Pillar 1 And Pillar 2 OECD Blueprints: An Overview
Posted by Valentiam Group on March 25, 2021
On October 12, 2020, the Organisation of Economic Co-operation and Development (OECD) released “blueprints” of proposed solutions to address tax challenges arising from the accelerating digitalization and globalization of the world economy.
The Pillar 1 and Pillar 2 OECD blueprints focus on nexus and profit allocations, in addition to base erosion and profit shifting (BEPS) challenges. In this article, we’ll examine the goals that the OECD hopes to achieve with regulatory changes, what is still to be determined in the proposed solutions, and the implications for transfer pricing and tax strategies.
Pillar 1 And Pillar 2 OECD Blueprints: Policy Goals
With Pillar 1 and Pillar 2, the OECD is seeking to address fundamental taxation issues. These are the broad outlines of the proposed solutions.
OECD Pillar 1: According to the OECD, Pillar 1 should “adhere to the concept of net taxation of income, avoid double taxation, and be as simple and administrable as possible.” In layman’s terms, the OECD has determined that companies aren’t paying enough tax in jurisdictions where they have market-facing activities.
Consider Facebook, for example. While Facebook has users in every country, it doesn’t have physical operations in every country. A country like Egypt might have millions of Facebook users; advertisers are targeting those users, and Facebook is earning revenue and profit from those advertisers. However, since Facebook has no physical presence in Egypt, the company pays no tax there.
The OECD’s contention is that significant value is being created by Facebook’s operations in Egypt, so it should pay some amount of tax there. Pillar 1 would give Egypt a share of Facebook’s profits for its revenue-generating activities in the country.
While Pillar 1 is primarily focused on digital companies, it would also potentially apply to consumer-facing businesses in which a company that does not have a physical presence in the jurisdiction sells products directly to consumers. This could include companies such as Amazon and others that sell and/or deliver their products directly to consumers.
OECD Pillar 2: Under the proposed framework, Pillar 2 would allow a “right to ‘tax back’ where other jurisdictions have not exercised their primary taxing rights, or the payment is otherwise subject to low levels of effective taxation,” according to the OECD. Essentially, Pillar 2 seeks to establish a minimum level of taxation on multinational companies doing business around the world.
Under Pillar 2, thresholds for effective tax rates would be established, and if companies fell below those thresholds, they would owe additional tax. Effectively, Pillar 2 would require companies to “top up” the tax paid to bring the amount to a minimum effective tax rate.
OECD Pillar 2 would be applied after Pillar 1, rather than concurrently. Companies would first allocate the tax due to jurisdictions where they generate revenue under Pillar 1 OECD guidelines; then, if they were still below the minimum effective tax rate, Pillar 2 guidelines would be applied.
Pillar 1 And Pillar 2 OECD Blueprints: Undefined Details
The OECD has proposed that the Pillar 1 and Pillar 2 OECD blueprints would apply only to high-revenue companies using the same threshold that applies to other BEPS activities, currently €750 million in annual revenue (equal to almost $900 million as of March 2020).
Other important parameters of the proposals are still un- or ill-defined, such as what constitutes a consumer-facing business, minimum effective tax rates, and the amount of profit that should be allocated to market jurisdictions where companies lack a physical presence.
The OECD has established a December 14, 2021 deadline for comments on the proposals outlined in the Pillar 1 and Pillar 2 blueprints, to be followed by a public meeting in mid-January 2022. The organization hopes to reach agreement on the final parameters by mid-year 2022.
If OECD does come to an agreement in 2022, Pillar 1 and Pillar 2 guidelines (as ultimately defined) will not automatically become law; adoption or rejection of the guidelines are the purview of each individual country. Even so, companies need to start considering the potential impacts of the proposals, since they represent a complete reordering of the current norms governing global tax and transfer pricing strategies.
Pillar 1 And Pillar 2 OECD Blueprints: Implications
Given that the blueprints are such a departure from current law, the implications for tax and transfer pricing strategies are huge. Using the above example of Facebook, if OECD Pillar 1 is adopted, what is the mechanism for allocating income to Egypt when no intercompany transaction exists? Who is the counterparty that is showing the reduction in income? How does Facebook pay the tax due to Egypt, when it has no Egyptian tax ID?
Businesses that think they might be affected should begin considering the impact, explain this potential impact to stakeholders, and examine whether restructuring or changes to their transfer pricing policies might be necessary.
For OECD Pillar 2, even though the minimum tax threshold has not been stipulated in the blueprint, companies should focus on jurisdictions where they have very low effective tax rates to see how “topping up” to a certain minimum rate might apply.
As the saying goes, “The devil is in the details,” and in regard to Pillar 1 and Pillar 2, OECD has yet to iron out many of those details. Nonetheless, the blueprints represent a radical departure from current global tax policy—and companies that may be impacted should start considering now how they will respond if and when the OECD reaches agreement and adopts the proposals outlined in the blueprints.
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On June 5, 2021, the G-7 reached an agreement on OECD BEPS 2.0 Pillar One and Pillar Two initiatives, with promise to repeal Digital Services Taxes (DST).