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November 14, 2019
OECD issues consultation document on technical design aspects of Pillar Two
On 8 November 2019, the Organisation for Economic Co-operation and Development (OECD) released a public consultation document on the Global Anti-Base Erosion (GloBE) proposal under Pillar Two of the ongoing project titled “Addressing the Tax Challenges of the Digitalisaton of the Economy” (the Consultation Document). The particular design proposals were prepared by the OECD Secretariat and do not represent the consensus view of the countries participating in the project as members of the Inclusive Framework.
For purposes of the consultation, the OECD welcomes comments on all aspects of the Workplan on Pillar Two, but specifically requests comments on three technical design aspects of the GloBE proposal:
Interested parties are invited to submit written comments on the Consultation Document no later than 2 December 2019. The OECD will hold a consultation meeting on 9 December 2019 to give stakeholders an opportunity to discuss their comments with the Inclusive Framework jurisdictions.
In October 2015, the OECD released the Final Report on Action 1 (the Action 1 Final Report), Addressing the Tax Challenges of the Digital Economy, together with the final reports on the other 14 elements of the BEPS Action Plan. The Action 1 Final Report provides the OECD conclusions regarding the digital economy and recommended next steps to address the tax challenges presented by its evolution. The Action 1 Final Report states that special rules designed exclusively for the digital economy would prove unworkable, broadly stating that the digital economy cannot be ring-fenced because it “is increasingly becoming the economy itself,” and summarizes key features of evolving digital business models that the OECD considers relevant for the overall BEPS analysis. In addition, the Action 1 Final Report considers broader direct and indirect tax challenges raised by the digital economy and evaluates options to address those challenges. However, the Action 1 Final Report does not recommend any of the options analyzed and leaves it up to individual countries to introduce any of them as additional safeguards against BEPS.1
In March 2018, the OECD released a document “Tax Challenges Arising from Digitalisation — Interim Report 2018” (the Interim Report) as a follow up to BEPS Action 1. The Interim Report sets out the Inclusive Framework jurisdictions’ agreed direction of work on digitalization and the international tax rules through 2020. The Interim Report does not make any specific recommendations to countries, indicating instead that further work will need to be carried out to understand the various business models operated by enterprises offering digital goods and services, as well as digitalization more broadly. However, despite the technical complexity and the diverse positions, the Inclusive Framework jurisdictions agreed to undertake a coherent and concurrent review of the rules and achieve a consensus-based solution by 2020.2
In January 2019, the OECD released a Policy Note communicating that the renewed international discussions were going to focus on two central pillars: one pillar addressing the broader challenges of the digitalization of the economy and focusing on the allocation of taxing rights, and a second pillar addressing remaining BEPS concerns.3 Following the Policy Note, the OECD released a Public Consultation Document4 describing the two pillar proposals at a high level in February 2019, received extensive comments from stakeholders, and held a public consultation in March 2019.5
Following the public consultation, in May 2019, the OECD released the “Programme of Work to Develop a Consensus Solution to the Tax Challenges Arising from the Digitalisation of the Economy” (the Workplan).6 The Programme of Work is divided into two pillars:
On 9 October 2019, the OECD released a public consultation document on an OECD Secretariat proposal for a “unified approach” under Pillar One and invited interested parties to submit comments no later than 12 November 2019.7 The OECD will hold a consultation meeting in Paris on 21 and 22 November 2019 to give stakeholders an opportunity to discuss their comments with the Inclusive Framework jurisdictions.8
On 8 November 2019, the OECD released this Consultation Document on the GloBE proposal.
The GloBe proposal
Pillar Two of the Workplan seeks to develop an integrated set of global minimum tax rules to ensure that the profits of internationally operating businesses are subject to at least a minimum rate of tax. The OECD has indicated that the level at which the minimum tax rate will be set is to be discussed by the participating jurisdictions once other key design elements of the proposal are fully developed.
The four components of the GloBE proposal set out in the Programme of Work are:
a) An income inclusion rule that would tax the income of a foreign branch or a controlled entity if that income was subject to tax at an effective rate that is below a minimum rate.
b) An undertaxed payments rule that would operate by way of a denial of a deduction or imposition of source-based taxation (including withholding tax) for a payment to a related party if that payment was not subject to tax at or above a minimum rate.
c) A switch-over rule to be introduced into tax treaties that would permit a residence jurisdiction to switch from an exemption to a credit method where the profits attributable to a permanent establishment (PE) or derived from immovable property (which is not part of a PE) are subject to an effective rate below the minimum rate.
d) A subject to tax rule that would complement the undertaxed payment rule by subjecting a payment to withholding or other taxes at source and adjusting eligibility for treaty.
