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Global tax reform: the OECD pillars

The OECD’s ‘Two-Pillar’ proposals seek to introduce fundamental reforms to the international tax framework to meet the needs of a globalised and digitalised 21st century economy.

At least 140 jurisdictions have signed up to the OECD’s July 2023 Outcome Statement on a Two-Pillar Solution which consists, in broad terms, of the following reforms to the global tax architecture.

Pillar One – reallocating taxing rights to market jurisdictions

Pillar One is designed to address the concern that the traditional international tax rules (broadly) requiring physical presence to allocate taxing rights are not fit for purpose in a globalised and digitalised economy where businesses no longer need to be physically present in a jurisdiction to do business there. The Pillar One reforms comprise two sets of measures:

  • Amount A is designed to reallocate taxing rights over part of the extraordinary profits of very large multinational groups from “relieving jurisdictions” to “market jurisdictions”, irrespective of whether businesses have a physical presence in those market jurisdictions.  These reforms are to be implemented via a multilateral convention (MLC), which will amend existing double tax treaties as required.  To be entitled to Amount A taxing rights, jurisdictions must remove unilateral digital services taxes and similar measures from their tax code.
  • Amount B is designed to modify the application of the arm’s length principle to “baseline marketing and distribution activities” – effectively by setting a fixed return for such activities in transfer pricing methodologies intended to approximate the arm’s length principle without requiring groups to undertake extensive transfer pricing benchmarking analysis.  This will be achieved by updating the OECD’s Transfer Pricing Guidelines.

Pillar Two – imposing a global minimum tax rate

Pillar Two seeks to ensure that large multinational groups are subject to tax at a minimum effective tax rate of 15%, with the aim of reducing the incentive for businesses to shift their profits to low tax jurisdictions as well as limiting the scope for tax competition between jurisdictions.

Under the OECD’s global anti-base erosion rules (GloBE Rules), in-scope multinational groups which are not subject to an effective tax rate of at least 15% in each jurisdiction in which they operate are subject to a top-up tax.  That top-up tax is charged under either the “income inclusion rule” (IIR) or the “under-taxed profits rule” (UTPR).  The GloBE Rules also allow jurisdictions to implement a “qualified domestic minimum top-up tax” (QDMTT), which takes priority over both the IIR and UTPR.

The Pillar Two reforms also include a new “subject to tax rule” (STTR): a treaty-based rule intended to ensure that cross-border payments between related parties are taxed at a rate of least 9%.

The GloBE Rules are complex and the overlay of domestic implementation adds significant further intricacies to their application.  This complexity is particularly acute in the context of international M&A transactions and joint venture arrangements, with Pillar Two expected to have a significant impact on financial modelling, deal structuring and risk allocation.

Our lawyers can help you understand what has been agreed, when implementation is expected, and what this means for your business – including, importantly, in the context of corporate transactions. 

Our commentary on the OECD’s Two-Pillar Solution is set out below.  If you would like to discuss this topic in further detail, please contact our tax team or your usual Freshfields contact.