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130 countries agree to international tax changes

130 of the world’s major economies have agreed to changes to the international tax system which will see multinationals paying a global minimum tax rate of 15% and the reallocation of some taxing rights to countries where multinationals do business, the Organisation for Economic Cooperation and Development (OECD) has announced.

The agreement, which is designed to address the tax challenges arising from the digitalisation of the economy, follows one reached between G7 finance ministers in June, but is more detailed and includes carve-outs for certain sectors.

“This is a landmark step forward,” said tax expert Eloise Walker of Pinsent Masons, the law firm behind Out-Law. “Up to this point there has been a lot of talk and argument but not much substantive agreement on a way forward, but it looks like this long-drawn out process is about to accelerate.”

The countries have agreed a two ‘pillar’ solution. Under pillar one, multinational enterprises with global turnover above €20 billion and profitability above 10% will be subject to tax on a proportion of their profits in the countries where they operate. The €20bn turnover figure will potentially fall to €10bn after seven years.  

Countries which will benefit from the new taxing right will be those where the multinational derives at least €1 million in revenue. For smaller jurisdictions with GDP lower than €40bn, the threshold will be set at €250,000.

Regulated financial services and extractive industries are not subject to the pillar one rules. Following the G7 agreement, the UK had been lobbying for financial services to be excluded on the basis that banks are forced by regulation to be capitalised in the countries where they are doing business so they already pay profits there.

In exchange for the pillar one taxing rights, part of the deal is that countries, such as the UK and France, which have adopted unilateral digital services taxes, will drop those taxes. The OECD statement says the package will provide for “appropriate coordination between the application of the new international tax rules and the removal of all Digital Service Taxes and other relevant similar measures on all companies”.

Pillar two of the agreement is the Global anti-Base Erosion Rules (GloBE) whereby multinationals can be forced to pay a minimum level of tax of 15%, regardless of where they are headquartered or the jurisdictions in which they operate.

Countries will not be forced to operate the GloBE rules, but where they choose to do so they must do so in accordance with what has been agreed. Countries which don’t choose to adopt the rules must accept the application of the rules by other countries.

“This will be an interesting aspect to see in practice ,especially in Europe where overarching rules like state aid will also be in play, and clashes are likely to occur,” said Walker.

Under the GloBE rules countries will not be required to increase their corporate tax rate to at least 15%. Instead parent companies in jurisdictions which decide to apply the rules will be subject to a top up tax, the income inclusion rule, to the extent that their subsidiaries have paid tax in another jurisdiction at less than 15% or deductions can be denied on payments to group members in low tax jurisdictions.

There will also be a double tax treaty based minimum level of tax of between 7.5% and 9% on interest, royalty and certain other payments between connected persons, the subject to tax rule. Where the recipient of such a payment is subject to tax at less than the specified rate, the subject to tax rule would enable the payer jurisdiction to impose a 'top-up' withholding tax.

The subject to tax rule was an integral part of achieving a consensus on pillar two for developing countries. As part of the agreement countries that apply nominal corporate income tax rates below the subject to tax minimum rate to interest, royalties and certain other payments agree to implement the subject to tax rule into their bilateral treaties with developing countries when requested to do so.

The GloBE rules will apply to multinationals that meet the €750m threshold used for country by country reporting. However, countries are free to apply the income inclusion rule to multinationals headquartered 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 has been agreed that the GloBE rules will include a ‘substance’ carve out  which will exclude an amount of income that is at least 5%, or in the transition period of 5 years, at least 7.5%, of the carrying value of tangible assets and payroll. This is so that the rules will not apply to incentives offered by countries on tangible investments in their countries such as establishing factories.

“As with all compromises,” said Walker, “the suggested way forward is a hodge-podge of new rules instead of a streamlined easy-to-apply one size fits all. That is as expected, but given the OECD is overhauling an international system of taxation that has been in place for a long time, we can expect a decade or two of chaos ahead as each country has its own take on the complex proposals.”

Non-profit organisations, pension funds or investment funds that are ultimate parent entities of a multinational group or any holding vehicles used by them will not be subject to the GloBE rules.

OECD members Ireland, Estonia and Hungary did not sign up to the agreement. Barbados, Kenya, Nigeria, Sri Lanka and St Vincent & the Grenadines were the other countries involved in the discussions which did not agree to the measures, with Peru abstaining.

Signatories to the agreement have set what is seen as an ambitious timeline for conclusion of the negotiations. This includes an October 2021 deadline for finalising the remaining technical work on the two-pillar approach, as well as a plan for effective implementation in 2023.

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