The agreement reached by the G20 finance ministers is a turning point in international tax law. In order to find a solution for the tax challenges arising from the digitalization of the economy, the long-standing physical presence standard for determining nexus which is about a state’s sovereign right to tax has been partially revised.
A two-pillar proposal by the OECD, on which BDI has provided comprehensive feedback and which has been significantly revised over the course of time serves as a foundation for the reform. A statement issued by the OECD/G20 Inclusive Framework on BEPS in the early days of July 2021 contains agreed upon key conceptual components of both pillars of the reform.
Pillar 1 would affect multinational companies of a certain size
The first pillar focuses on the partial re-allocation of taxing rights over corporate profits. In the future, corporate income tax would also be payable in the respective market states. The original intention to bring in scope digital business models and to delimit them from conventional business models has been abandoned. Rather than focusing on qualitative factors, the new approach would be based on quantitative criteria in order to scope in the world’s largest and most profitable businesses. As a consequence, the focus on the digital economy has been eliminated and shifted instead to high profitability when defining in-scope businesses. Therefore, “Amount A” will apply to almost all multinational businesses above a certain size, irrespectively of industry affiliation and business model in most of the cases.
In order to strengthen taxation in market jurisdictions where an in-scope MNE participates with significant economic activity but without physical presence, a portion of the global profits will be allocated for tax purposes. In concrete terms, under “Amount A” market states could exercise taxing rights over a range of 20-30 percent of an in-scope MNE’s profit in excess of 10 percent. This will apply to multinational enterprises with an annual turnover of at least 20 billion euros globally which earn a rate of return on revenue above 10 percent. In the future, the revenue threshold may be reduced from 20 billion euros to 10 billion euros. Amount A will only be allocated to a market jurisdiction when the business derives a certain minimum revenue from that state.
Pillar 2 is about global effective minimum taxation
Global minimum taxation under Pillar 2, in turn, is intended to address behaviour by multinational companies with revenues exceeding 750 million euros which are able to shift their profits from high-tax jurisdictions such as Germany to low-tax jurisdictions. To this end, an international effective minimum tax level of 15 percent is to be introduced for corporate profits. In case an MNE’s effective tax rate in a country is below 15 percent, the so-called Income Inclusion Rule imposes a top-up tax on the parent company. In addition, a so-called Undertaxed Payment Rule places a tax on base eroding payments in case the income was not subject to an Income Inclusion Rule. It targets transactions between connected entities and would deny the deduction where the payment to another entity is not subject to the global effective minimum tax. The global minimum tax under Pillar 2 is calculated on a country-by-country basis, not allowing to reduce taxes by blending profits in high- and low-tax jurisdictions.
Numerous open technical details despite political agreement in principle
The political agreement on the core elements of the reform should not obscure the fact that there is still a long way to go before final implementation. There are several details that still need to be defined in the coming months. Negotiators agreed on an ambitious timetable which is scheduled to develop a multilateral treaty for the global minimum tax by 2022 with implementation in 2023. Amount A will come into effect in 2023.
From a business perspective, several ambiguities remain. They result from the partly arbitrary character of the reform as there is no conceptual link to the well-established arm’s-length-principle-based approach for profit allocation to permanent establishments of a multinational enterprise. In principle, the dropped distinction between digital and conventional companies under Pillar 1 represents a simplification.
However, there is a risk that the number of businesses affected by the new provisions under Amount A could be expanded in the future by political decision. It is equally crucial to address issues of legal certainty and to ensure that the rules are easy to implement and contain elements to avoid double taxation. Therefore, an internationally coordinated model legislation is essential. It is expected that the European Commission will table two directives for the implementation of Pillar 1 and Pillar 2 in the EU.
EU digital levy is put on hold and should be finally abandoned
The European Commission had previously announced to present a legislative proposal for a European digital levy only a few days after the agreement to be reached at the G20 finance ministers meeting in July. This digital levy was considered as a basis for a new own resource for the EU budget to be introduced by January 1, 2023. It was intended to serve as a repayment capacity for the “Next Generation EU” recovery fund. However, presenting such a legislative proposal would have undermined the spirit of the international agreement. One of the key components of the agreement is the commitment to remove all unilateral Digital Services Taxes and other relevant similar measures on all companies.
Not only the business community, but also international partners such as the US had been concerned in advance about the European Commission's ambitions. After the G20 finance ministers have agreed to the outlines of the global tax reform, the European Commission has announced to put on hold the proposal for a Digital Levy which was due to put forward on July 14, 2021 at least until October.
In the view of BDI, the European Commission should now finally withdraw the announced proposal. A similar initiative has already failed in 2019 due to a lack of support among EU Member States. At the international level, it has become clear that the digital economy cannot be ring-fenced for tax purposes. In addition, unilateral measures are inconsistent with a stable and sustainable international tax system. It is more coherent to unconditionally support an international agreement because a European digital levy would counter the objective of strengthening Europe as a business location. Without digitalization, however, Europe cannot be competitive. Instead of imposing an additional tax on digital technologies, they need to be supported by the EU.