Introduction of the OECD’s Pillar Two
The introduction of the OECD’s Pillar Two marks a significant departure from traditional methods of calculating and imposing tax in an attempt to ensure a level playing field for businesses worldwide. However, only time will tell whether Pillar Two emerges as a beacon of fair taxation or whether it casts a shadow of unintended harm upon the future of global taxation.
The Pillars
In October 2021, the OECD - as part of its Base Erosion and Profit Shifting (BEPS) project - proposed a ‘two-pillar’ approach to tackle tax challenges arising from the digitalisation of the economy. Pillar One addresses cross-border digital transactions and reallocates taxing rights to the jurisdiction in which profits are derived, as opposed to the jurisdiction in which the multinational enterprise (MNE) is physically located. Pillar Two, also known as the Global Anti-Base Erosion (GloBE) proposal, sets a global minimum tax rate for MNEs with the objective of addressing concerns related to MNEs artificially shifting profits to low-tax jurisdictions.
Understanding Pillar Two
Pillar Two establishes a global minimum effective tax rate of 15% for MNE groups with over €750m (AUD$1.2b) in consolidated revenue. The proposed minimum tax rate is intended to discourage profit shifting and maintain a level playing field for businesses worldwide, effectively ‘hitting the brakes’ in the competition for corporate income tax rates.
Pillar Two will consist of three interlocking rules:
1. An Income Inclusion Rule (IIR), which imposes top-up tax on a parent entity in respect of the low taxed income of a constituent entity.
2. An Undertaxed Payment Rule (UTPR), which denies deductions or requires an equivalent adjustment to the extent the low tax income of a constituent entity is not subject to tax under an IIR; and
3. A Qualified Domestic Minimum Top-Up Tax (QDMTT), which will apply ahead of the IIR and UTPR to allow the local jurisdiction first priority to collect and retain all revenue from the top up tax.
Implementation of Pillar Two
In its 2023-24 Federal Budget announcement, the Australian Government slated the implementation of Pillar Two with an effective date for the IIR on 1 January 2024 and the UTPR on 1 January 2025. The Government also announced that it planned to adopt a minimum tax of 15% with an effective date of 1 January 2024.
Globally, at least 25 jurisdictions have enacted Pillar Two legislation. This includes France, Germany, Japan, South Korea, and the United Kingdom. In more recent times, Singapore and New Zealand have advanced their implementation of Pillar Two.
Implications of Pillar Two
1. Calculation of Tax: Perhaps the most significant change introduced by Pillar Two is that tax will be calculated on accounting profit as opposed to tax profit. The OECD has, in effect, created a whole new method on which taxes will be calculated, that has readily been accepted by governments worldwide. It begs the question: how far will the OECD and governments go?
2. Increased Tax Revenue: The OECD’s aim to raise revenue through the implementation of Pillar Two comes at the expense of international competitiveness and investment. The OECD estimates that Pillar Two will increase global tax revenue by 9% whereas the IMF’s estimate is more conservative at 5.7%. The 2023-24 Australian Federal Budget estimates that Pillar Two will generate $160 million in the 2025-26 financial year and $210 million in the 2026-27 financial year. The seemingly small revenue impact is attributed to Australia’s headline corporate income rate of 30%. Interestingly, within the OECD, only a handful of countries have a lower rate than 15%.
3. Slippery Slope: As jurisdictions worldwide seek to implement Pillar Two, it is reasonable to expect that the revenue threshold may reduce over time, capturing more entitles within the shadow of Pillar Two.
What does Pillar Two mean for MNEs?
1. Increased Compliance Requirements: MNEs may be required to prepare and lodge a separate QDMTT return with the Australian Taxation Office (ATO) in addition to an annual income tax return.
2. Reassessment of Business Structures: Pillar Two aims to curb profit-shifting practices by MNEs, prompting a shift towards transparent and compliant tax strategies. This may necessitate MNEs to reassess existing tax arrangements and business structures across jurisdictions to ensure compliance while maintaining tax efficiency.
3. Heightened Competitive Landscape: As Pillar Two aims to prevent tax competition between countries, it is expected to help level the playing field for businesses. For clients who previously benefited from lower tax rates, this could lead to a reduction in their competitive advantage. As a result, businesses may need to reassess their pricing strategies, cost structures, and overall profitability to adapt to the changing landscape.
The implementation of Pillar Two represents a dramatic change in the international tax landscape. While the full impact of Pillar Two will depend on the specific measures implemented by each jurisdiction, it is nevertheless imperative for businesses to stay informed and be proactive.
If you would like to know more about the Pillar Two and its potential implications (such as how to approach Pillar Two), please reach out to your trusted Hall Chadwick advisor.
For more information on Pillar Two, follow the below link:
