We provide here our analysis of the proposals in the Statement published 1 July 2021 by the OECD from the Inclusive Framework on BEPS for addressing the tax challenges arising from digitalisation of the economy.

Summary

This agreement is historic in accepting for the first time the need to apply a formulaic method to apportion at least part of the total global profits of the MNEs concerned, complemented by proposals for a global anti-base-erosion tax. These elements point a way forward to further reforms that could be comprehensive and long-lasting.

However, as presently formulated Pillar One is only a stop-gap solution, creating a special tax regime for only around one hundred of the largest and most profitable MNEs, and allocating only a small share of their profits. The vast bulk of MNEs’ profits would continue to be allocated under the current inappropriate and ineffective rules. While its initial limited scope may be necessary for political reasons, the aim should be to create a basis for a more comprehensive and long-term solution.

The global minimum tax proposed in Pillar Two could be transformational, but as currently designed would be unfair and ineffective for MNE host countries. The priority given to home countries in the GloBE, coupled with the low minimum rate of at least 15%, would not remove the incentive for MNEs to shift profits out of source countries which mostly have rates of 25% or higher. Although an additional source taxation right is now stated to be ‘an integral part’, its scope is still uncertain, and it would have an even lower rate of 7.5-9%, which is also its maximum. This is lower than the existing withholding tax rates in the vast majority of treaties, so host countries would gain nothing unless it is actually included in the minority of treaties with lower withholding tax rates, and its scope is expanded. There is a formal commitment for participating countries to accept treaty changes, but only for countries that are also participating, and if they are classified as developing countries. Unless Pillar Two can be redesigned, a better solution for MNE host countries would be to change all their tax treaties to allow taxation of all payments, including those for automated digital services, based on Article 12B of the UN model. Since treaties with low withholding tax rates would lose any value they might have for source countries, the threat of cancellation should facilitate their renegotiation.

While this agreement is a significant step forward, it should not preclude a continuation of work on wider reforms, and countries should retain their rights to adopt measures more suited to protecting their tax base. Negotiations must continue, in this and other forums, to achieve reforms that could ensure that MNEs are taxed where their economic activities occur. A common approach to a global minimum effective tax rate requires a common approach to the allocation of undertaxed profits. These complex interacting rules should be replaced by a substance-based allocation of the rights to tax undertaxed profits.