Digitalization of the Economy and the Global Minimum Corporate Tax
In recent years, many new business models have emerged and traditional business models have changed greatly, within the increasing digitalization in the economy. Along with said change, challenges arose for taxing the international business income of multinational companies. The Organization for Economic Co-Operation and Development (“OECD”) and the G20 have determined that current international tax rules still allow large multinational companies (“MNE”) to earn significant income in a country without paying a minimum level of corporate income tax in that or any other country. In this context, countries have started to work on amendments to the international tax rules applicable to MNEs.
As a result of long negotiations to update and reform international tax rules, in October 2021, 137 members of the OECD/G20 Inclusive Framework on Base Erosion and Profit Shifting (“BEPS”) joined the Statement on a Two-Pillar Solution to Address the Tax Challenges Arising from the Digitalization of the Economy (“the Statement”).[1] On 20 December 2021, OECD published the “Model Rules on Global Minimum Tax” (“Model Rules”) regarding the second step of the two-step approach approved under the OECD/G20 Base Erosion and Profit Shifting (BEPS). These Model Rules cover the Income Inclusion Rule (“IIR”) and the Undertaxed Payment Rule (“UTPR”); all these rules are collectively referred to as the Global Anti-Base Erosion Proposal Rules (“GloBE Rules”).
The new framework is comprised of Pillar 1 and Pillar 2 and both Pillars include multiple elements. Briefly, the Two-Pillar Solution will ensure that MNEs which meet the criteria detailed later in this article will be subject to a minimum tax rate of 15%, and will re-allocate profits of the largest and most profitable MNEs to countries worldwide. In other words, both Pillars basically allow the country where the ultimate parent company is located to directly tax the company on income that is generated in a foreign country to the extent that this foreign income was taxed at an effective tax rate lower than 15%. It will not only provide market countries with a larger share of the profits of global large companies, but also prevent harmful tax practices such as tax havens.
In all likelihood, these rules determined in the context of Pillar 1 and Pillar 2 will lead to significant changes in current international taxation standards and change the fundamental elements of the long-standing global framework for the taxation of international corporations. In particular, it is very likely that the Digital Services Tax and similar unilateral practices, which are applied by many countries as a temporary solution until a common solution is found at the OECD, will be abolished.[2]
Pillar 1
Briefly, Pillar 1 aims to ensure a fairer distribution of profits and taxing rights of the MNEs with global revenues of 20 billion Euros and profitability exceeding 10% among countries.[3] Through Pillar 1, 25% of the residual profits of companies whose profitability exceeds 10% are distributed among the market countries in accordance with the revenue-based distribution key and thus taxed in the relevant countries. In this regard, through Pillar 1 the profit of these companies can be reallocated to the jurisdictions where sales arise – irrespective of the physical presence in those jurisdictions.[4] Although it is still vague and unclear how Pillar 1 will be implemented in the current situation, it appears that the OECD is continuing to work on this subject. As a matter of fact, within the scope of Pillar 1, the Multilateral Convention (“MLC”) is expected to open for signature in 2022 and enter into force in 2023.
Pillar 1 will apply to MNEs with a worldwide revenue of more than 20 billion Euros and a profitability of more than 10 percent. It is estimated that there will be a reallocation of 125 billion dollars in profits globally thanks to Pillar 1.[5]
Pillar 2
The aim of Pillar 2 is to ensure MNEs pay a minimum level of tax on the income arising in each jurisdiction in which they operate. Therefore, Pillar 2 will be used to end tax competition between countries by introducing a global minimum corporate tax of 15% that countries can use to protect their tax base. In other words, although Pillar 2 does not eliminate tax competition, it does set multilaterally agreed limitations on it.
The GloBE rules would apply if the ultimate parent company of MNEs has annual revenue in the consolidated financial statements of 750 million euros or more in the financial year concerned and in at least two of the four preceding financial years. However, government entities, international organizations, non-profit organizations, pension funds or investment funds that are Ultimate Parent Entities of a MNE or any holding vehicles used by such entities, organizations or funds are not subject to the GloBE rules.
It should be emphasized that; countries do not have to apply GloBE rules. However, even if an Inclusive Framework member chooses not to apply GloBE rules, they agree to have GloBE rules applied by another country with respect to MNEs operating in their country.
Finally, two important rules provided by Pillar 2 should be examined. The main rule of Pillar 2, the Income Inclusion Rule (IIR), provides for a top-down taxation. Namely; the country of ultimate parent business of the company whose income is taxed at a low rate with IIR imposes additional taxes, bringing the effective tax rate to a minimum of 15%. In this context, IIR, which is the main mechanism proposed to ensure the taxation of “untaxed” profits, operates similarly to the Controlled Foreign Company rules.[6] To be covered by the IIR, the MNE group must have had consolidated group revenues in excess of 750 Million Euros in two of the previous four years. In this context, IIR usually be applicable at the ultimate business level. The IIR is expected to be implemented as of 2023.
The Low Taxed Payment Rule (UTPR) is applied as a secondary rule to corporations where the effective tax rate in a country is below the minimum 15% rate and the IIR is not fully implemented. The UTPR is expected to be implemented as of 2024.
