saga, the OECD and the 140 members of the inclusive framework are pursuing a two-pillar solution to address the tax challenges of digitalization. It has proven to be quite tricky to find consensus on what can be done, but recently the OECD announced some significant progress.
Here to talk about the latest developments is Tax Notes chief correspondent Stephanie Soong Johnston. Stephanie, welcome back to the podcast.
Stephanie Soong Johnston: Thanks for having me again.
David D. Stewart: All right. Well, why don't you start us off with a brief refresher on the two pillars?
Stephanie Soong Johnston: So, brief is a relative term, especially when it comes to the two pillars. So, I'll try my best.
So, for years, the OECD inclusive framework on base erosion and profit shifting (BEPS) have been working on a global corporate tax reform plan, as you referred to earlier. And that work builds on action 1, which is sort of a leftover of the original BEPS project from 2015. Action 1 was supposed to address the tax challenges of digitalization of the economy. And the main question there was, "How do you tax new business models that sell goods and services, often digital in nature, to another country and profit off consumers in those countries without physical presence under the existing rules?"
So, over the years, the plan took shape and now it's got two pillars. Pillar 1 would change profit allocation and nexus rules, so that market countries where consumers are located will be able to have a new taxing right called amount A. And amount A, just as a reminder, would allow those countries to tax companies on a portion of so-called residual or non-routine profits earned from activities in those jurisdictions, even if they lack physical presence. And pillar 1 also calls for amount B, which represents a fixed return for the baseline marketing and distribution activities and market jurisdictions in line with the arm's-length standard. And it also provides dispute prevention and resolution mechanisms to ensure tech certainty.
Pillar 2, meanwhile, would ensure that large multinationals would pay a minimum level of tax primarily through global antibase erosion rules, which are nicknamed the GloBE. These are based on a minimum effective tax rate. The GloBE rules would contain the income inclusion role and the under-taxed payment rule, both of which were inspired by the GILTI regime and the BEAT of the Tax Cuts and Jobs Act, respectively. Just a reminder, the income inclusion rule would apply a top-up tax to an in-scope MNE's income that is taxed below the agreed effective minimum tax rate, while the under-taxed payments rule would deny deductions for payments that are taxed under the minimum tax rate. And pillar 2 also has the treaty-based subject to tax rule, which would let sourced jurisdictions apply limited source taxation to some related party payments that are taxed below a minimum rate.
David D. Stewart: All right. So, what is the latest from the inclusive framework?
Stephanie Soong Johnston: So, a lot has happened since the last time I was on the podcast in July. On July 1, 130 out of 139 countries in the inclusive framework on BEPS had reached a preliminary political agreement on several elements of pillars 1 and 2. But there are still open questions that still need to finalize things. So, the inclusive framework said that they'd work to finalize that agreement by October, which they did. On October 8, the inclusive framework, which had increased its membership to 140 countries in that short period, had announced that 136 of those 140 countries had finalized the agreement.
David D. Stewart: So, what do we now know about pillar 1?
Stephanie Soong Johnston: So, there were two big outstanding issues from the July agreement. These relate to amount A. And that is the quantum, which is a fancy word for the percentage of the in-scope MNEs and residual profits that should be allocated to market countries. And there's also the tax certainty requirements for developing countries. Those are two big issues that needed to be addressed.
There's also an open question about how countries would be expected to withdrawal unilateral digital services taxes and other relevant measures. And how they would be prevented from introducing new ones in the future. And also, there was no definition of what constituted relevant unilateral measure. The October agreement confirms that companies in scope of amount A rules are MNEs with global turnover exceeding €20 billion with profitability of more than 10 percent. And that turnover threshold would eventually decrease to €10 billion, if the amount A rules and tax certainty mechanisms are successfully implemented. And there's also a new special purpose nexus rule that would allocate amount A to market countries if an in-scope MNE has at least €1 million in revenue in those countries. And smaller market countries with GDP of less than 40 billion would have a lower nexus of €250,000.
The October agreement also confirmed the quantum of amount A. So, countries agreed that 25 percent of in-scope MNE residual profits will be allocated to market jurisdictions with a nexus based on an allocation key tied to revenue. This is a development from the July agreement, which had given a range of 20-25 percent for the quantum, so this is more precise. The inclusive framework also agreed that there would be a multilateral convention, or MLC, which will be developed to implement amount A rules, which countries will be able to sign in 2022. So that amount A rules will take effect in 2023.
Countries that joined the multilateral convention will also be required to withdraw all digital services taxes and other relevant, similar measures and are barred from introducing new DTSs on any companies, not just those in scope of amount A, from October 8 to either December 31, 2023, or the date when the MLC comes into force, whichever comes first.
