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OECD framework and the shifting international tax landscape

Nov 03, 2021
International tax Global services

Grace Perez-Navarro, deputy director of the Organisation for Economic Co-operation and Development’s Centre for Tax Policy and Administration, conveyed a sense of promise Wednesday in looking forward to outcomes of the recent landmark agreement to reform the international tax system.

"This is a whole new way of taxing multinationals,” Perez-Navarro said in her keynote presentation at RSM Tax Summit 2021—Tax in Motion.

Perez-Navarro’s presentation highlighted a day-long focus on the international tax landscape, given multilateral efforts underway to transform corporate tax obligations in the context of an increasingly digitalized and globalized economy.

At the center of these impending changes is a two-pillar system—a framework developed by the OECD—that aims to address tax challenges resulting from this digitalization. The first pillar focuses on new ways to apportion income of the largest multinationals among taxing jurisdictions, and the second focuses on imposing a global corporate minimum tax of 15%, as well as the denial of deductions or imposition of withholding taxes on payments made to “low-tax” entities.

“We are looking at the profits of the group as a whole and applying a formula, so it’s not traditional transfer pricing anymore,” Perez-Navarro said. “The threshold for determining which MNE groups would be subject to the new taxing right was set high—global turnover of 20 billion euros—but it is expected to be reduced to 10 billion euros if implementation of the new taxing right is successful.

“We need to make sure the tax certainty component works before declaring the implementation a success. The reduction of the threshold was a key part of the deal.  You can imagine that smaller countries are interested in seeing a bigger piece of the pie being shared under this taxing right.”

This effort to level the international playing field from a tax perspective comes after a decade of conversations about and criticisms of tax havens and corporate tax avoidance.

“International tax is no longer just the stuff of international tax experts,” she said. “It's become an extremely political issue of increasing importance to the global economy.”

More work remains before the framework goes into effect. In the United States, for example, although it was one of 136 countries and jurisdictions that agreed to the Oct. 8 deal, Congress is currently considering significant federal tax changes, and it will have to reconcile how the international framework coexists with domestic laws.

Draft legislation for global tax reforms is expected in 2022 and effective implementation is expected in 2023.

The new way of taxing multinationals

The OECD-developed framework is meant to put a stop to the so-called “race to the bottom” that results from multinational companies shopping around for jurisdictions with the lowest tax rate. The rise of digital products and services has brought this issue to the forefront even more so since the inclusive framework was first established in 2016.

“There was a fundamental issue: that businesses were changing as a result of technology, and you could have a business earning tremendous profits in a jurisdiction without having any legal nexus there,” said Perez-Navarro. “And the notion of physical presence didn’t make sense in that context."

Here’s a look at the types of companies that would be subject to these international tax changes:

Pillar 1

  • What it is: New ways to apportion income
  • Who is subject: Multinational enterprises with a global turnover above 20 billion euros and profitability above 10%

Pillar 2

  • What it is: A minimum tax and rules for denial of deductions or imposition of withholding taxes
  • Who is subject: Multinational enterprises with a global turnover above 750 million euros
  • But also: Countries are free to apply the income inclusion rule even if multinational enterprises do not meet the threshold (i.e., to HQ companies)

Looking forward

As implementation of the two pillars comes into clearer view in 2022, Perez-Navarro said, it is important to take a step back and think about what these changes mean more broadly for international entities. Here are some key takeaways from her keynote address:

  1. “Multilateralism in the tax area is alive and well,” she said, adding that organizations should expect more international coordination on tax rules in the future.
  2. Countries have strengthened their relationships with one another through the process of developing these rules within the inclusive framework.
  3. Tax certainty is a critical part of this project, including binding dispute prevention and resolution mechanisms. “We think that this will provide a level of comfort to countries that are wary of arbitration,” Perez-Navarro said.

In the future, it may make sense for the OECD to explore implementing a similar approach to address mitigation efforts related to climate change, Perez-Navarro said.