The GloBE proposal would also incorporate an ordering rule to avoid the risk of double taxation.
The Consultation Document
The Consultation Document invites comments on all aspects of the Workplan on Pillar Two, but in particular requests input on the following three technical design aspects of the GloBE proposal:
The Consultation Document also includes an annex that sets out several simplified examples illustrating the approaches for addressing temporary differences in the measurement of tax and accounting income. The facts of the examples are based on the potential application of the income inclusion rule. However, the Consultation Document indicates that the examples are not intended to suggest that these approaches are any less feasible for addressing temporary differences on the applicability of other elements of the GloBE proposal.
Tax base determination
The Consultation Document notes the importance of using a consistent tax base for the GloBE proposal. The Workplan had called for the exploration of possible simplifications to help address compliance and administrability issues for both taxpayers and tax authorities, and to neutralize possible structural differences in the calculation of the tax base in the parent and subsidiary jurisdictions.
Use of financial accounts to determine income
One of the simplification options identified in the Workplan was the use of financial accounting rules, subject to agreed adjustments to align the income calculated for accounting purposes with an appropriate measure of taxable income.
According to the Consultation Document, consideration must be given to the choice of accounting standard to be used for purposes of GloBE calculations if financial accounting were to be used as a starting point for determining a common tax base under the GloBE proposal. A first question is whether to use the accounting standard applicable to, or used by, the parent entity or the accounting standard applicable to, or used by, the subsidiary for local reporting purposes. Another item that needs to be agreed on is which financial accounting standards would be acceptable for purposes of the GloBE proposal.
The Consultation Document states that using the accounting standard of the ultimate parent entity when it prepares its consolidated financial statements would address some of the concerns raised by using the accounting standards of the subsidiaries, offering more transparency and ensuring that differences among the various subsidiaries’ accounting standards do not produce distortions. However, the Consultation Document notes that these consolidated financial accounts would need to be prepared under an acceptable set of financial accounting standards (e.g., International Financial Reporting Standards (IFRS), United States Generally Accepted Accounting Principles (GAAP) or Japanese GAAP).
As the Consultation Document notes, such an approach may lead to different results based on where the ultimate parent entity of a group is located.
Other options will also need to be considered for multinational enterprises (MNEs) that have no obligation to prepare consolidated statements.
While using unadjusted financial figures would be the simplest approach to determine the GloBE tax base, the Consultation Document suggests that this may lead to an understatement or overstatement of net profit when compared to the amount reported for tax purposes. Adjustments could be made to take into account certain permanent and temporary differences between financial accounting and tax accounting.
Permanent differences are differences between the income as reported for financial accounting purposes and the income reported for tax purposes that are not expected to reverse in the future.
The Consultation Document identifies a few types of permanent differences (e.g., dividends, treatment of corporate acquisitions, other types of disallowed expenses), noting that they arise for a variety of reasons and stating that the need to adjust for them may depend upon the level of blending ultimately adopted.
Temporary differences are differences between the income as reported for financial accounting purposes and the income reported for tax purposes that are expected to reverse in the future.
The Consultation Document discusses three basic approaches for addressing temporary differences:
The Consultation Document notes that this approach could eliminate variation in the effective tax rate caused by temporary differences. Moreover, taxpayers that prepare their financial statements under IFRS and other commonly used financial accounting standards already use deferred tax accounting. The Consultation Document also states that another benefit of this approach is that tax assets and liabilities are already computed on an entity-per-entity basis and generally are netted only based on the tax expense of that same entity. Thus, the Consultation Document indicates that this approach is expected to reduce the additional compliance burden of the MNEs that prepare their financial statements under IFRS and other commonly used accounting standards.
The Consultation Document indicates that a number of compliance, administration, and tax policy considerations need to be considered in the design of the rules for addressing temporary differences under the GloBE proposal. For example, whether to impose a time limitation on the above three approaches, treatment of changes in the tax rate in a subsidiary jurisdiction, recordkeeping considerations, whether and to what extent credits should be eligible to be carried forward when there is a change in ownership of the subsidiary, and possible transition rules for disposition and acquisition subsidiaries.
The Workplan called for the exploration of different blending options, including blending at the entity level, at a jurisdictional level and at global group level as follows:
The Consultation Document acknowledges that the three approaches to blending pose different challenges and have different compliance cost implications.