And according to the agreement, the definition of relevant similar measures will be included as part of the MLC and its explanatory statements. So, again, we don't have a definition of what constitutes relevant similar measures. So, that's very weird because if countries are not supposed to introduce new measures in the interim, how are they supposed to know which ones are off limits besides DSTs? Very interesting question. Don't know if there's an answer, but we'll see.
So, the October agreement also confirms that in-scope MNEs would have a mandatory and binding dispute prevention and resolution mechanism for amount A issues only. But developing economies that meet certain conditions, like if they have no or low mutual agreement procedure cases, are allowed an elective binding dispute resolution mechanism. This is to respond to several developing countries' concerns that their sovereignty would be impugned on if they had to agree to these rules. So, the main elements of pillar 1 that were confirmed in the agreement.
One thing I did notice from the October statement is that it said nothing more about segmentation. The inclusive framework agreed that there would be a need for singling out business lines of a company to subject it to amount A rules only in exceptional circumstances. So, the October agreement didn't say much more about that. The segmentation issue was put in there to address concerns from countries that certain companies — you know, Amazon — would not actually get taxed because their profit margins are too low to qualify for amount A rules. This segmentation element, I guess, of pillar 1 was supposed to address those concerns, so that there were profitable business lines would fall under scope of the Amount A rules.
David D. Stewart: That's a lot of new information about pillar 1. Did we get anything similar about pillar 2?
Stephanie Soong Johnston: All right. So, the biggest issue that everyone kept talking about pillar 2 was, "What is the effected tax rate that countries will agree to for the purposes of the income inclusion rule and the under-taxed payment rule?"
So, originally in July, countries agreed that this rate would be at least 15 percent. That's sort of in line with what the United States had suggested to kick-start the negotiations when the Biden administration took over. So, now the precise rate is 15 percent after a lot of haggling with several countries, especially Ireland, which was concerned about how pillar 2 would affect its headline corporate tax rate of 12.5 percent. So, now we've got an answer: effective tax rate 15 percent.
The October agreement also confirms that MNEs that are just starting to branch out with international activities will be temporarily excluded from the under-taxed payments rule. So now, MNEs with a maximum of €50 million in tangible assets abroad and operations in a maximum of five other countries will be exempt for five years after the first time an MNE falls under the scope of the GloBE rules.
The GloBE rules also have a formulaic substance carveout that will exclude an amount of income that is 5 percent of the carrying value of tangible assets and payroll. But now we see there's a 10-year transition period where the amount of income to be excluded will be 8 percent of the carrying value of tangible assets and 10 percent of payroll. And these percentages would decrease annually by 0.2 percentage points for the first five years and by 0.4 percentage points for tangible assets and by 0.8 percent of points for payroll in the last five years.
The pillar 2 agreement also provides a concession for countries with distribution tax systems. The agreement now says that there will be no top-up tax liability if earnings are distributed within four years and taxed at or above the minimal level. And so, there's also a de minimis exclusion for jurisdictions where MNEs have revenues of less than €10 million and profits of less than €1 million. And the agreement also confirms that the subject to tax rule rate will be 9 percent. There's a lot more in there, but those are the main highlights.
David D. Stewart: Well, I think that is a lot of information to digest as it is. But turning back a little bit to what you mentioned earlier, as of July, there were 130 countries that had signed onto the agreement as it was at the time. Now we're up to 136 out of 140. So, which reluctant countries have signed on? And who is still holding out?
Stephanie Soong Johnston: Between the July and October agreements, there were essentially six holdouts. Three EU countries — Ireland, Estonia, and Hungary — and three developing countries — Nigeria, Kenya, and Sri Lanka.
So, there was a lot of press coverage, including Tax Notes, about Ireland, because Ireland was really worried about the "at least 15 percent" language in the July agreement. Because, as you know, Ireland has a 12.5 percent headline corporate tax rate. And Ireland was worried that the effective tax rate under pillar 2 would basically undercut their ability to attract multinationals to Ireland. So, they worked really hard to get that "at least" language pulled out of that agreement. So, now you can see in the final agreement that Ireland got its way and is now part of the agreement.
Estonia also had some concerns about how pillar 2 would treat its distribution tax system, which has been addressed. And Hungary had concerns about the formulaic substance carveout for the GloBE rules, which as I explained earlier, they managed to get a lot of concessions, which is probably why that language in the agreement on the substance carveout is so complicated because you can see that the inclusive framework has accommodated a lot of these concerns that Estonia, Hungary, and other countries have.