Timeline
In accordance with the general understanding, the Multilateral Convention is expected to be opened for signature by member states in the middle of 2022 and to become effective in 2023. It is also aimed to publish an Implementation Guide on GloBE rules during the transition period. Also, many countries are expected to make the necessary legal arrangements regarding the minimum corporate tax application without waiting for the effective date.
The Possible Impacts of Pillar 2
Firstly, through the minimum corporate tax that will be applied worldwide with Pillar 2, companies will have less incentive to move their operations to low-tax jurisdictions. Besides, as a result of Pillar 2, the profits of about 100 of the biggest MNEs, such as Amazon and Google, would be sliced differently for taxation purposes, so that more countries share in the tax revenue.[7] Indeed, Pillar 2 is estimated to generate 150 billion dollars in additional global tax revenue annually.[8]
Secondly, if the minimum corporate tax rate of 15% is higher than the current corporate tax of a country, an additional tax burden will arise for the relevant country. Therefore, countries with low tax rates will not be able to benefit from the investment advantages they have enjoyed so far and will suffer losses. On the other hand, there may be new advantages for countries with corporate tax rates higher than 15%.
Thirdly, as mentioned above, digital service taxes applied unilaterally by countries that criticized by the United States and have caused trade wars will also come to an end through the new rules. However, large United States companies will pay less to the United States government and more to overseas governments, while the foreign earnings of these companies will face higher taxes.[9]
Fourthly, offshore investment centers such as Malta, the Cayman Islands, Samoa, Bermuda, the Marshall Islands or the British Virgin Islands will have no reason to continue to offer reduced or zero income tax rates to MNEs. For this reason, some of them are already planning to change their corporate tax rates.
Also, the global minimum tax will also affect developing countries by leading to tax revenue being lost to other jurisdictions. More specifically, although developing countries have relatively high corporate income tax rates, they have given tax exemptions to specific sectors, investors, or regions. Hence, the effective tax rate paid by large companies can be quite low in developing countries. Through the new approach, considering that the market countries are predominantly in developing countries, it is expected that the developing countries will be given the right to tax earnings and tax revenues will increase.
Finally, it should be noted that while the work on the ratification and entry into force of the new rules continues, some countries are already changing their tax policies to get ahead of the change.[10]
Conclusion
In recent years, rapid and expansive digital transformation in the economy has had deep impacts, resulting in significant changes. As a result of these changes, after long negotiations, the OECD/G20 has prepared the Two-Pillar Solution. This solution will ensure that MNEs will be subject to a minimum tax rate of 15%, and will re-allocate profit of the largest and most profitable MNEs to countries worldwide. It is expected that these rules determined in the context of Pillar 1 and Pillar 2 will lead to significant changes in current international taxation standards and change the fundamental elements of the long-standing global framework for the taxation of international corporations. In this regard, we would like to underline that corporate taxpayers should prepare themselves for these new rules and assess how these rules will impact their organization’s tax liability.
- 137 countries of the 141 engaged in the negotiations signed the outline in October 2021. The holdouts were Kenya, Nigeria, Pakistan, and Sri Lanka.
- https://www.oecd.org/tax/beps/brochure-two-pillar-solution-to-address-the-tax-challenges-arising-from-the-digitalisation-of-the-economy-october-2021.pdf. (Accessed on: 18.03.2022); Joint Statement from the United States and Turkey Regarding a Compromise on a Transitional Approach to Existing Unilateral Measures During the Interim Period Before Pillar 1 Is in Effect, 22nd November 2021, https://www.hmb.gov.tr/duyuru/mevcut-tek-tarafli-onlemlerle-ilgili-olarak-1-sutunun-yururluge-girisi-oncesi-ara-donemdeki-gecis-yaklasimina-dair-uzlasma-hakkinda-turkiye-ve-amerika-birlesik-devletlerinin-ortak-b, (Accessed on: 18.03.2022)
- https://www.oecd.org/tax/beps/beps-actions/action1/ (Accessed on: 20.03.2022)
- EY, https://www.ey.com/en_be/tax/the-global-minimum-tax-could-it-impact-my-organization (Accessed on: 22.03.2022)
- Akçura, Arzu:“İki Sütunlu Yaklaşım ile Uluslararası Vergi Reformu'nun 2023 yılında Uygulamaya Geçirilmesi Planlanıyor”, Deloitte, 14.10.2021, https://www.verginet.net/dtt/1/iki-sutunlu-yaklasim-vergi-reformu.aspx, (Accessed on: 18.03.2022)
- Deloitte, “Global minimum corporate income tax How might countries with ‘low’ or ‘no’ taxation respond?” https://www2.deloitte.com/xe/en/pages/tax/articles/global-minimum-corporate-income-tax.html (Accessed on: 22.03.2022)
- Bloomberg, “A New Way to Tax Global Corporations, Explained” https://www.bloomberg.com/news/articles/2021-10-15/a-new-way-to-tax-global-corporations-explained-quicktake (Accessed on: 22.03.2022)
- Akçura.
- Bunn, Daniel: “What’s in the New Global Tax Agreement?”, Tax Foundation, March 16, 2022, https://taxfoundation.org/global-tax-agreement/ (Accessed on: 20.03.2022)
- Currently, it appears that the United Arab Emirates, Singapore and Montenegro are going to make changes to their corporate tax rates in compliance with the global minimum corporate tax.
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