The Consultation Document further explores these challenges and puts forward questions for consultation on each of these items:
Carve-outs and thresholds
The Workplan called for the exploration of options and issues in connection with the design of thresholds and carve-outs to restrict application of the rules under the GloBE proposal, including the following:
The Consultation Document recognizes that the existence and design of any carve-outs or thresholds are mainly policy questions. However, such rules also would impact compliance and administration costs for MNEs and tax administrations, as well as the neutrality of the tax system and activities generating positive or negative externalities. The Consultation Document notes that any carve-out and threshold should also take into account existing international obligations, including the European Union fundamental freedoms.
The Consultation Document provides that a carve-out can apply on a qualitative basis (facts and circumstances) or an objective basis (formulaic). Both these approaches could be tailored in multiple different ways depending on what is sought to be achieved. For example, carve-outs based on facts and circumstances could target specific situations intended to be covered and may be more resistant to abuse, but they also would be more difficult to design and would increase complexity. Conversely, carve-outs based on objective criteria (e.g., asset values) would be simpler to apply and administer, but could result in additional compliance costs if taxpayers were required to produce and maintain documentation to prove they qualify for the exclusion. The Consultation Document suggests that these formulaic criteria may be easier to manipulate and thus they would require further anti-abuse rules (which themselves could be based on facts and circumstances tests).
On thresholds, the Consultation Document notes that broad-criteria thresholds (e.g., total revenue or profit) may be easier to administer and comply with compared to a specific carve-out. However, such thresholds could create volatility for taxpayers that operate near the amount set by the threshold.
Finally, the Consultation Document contains a series of examples, illustrating the application of the carry-forward of excess taxes and tax attributes and the application of deferred tax accounting.
These simplified examples are intended to illustrate the workings of some of these rules, but they also illustrate the complexities that could arise from the adoption of some of the proposals currently being discussed.
The Consultation Document includes 38 questions for comments. Interested parties are invited to submit written comments on all of the Programme of Work on Pillar Two, and on specific questions on the three technical design aspects in particular, no later than 2 December 2019. The OECD will hold a consultation meeting on 9 December 2019 to give stakeholders an opportunity to discuss their comments with the Inclusive Framework jurisdictions.
The Consultation Document does not represent the consensus views of the jurisdictions participating in the Inclusive Framework. However, the OECD Secretariat prepared the Consultation Document to focus on specific technical issues in respect of the GloBE proposal where input from stakeholders would be valuable in continuing the work on the project.
There are additional technical and design aspects of the GloBE proposal that depend on policy choices that will need to be agreed within the Inclusive Framework, including, for example, the minimum tax rate, the mechanics and operation of the undertaxed payment rule, and the nature and scope of the subject to tax rule.
As the Consultation Document expressly states, the proposals under Pillar Two represent a substantial change to the tax architecture and go well beyond digital businesses or digital business models. These proposals could lead to significant changes to the overall international tax rules under which multinational businesses operate. It is important for businesses to follow these developments closely in the coming months as work continues on key technical, design, and policy aspects of the GloBE proposal and to consider engaging with the OECD and policymakers at both national and multilateral levels on the business implications of these proposals. Companies should also begin to evaluate the potential impact of these changes on their business models.
1. EY Global Tax Alert, OECD issues final report on the tax challenges of the digital economy under Action 1, dated 23 October 2015.
2. EY Global Tax Alert, The OECD’s interim report on tax challenges arising from digitalisation: An overview, dated 20 March 2018.
3. EY Global Tax Alert, OECD’s new insights describe growing support on comprehensive changes to international tax policy, beyond digital, dated 29 January 2019.
4. EY Global Tax Alert, OECD opens public consultation on addressing tax challenges arising from digitalization of the economy: time-sensitive issue impacting all multinational enterprises, dated 14 February 2019.
5. EY Global Tax Alert, OECD hosts public consultation on document proposing significant changes to the international tax system, dated 18 March 2019.
6. EY Global Tax Alert, OECD workplan envisions global agreement on new rules for taxing multinational enterprises, dated 3 June 2019.
7. EY Global Tax Alert, The OECD takes next step on BEPS 2.0 – Proposal for a “unified approach” for additional market country tax, dated 10 October 2019.
For additional information with respect to this Alert, please contact the following:
Ernst & Young Belastingadviseurs LLP, Rotterdam
Ernst & Young Belastingadviseurs LLP, Amsterdam
Ernst & Young LLP (United States), Global Tax Desk Network, New York
Ernst & Young LLP (United States), Washington, DC