James Ross and Sarah Gabbai, attorneys at law firm McDermott Will & Emery, said:
“At its fundamental core, the agreement reached by the G7 countries purportedly aims to remove incentives for the largest multinationals to shift profits to low-tax jurisdictions (Pillar 2), and to tax those multinationals (MNCs) in the countries where their consumers are based (Pillar 1). It does this by imposing a 15% global minimum tax rate, and by requiring their consumer countries to tax 20% of profits above a 10% margin threshold.
At the moment, it is unclear exactly how many MNCs will be affected by these proposals. The new Pillar 1 proposal is expected to apply to the largest MNCs in all industry sectors, rather than just those in the automated digital services and consumer-facing sectors. This differs from the previous OECD thinking on Pillar 1, yet remains aligned with the U.S.’s consistently-held position that the digital economy cannot be ring-fenced from the wider economy. Although the G7 agreement stated that Pillar 1 would only be expected to affect the very largest MNCs, it remains to be seen whether countries could extend the scope of Pillar 1 more widely to include smaller MNCs.
It would be prudent, however, to assume that Pillar 2 will potentially affect all MNCs. Many MNCs with operations in countries with effective rates in the 10-13% range, such as Singapore, Ireland, Switzerland, Cyprus and Malta, may have effective rates in those jurisdictions at or below the statutory rates therefore could be subject to significant additional taxes in their home countries. Indeed, many groups have substantial operations in Ireland that generate significant profits subject to a 12.5% statutory rate, and the 15% minimum tax rate would bite here. It remains to be seen how the EU will respond, and in particular how the new proposals would interact with the EU Commission’s “Business In Europe: Framework for Income Taxation” (BEFIT) plan if it goes ahead. That being said, BEFIT would need the unanimous consent of all Member States, which will be difficult to achieve given that a number of countries, including Ireland, have expressed their opposition to it.
In the case of U.S.-based MNCs, the ultimate U.S. parent company would be subject to the top-up tax to the minimum 15% rate, One would therefore think that the U.S. ought to gain significant tax revenues under Pillar 2. However, this does not factor in responses from other countries to Pillar 2. For example, tax authorities in other countries may could simply increase their local rates or make other changes to bring the effective country rate on most MNCs to the 15% minimum rate in response to Pillar 2, thus ensuring that the revenues go to that country instead. As such, the magnitude of U.S. revenue gains from Pillar 2 remains uncertain, although given the profitability of many U.S.-based MNCs, U.S. revenue gains may still outstrip revenue gains in other jurisdictions under Pillar 2.
Other countries will probably gain modest amounts from Pillar 1, but given the current uncertainty on scope and allocation, it may turn out to be something of a damp squib for countries that had particular vested interest in gaining significant revenues from Pillar 1, notably France and the UK. While the G7 countries with DSTs have committed to abolishing them when introducing Pillar 1, it remains to be seen whether the numerous other countries which have adopted DSTs decide to follow suit. We could well see some crossover between DSTs and the entry into force of Pillar 1 since those countries may well want to see what Pillar 1 is capable of delivering before they decide to drop their DSTs. Furthermore, there is a considerable amount of detail still to be fleshed out by the OECD, and it remains to be seen whether the final package meets with broader approval from OECD and G20 countries [especially China], and whether it is capable of being passed through the US Congress – which is likely to be critical to its implementation.
More generally, it remains to be seen whether the deal will achieve its overall objectives. By the time you’ve calculated the Pillar 1 tax followed by Pillar 2 jurisdictional blending and top-up tax calculations – each component of which will be a hugely complicated task in itself – the reality may well look very different. The cost of complying with the new rules may also end up looking disproportionately high, given the likely macroeconomic effect (on current estimates, an increase in global CIT revenues by approximately 4%). What’s more, many multinationals will likely restructure their operations to minimise the potential impact of Pillar 2, so the deal may not turn out to be quite the game-changer that some have predicted.
Moreover, the timing of implementation of the any OECD agreement, whether or not based on the G7 agreement, is also unclear. All 139 Inclusive Framework countries will need to agree on Pillar 1, at least, before it can be implemented. Pillar 2 changes, on the other hand, may be adopted by countries in legislation regardless of any OECD agreement. If the time it took for these countries to ratify the BEPS tax treaty changes under the MLI is anything to go by, we could be here for approximately 4 more years before Pillar 1 becomes fully applicable.”