On 8 October 2021 the OECD announced that 136 countries had reached agreement on significant international tax reform that will:
- Reallocate more than USD 125 billion of profits from approximately 100 of the world’s largest and most profitable multinational enterprises (MNEs) to market/user jurisdictions (Pillar One)
- Impose a 15 per cent minimum tax rate on some large MNEs (Pillar Two).
In particular, the OECD released an eight-page statement that updates its 1 July 2021 plan and includes an annex that outlines the proposed steps to implement the reform. There is also an ambitious goal to implement the new rules with effect from 2023.
Pillar One
Pillar One will re-allocate some taxing rights over MNEs from their home countries to the markets where they have business activities and derive profit, regardless of whether there is a physical presence. Pillar One will apply to MNEs with global turnover above EUR 20 billion and profitability above ten per cent. Businesses operating in the extractive and regulated financial services industries, both significant in Australia, are excluded.
Due to the turnover threshold and excluded industries, it is unlikely that Pillar One will impact many Australian MNEs. However, the Australian operations of large foreign MNEs will be impacted by the measure, increasing the amount of profit subject to Australian tax.
There are two aspects to Pillar One: Amount A and Amount B.
In relation to Amount A, a new nexus rule will be introduced to allow the allocation of a share of residual profits (being 25 per cent of the profit above ten per cent) to market/user jurisdictions where an in-scope MNE derives turnover of at least EUR 1 million (or EUR 250,000 in smaller jurisdictions with gross domestic product lower than EUR 40 billion).
Importantly, the reforms will require all parties to remove Digital Services Taxes and similar measures and to commit not to introduce such measures in the future. Australia has not introduced any such measures yet, so Pillar One will be the first action on the matter.
In relation to Amount B, the application of the arm’s length principle to marketing and distribution arrangements will be simplified and streamlined. There are no OECD updates available on Amount B yet, however the OECD noted that this work will be completed by the end of 2022. The introduction of this simplification will likely require a revision of the existing Practical Compliance Guideline PCG 2019/1 - Transfer pricing issues related to inbound distribution arrangements.
Pillar Two
Pillar Two will introduce a global minimum tax rate, to be set at 15 per cent. The global minimum tax rules will apply to MNEs that meet the EUR 750 million threshold, as determined under the Country-by-Country Reporting rules. Considering the lower turnover threshold, this measure is likely to impact more Australian MNEs than Pillar One.
Interaction with the Australian tax system
Although the Australian corporate tax rate is higher than the 15 per cent minimum for Pillar Two, the effective tax rate is not based on the nominal corporate tax rates of 25 per cent to 30 per cent for Australia.
Rather, the effective tax rate uses a tax base calculated with reference to the financial accounts. This means certain tax concessions available in Australia may reduce the effective tax rate for a particular entity to below the 15 per cent minimum. However, other Australian tax measures increase the effective tax rate and could help to counter this.
We note a potential interaction of Pillar One and Pillar Two with the following Australian tax measures:
- Controlled Foreign Company (CFC) rules
- Dividend imputation system
- Foreign permanent establishment exemption
- Hybrid mismatch targeted integrity rule
- Multinational Anti-Avoidance Law (MAAL) and Diverted Profits Tax (DPT).
Further information
BDO’s Global Tax Alert ‘Global Tax: OECD announcement of agreement on International Tax Reform’ provides further analysis surrounding the key details of the agreement and clarifications arising from the OECD’s announcement 8 October 2021.
Key contacts
If you would like to discuss the proposed international tax reform, please contact our Corporate & International Tax and Transfer Pricing teams.