So the fact that there was a lot of attention on Ireland, Hungary and Estonia not joining the agreement has a lot to do with the EU's ability to pass legislation to implement these rules. So, as you know, the EU requires unanimity to pass any directive involving taxation. So, if Estonia, Hungary, and Ireland weren't on board with the agreement, then the EU would have a very hard time trying to get those rules implemented. So, obviously now that Ireland, Estonia, and Hungary are now on board, not a problem for the EU.
Kenya, Nigeria, and Sri Lanka were the three holdouts that continued to hold out. They did not sign the October agreement. And in fact, actually Pakistan, which had agreed to the July agreements, was part of the July agreement, withdrew that support and is now out. So, now we've got four holdouts: Kenya, Nigeria, Sri Lanka, and Pakistan.
I have to admit that I'm not 100 percent sure what Pakistan's deal is. I would imagine that the reason why Kenya and Nigeria did not want to join was that Kenya imposes a digital services tax and Nigeria has a significant economic presence provision in its tax laws. So, I'd imagine they want to hang on to those to raise more revenues from digital activity. Sri Lanka, I would imagine has concerns with pillar 2 and special economic zones. Sri Lanka has special economic zones that they use to attract international investment. So, I assume that's what their problem was on pillar 2. I hope to report back to find out more about what Pakistan's position is. So, stay tuned.
David D. Stewart: So, beyond the countries, the holdouts, and the joiners, what other reactions have we heard to this latest announcement?
Stephanie Soong Johnston: I think reactions kind of fall into two camps. One: "Hey, thank God we have some certainty finally." There are some major blanks that are fulfilled. But at the same time, there are a lot of outstanding issues that need to be addressed. Developing countries— it was interesting to actually cover this story because as you follow the negotiations you find that developing countries, even within the inclusive framework, even within the G-20, were raising concerns about whether this deal will actually help countries, help developing countries. I covered an event where the Finance Minister of Argentina, who is a member of G-20, said, "This deal is a bad deal, but what's worse is nothing. So, we have to sign up to this." He actually acknowledged this is not what we want, but we're signing up anyway, which kind of makes you wonder how strong this agreement really is, how solid it is among developing countries.
So, of course, you've heard civil society really criticized this deal. That doesn't do enough to develop— help developing countries. It's asking too much of them. They're asking too much to give up in exchange for too little. So, there's that voice in debate. Companies, I think are just happy that there is some certainty going forward about what these new rules might look like. So far, I've seen a lot of statements from business in that regard. I think a lot of tech companies are still worried about what the rollback and standstill provisions are under pillar 2 regarding digital services taxes. One question that I had in mind when I read this agreement was, you know, there is more language about the standstill and rollback of digital services taxes in relevant unilateral measures, but the language did provide a sunset clause for countries that have digital services taxes to phase them out.
But at the same time, countries will still be allowed— they'll be allowed to have these taxes for two years. So, in the meantime the office of the U.S. Trade Representative, it's poised to impose 25 percent tariffs on millions of dollars of imports from several countries that have digital services taxes, including Italy, France, India, Spain, and Turkey. I mean, what's going to happen to those tariffs? The USTR had suspended those tariffs until the end of November. Now that this agreement's in place, what happens to those tariffs? Are they going to be put off or what? We don't know.
So, I think companies are worried that we'll still have some trade wars happening while the multilateral convention is being developed. So, I covered a press briefing with Treasury recently, and officials there said that they were having conversations with a lot of these countries that have digital services taxes to figure out a way to compromise.
You know, I—They didn't really say what that meant. I suspect it means that they're trying to find a way for these countries to withdraw their digital services taxes early, or at least say publicly that, "We are going to phase these out." We were told to look out for some more information to come out in public, to be publicized in the coming weeks, so I'm looking out for that.
Another concern is that what's going to happen with the U.S. on pillar 2? And pillar 1? Will the U.S. be able to push legislation to implement pillars 1 and 2 through Congress? As you know, the Biden administration has a pretty thin majority in the Senate and in the House of Representatives, so it's an open question now. That will the U.S. be able to make good on its promises that it can deliver on implementing pillars 1 and 2? Because as everyone knows the U.S. is pretty important to have on board to ensure the effective implementation of both pillars.
To that end, another reaction was from the Republicans here in the States. Because Kevin Brady, R-Texas, and Mike Crapo, R-Idaho, who are the top Republican tax writers in Congress, have been very vocal about Biden administration and Treasury not being that forthcoming with their plan to get these two pillars implemented. Secretary Yellen recently indicated that there could be another way around the need to have a multilateral convention pass in the Senate, which as you know, requires two thirds majority vote.
