Pillar Two: global effective minimum taxation

Pillar Two of the proposals addressing the tax challenges of the digitalisation of the economy seeks to develop measures which ensure that corporate profits are subject to taxation at an effective minimum rate. The underlying assumption is that the characteristics of the "digital economy" allow profits to be shifted to low-tax countries and therefore justify limiting tax competition to a minimum level.

The measures under Pillar Two propose rules for taxation where other primary taxing rights are not exercised, or the income is subject to low levels of effective taxation. The Global Anti-Base Erosion Proposal (“GloBE”) comprises multiple elements and, according to the G20/OECD, tackles the remaining Base Erosion and Profit Shifting (BEPS) issues.

Income Inclusion Rule

The “Income Inclusion Rule” would require a parent company to bring profits of foreign subsidiaries into account for the domestic taxation, if the income of the foreign subsidiary was not subject to tax at a minimum rate. The current proposals do not consider the nature of income, the activity conducted or the substance of the foreign subsidiary. In the EU context, the “Income Inclusion Rule” could be implemented by means of an EU directive.

Undertaxed Payments Rule

The “Undertaxed Payments Rule” places a tax on base eroding payments. If a payment to a related party was not subject to a tax at a minimum rate, the deduction the payment would be denied or source-based taxation imposed.  This expenditure-oriented approach would lead to a taxation of profit and has considerable negative effects since it does not allow for a general deduction of all group-related expenses. This does not correspond to the developments of a globalised world as companies would not be as successful without their multinational group.

BDI assessment of the GloBE proposal

German industry is critical of the proposed measures under Pillar Two in view of their complexity and the associated risks. Before implementing the proposed measures, the measures of the BEPS project should first be evaluated within the “Inclusive Framework on BEPS”. It should be examined whether some BEPS measures have achieved their objective or whether they can be improved, replaced or simplified to reach satisfying results. If the evaluation shows that most harmful tax practices have been eliminated, Pillar Two should not be implemented.

In case the previous BEPS project is judged to be inadequate and further action is deemd to be required, the “GloBE”-Proposal should be realigned with the stated policy rationale. Therefore, the rules should be targeted and proportionate and address artificial arrangements only. This would focus the “GloBE”-Proposal and would mean that it could be simplified significantly. Proportionality would be even more important should the „GloBE“-Proposal target genuine commercial transactions as well.

If the elements of Pillar Two are implemented without clear rules on the interaction between the proposals under Pillar One and under Pillar Two, between the different elements of Pillar Two as well as between the measures proposed under Pillar Two and existing international and domestic tax rules, severe double taxation risks would be inevitable. Since the current dispute resolution mechanisms seem to be unfit to solve such an increase in disputes, it should be ensured that double taxation is eliminated through rule coordination. Additionally, binding dispute resolution mechanism implemented must form an integral part of any reform of the international tax system.