The new global tax reform framework, the two-pillar solution, is expected to address the tax challenges posed by large multinational companies paying low taxation.
To date, some 136 countries and jurisdictions representing more than 90% of global GDP have signed up to the deal.
But the details of the solution must still be fleshed out. After that, the requisite changes will have to be made to the tax laws of all the jurisdictions that have signed up to this endeavour.
At the recent transfer pricing summit hosted by the South African Institute of Taxation (Sait), its CEO Keith Engel as well as Lee Corrick, technical tax expert at the African Tax Administration Forum (ATAF), Diane Hay, a director of PwC UK, and Professor Lorraine Eden of Mays Business School USA, discussed where the global tax system is headed.
Pillar 1 deals with the transfer pricing aspect and Pillar 2 sets a minimum corporate tax rate of 15%.
Corrick set the ball rolling by questioning who will be the winners and who the losers in the Pillar 1 solution.
Pillar 1 will only apply to companies with a global turnover greater than €20 billion and a profit margin of more than 10%.
Extractives (such as mining companies) and regulated financial services have been excluded from the deal. So far, no definition has been provided for ‘regulated financial service’.
If the agreement comes into force, the plan is for implementation in 2023.
Calculating the excess global profits to be allocated to market jurisdictions
A ‘market jurisdiction’ is where the multinational entity (MNE) derives at least €1 million from that jurisdiction. For smaller jurisdictions, with a GDP of less than €40 billion, the amount is set at €250 000.
Twenty-five percent of the profit in excess of a 10% profitability ratio will be allocated to the countries in which that multinational does business (the market jurisdictions).
The Organisation for Economic Co-operation and Development (OECD) is also working on developing rules that are based on the arm’s length principal, which will apply to entities other than the so-called digital companies, but this is still in the discussion phase.
Work is still being done on how to provide tax certainty, and it is suggested that all jurisdictions will have to apply a mandatory binding dispute resolution, to resolve issues relating to the allocation of the excess profits. Work is still being done on an elective binding dispute resolution system for developing countries.
A very controversial measure is that countries that sign up to this new system will have to remove all digital service taxes (DST) that have already been introduced into their legislation and imposed on the so-called tech companies. Some countries feel that removing the DST for all companies is a step too far.
It is noteworthy that Nigeria, Kenya, Pakistan and Sri Lanka have not yet signed the agreement to this deal.
Engel said that administratively it looks like a simple system. But he questioned to what extent jurisdictions would benefit, given that there could be a lot of jurisdictions.
Corrick said the rationale for Pillar 2 is to address remaining base erosion and profit shifting (BEPS) issues associated with low taxes.
Jurisdictions will be provided with the opportunity to ‘tax back’ group profits that are subject to a low effective rate of tax.
A minimum rate of tax of 15% has been imposed. However, a double taxation treaty may override this, and there is also a concern about how the additional tax will be allocated between residence (resident is taxed on worldwide income) and source countries (resident is only taxed on the income derived in country of residence).
Corrick pointed out that African countries are concerned with the impact on tax competition and tax incentives in Africa.
The impact of Pillars 1 and 2
Hay commented that a lot will depend on whether Pillars 1 and 2 can be implemented. “I think there is a question mark around whether this will ever see the light of day … so many issues have to be sorted out, and then countries still have to sign up to it in the form of a multilateral convention.
“It sounds simple, but the implementation is critical”.
Hay has “seen from the OECD an ambivalence to the arm’s length standard”.
She sees this as a signal to countries that they can go beyond the arm’s length principle, and beyond the permanent establishment principle.
“This may trigger new types of taxation,” she says.
“I am nervous about where this is going.”
Hay is of the view that if the method of reallocating profit is simplified, and the mutual agreement procedure (MAP) can be resorted to, that this will be an improvement.
Eden agreed with everything Hay said. She also noted that “the critical thing is when the OECD secretariat came out and said there were problems with the arm’s length principle”. She has always seen this as being part of the tax rules, and that the original BEPS project was to plug these rules. “The loopholes were put there by those who want to use them.”
It appears that the proposed two-pillar solution does not address the many loopholes that corporates use to minimise their taxes.
Hay does not think it is too big to fail, and is sceptical as to whether it will bring about a fairer system of taxation, and Eden is sceptical as to whether it will achieve the goals it set out to achieve. Engel opined that when the political winds in various countries change over time, it will gradually be whittled away.