Since pillar 1 will require a multilateral convention, there are questions now, like will the Senate be willing to push through this convention? Given our track record so far on treaties and treaty ratification, it's very doubtful that Treasury will be able to pull that off, really. The Republicans are worried that Treasury is trying to get around Senate treaty ratification application process, which is also an open question like, what are they planning? We don't know. The Treasury officials told us reporters that they're working to get bipartisan support for pillar 1. Because there's a lot to like about pillar 1, you know, getting rid of digital services taxes that both Democrats and Republicans hate. They basically said, "We can't think about that now. It's too early to think about that." But the rest of us were thinking, "Well, it's kind of important question."
David D. Stewart: So, as I understand it, one of the big outstanding issues for pillar 2 was how it would work with the U.S. GILTI regime. What are the remaining questions there?
Stephanie Soong Johnston: So, it was a little disappointing to see in the October 8 agreement that there really wasn't much to add on the GILTI coexistence. Treasury officials have told us that basically countries accept that the GILTI coexistence would happen. And that countries really only had two issues: the rate and the country-by-country determination for the GloBE rules. So, the GILTI regime as it exists now, it differs in that it's not on a country-by-country basis. But as you might know, Treasury is trying to reform the TCJA so that the GILTI regime is on a country-by-country basis. So, now that the U.S. is making moves to kind of better align the GILTI regime with the GloBE rules, I guess it remains to be seen how exactly the GILTI coexistence will be spelled out in the future.
David D. Stewart: I guess that leads me on to my last question. What are the next steps for this agreement?
Stephanie Soong Johnston: The G-20 finance ministers approved the agreement on October 13 at their meeting on the sidelines of the IMF-World Bank meeting. So, that is one milestone. The next milestone is to have the G-20 leaders approve the agreement at their October 30-31 meeting. And after that, we can expect model rules for pillar 2 to define the scope and mechanics of the GloBE rules, as well as model treaty provisions to give effect to the subject to tax rule in November 2021. In mid-2022, we can expect a multilateral instrument for the implementation of the subject to tax rules in bilateral treaties. At the end of 2022, the OECD expects to have implementation framework to facilitate the coordinated implementation of the GloBE rules. So, that's pillar 2, which we'd always known that the work on pillar 2 was more advanced than pillar 1.
Meanwhile in pillar 1, in early 2022, we can expect the text of a multilateral convention and explanatory statement to implement amount A. Also model rules for domestic legislation that's needed for implementing pillar 1. Also mid-2022, for pillar 1, we can expect a high-level signing ceremony for the MLC. And by the end of 2022, the inclusive framework expects to finalize its work on amount B for pillar 1. And 2023 is the target implementation timeframe for both pillars.
David D. Stewart: All right, well, I anticipate that we're going to be having you back several more times before this is finished out. But thank you for being here this week.
Stephanie Soong Johnston: Oh, thanks for having me.
David D. Stewart: And now, coming attractions. Each week we highlight new and interesting commentary in our magazines. Joining me now is Acquisitions and Engagement Editor in Chief Paige Jones. Paige, what will you have for us?
Paige Jones: Thanks, Dave. In Tax Notes Federal, Robert Culbertson argues that the foreign tax credit regulations proposed last November 2020 are inconsistent with the legislative purposes reflected in Section 901 and with the statute’s long-standing interpretation. Robert Willens explores whether an out-of-sequence reverse Morris Trust transaction can be repaired, and he considers the recently announced “defective” transaction to be undertaken by BHP Group. In Tax Notes State, Jenice Robinson and Kamolika Das reflect on the 40-year fight for progressive tax policies including an examination of how antitax advocates have used racialized language and stereotypes to push for regressive tax policies. Robert Plattner begins to lay out a coherent path for commerce clause doctrine post-Wayfair — highlighting the flaws of the Bellas Hess decision that shaped so much of the remote sales tax debate. In Featured Analysis, Joseph Thorndike traces the ugly history of debt limit fights back to 1941, when Democrats and Republicans in Congress squared off in a bitter but ultimately minor conflict over federal borrowing, setting the stage for future battles. On the Opinions page, Marie Sapirie argues that the financial account information reporting plan being considered by lawmakers would capture more data than necessary to accomplish its goals but wouldn’t capture the information the IRS would need to readily identify tax mistakes or misdeeds.
And now, for a closer look at what’s new and noteworthy in our magazines, here is Tax Notes Executive Editor for Commentary Jasper Smith.
Jasper Smith: Thank you Paige. I'm here with Lucas de Lima Carvalho, a professor of international tax at the Brazilian Institute of Tax Law. Lucas, welcome back to the podcast.
