In response to growing international concern at MNEs exploiting gaps in tax rules to shift profits from higher to lower tax jurisdictions and legally avoid taxes, the OECD/G20 Inclusive Framework on BEPS has designed a Two-Pillar Solution reflecting a comprehensive reform of the international tax system to close these loopholes, and ensure the rules are adapted to today's digitalised and globalised world economy. Pillar One includes a co-ordinated reallocation system for the biggest and most profitable MNEs extending the taxing rights of market jurisdiction (Amount A), together with a framework for the simplified and streamlined application of transfer pricing rules to certain marketing and distribution activities (Amount B). Pillar Two subjects a much larger group of MNEs (any company with over EUR 750 million in annual revenue) to a Global Minimum Tax rate, and includes also a Subject to Tax Rule (STTR) which will enable developing countries to update bilateral tax treaties to “tax back” certain intra-group income that is subject to low or no nominal taxation in the other jurisdiction.
Cross-border and international tax
Digitalisation and globalisation have transformed the global economy at a breadth and speed that has created challenges for taxation. The OECD’s work on cross-border and international taxation seeks to better coordinate tax rules within and across jurisdictions and covers projects such as the Multilateral Convention to implement Amount A, setting a global minimum tax on multinational enterprises (MNEs), analysing harmful tax practices, and developing transfer pricing rules for transactions between subsidiary companies.
Key messages
International tax rules on allocating taxing rights among countries were designed a century ago. Changing business models and a heavy reliance on intangibles rather than capital and labour to generate profits mean they are in certain cases no longer fit for purpose. In particular, existing rules rely on a concept of physical presence for deciding tax obligations, and fail to allocate taxing rights in situations where highly digitalised companies can earn substantial profits in a jurisdiction without the need for a physical presence.
Amount A of Pillar One provides for a co-ordinated reallocation of taxing rights over a portion of the profits of the largest and most profitable MNEs to market jurisdictions (the location of the customers or users), including in situations where the MNE has no physical presence in that market.
Digitalisation and globalisation have allowed large multinationals to structure their global operations in a way that lets them shift profit and achieve effective tax rates on some or all of their income that are much lower than those paid by smaller businesses or workers. This practice has also put pressure on countries to lower their corporate income tax rates or offer incentives to compete for capital and investment, leading to a race to the bottom.
To address this problem, the Global Minimum Tax of Pillar Two set a multilaterally agreed limit on corporate tax competition which will ensure an MNE is subject to tax in each jurisdiction at a 15% effective minimum tax rate regardless of where it operates. This will help to level the playing field and should see countries collect around USD 150 billion annually in new tax revenues.
Furthermore, the OECD Forum on Harmful Tax Practices conducts reviews of preferential tax regimes to determine if they could be harmful to tax bases of other jurisdictions.
The OECD Transfer Pricing Guidelines are a cornerstone of the international tax system, providing a stable and efficient business environment for MNEs while ensuring a principled allocation of profits for governments. The Guidelines provide a framework for applying the so-called “arm's length” principle, the international consensus on the valuation of cross-border transactions between associated but separate enterprises which reduces the risk of tax disputes, increases transparency, and promotes cooperation on transfer pricing.
On 19 February 2024, the Guidelines were updated to incorporate the guidance on Amount B of Pillar One, in line with the July 2023 Outcome Statement on the Two-Pillar Solution to Address the Tax Challenges Arising from the Digitalisation of the Economy. This guidance provides a simplified and streamlined approach to the application of the arm's length principle to baseline marketing and distribution activities, which will be particularly helpful for countries with low-capacity tax administrations.
To avoid mismatches in tax treatment and instances of double non-taxation, the OECD Forum on Harmful Tax Practices (FHTP) agreed on a standard on the compulsory spontaneous exchange of relevant information on taxpayer-specific rulings which, in the absence of such exchange, could give rise to BEPS concerns.
BEPS Action 12 provides recommendations for the design of rules to require taxpayers and advisors to disclose aggressive tax planning arrangements. These recommendations seek a balance between the need for early information on aggressive tax planning schemes with a requirement that disclosure is appropriately targeted, enforceable and avoids placing undue compliance burden on taxpayers.