Lucas de Lima Carvalho: Thank you very much for having me.
Jasper Smith: So, of course we asked you on to talk a little about your recent Tax Notes International piece titled, "The Andean Question: Two Pillars, Two Sides?" So, could you just give listeners a brief overview of that article?
Lucas de Lima Carvalho: Sure. The article explores the Andean community and its relationship with the OECD. The Andean community with its four countries — Bolivia, Ecuador, Peru, and Colombia — is a community that is playing a relevant role in Latin America and has been playing that role for some time. And two of its members are part of the inclusive framework of the OECD, namely Peru and Colombia. And the other two are not part of the inclusive framework and have not declared that they would join in the initiative with the two pillars. So, this seemed to me like a unique situation of a community that is divided in half. Two members are favorable to whatever the OECD wants to propose. And the other two members are not favorable. They are not part of the inclusive framework, and they have shown no indication that they want to join. So, the article explores the specific international exposure of each of the four countries, how their tax laws, and specifically tax treaties, have adapted to the OECD BEPS action plan and its measures, and also explores what's next or what comes next for the Andean community, considering that it is divided into these two very distinct parts.
Jasper Smith: Thank you. Well, obviously that's a very timely issue that you wrote about. But was there anything in particular that drew you to that topic?
Lucas de Lima Carvalho: Yes. I was looking at the list of the countries that are part of the inclusive framework. And I was trying to wrap my head around the idea of how the new commitments after pillar 1 and pillar 2 will relate to preexisting agreements that are signed by countries in regional blocks and regional cooperation councils. And then I started looking at the list and I was thinking, "Well, maybe the Gulf Cooperation Council is divided in half or none of its members have joined." And then I saw that most of its members had joined. Mercosur, in South America, most of its members, or the totality of its members if you disregard Venezuela, have committed to that they will be a part of pillars 1 and 2. And so, I was looking at these regional blocks and the one that caught my attention was the Andean community because of this 50/50 divide. That should bring an interesting aspect to how these countries will relate to one another after the OECD releases the multilateral instrument with pillars 1 and 2. So, that was the reason behind the article. I just wanted to explore the topic that seemed to me to be unexplored in academia and magazines and articles today about how the Andean community, which is a relevant, growing community — the economies of the Andean community are growing — how the Andean community exposes itself to these new international tax reform initiatives coming from the OECD.
Jasper Smith: Excellent. Well, thank you. We certainly appreciate you tackling that novel topic. And it's an interesting read for sure. So, before we let you go, where can listeners find you online?
Lucas de Lima Carvalho: So, they can find me on Twitter @lucasdelimac. They can also find me on LinkedIn. It's my full name, Lucas De Lima Carvalho is the address. And also they can find my articles, all of the articles of the column Ahead of Tax on Tax Notes International on the Tax Notes website.
Jasper Smith: Right. Thank you for that. And again, Lucas, thanks so much for taking some time out to talk to us today. It's always a pleasure.
Lucas de Lima Carvalho: Thank you very much for having me.
Jasper Smith: And for listeners, once again, you can find Lucas's articles online at taxnotes.com. And be sure to subscribe to our YouTube channel Tax Analysts for more in-depth discussions on what's new and noteworthy in Tax Notes. Again, that's Tax Analysts with an S. Back to you, Dave.
David D. Stewart: That's it for this week. You can follow me online @TaxStew, that's S-T-E-W. And be sure to follow @TaxNotes for all things tax. If you have any comments, questions, or suggestions for a future episode, you can email us at podcast@taxanalysts.org. And as always, if you like what we're doing here, please leave a rating or review wherever you download this podcast. We'll be back next week with another episode of Tax Notes Talk.
Tax Analysts Inc. does not provide tax advice or tax preparation services. The information you have seen and heard today represents the views of the presenters, which may not be the same as those of Tax Analysts Inc. It may include information obtained from third parties, and Tax Analysts Inc. makes no warranties or representations of any kind, and is not responsible for any inaccuracies. Nothing in the podcast constitutes legal, accounting, or tax advice. The tax laws change frequently, and neither Tax Analysts Inc. nor the presenters, can guarantee that any information seen or heard is accurate. Also, due to changing tax laws, any information broadcast or downloaded after its original air date may no longer represent the current views of the presenters. If you have any specific questions about any legal or tax matter, you should always consult with your attorney or tax professional.
All content in this broadcast is protected under U.S. and international laws. Copyright © 2021 Tax Analysts Inc. Unauthorized recording, downloading, copying, retransmitting, or distributing of any part of the podcast is strictly prohibited. All rights reserved.