OECD’s BEPS and what it means for multinational businesses

Answer

Large economies with high tax rates are increasingly concerned by capital flight and an emerging trend of highly digitised activities moving offshore, causing an erosion of the ‘tax base’ – the local assets and economic activities capable of being taxed – and consequential challenges for funding ever-increasing government spending. Conversely, smaller economies that have sought to attract economic activity (in part by offering low taxes and other incentives) are finding that the mobility of intangible assets enables businesses to pit nations against each other, in Justice Louis Brandeis’ race to the bottom from which only Pyrrhic victory is possible.

In an effort aimed at discouraging tax competition, the Organisation for Economic Co-operation and Development (OECD) first published a report on base erosion and profit-shifting (BEPS) around 2013, and has since designed and adopted a number of BEPS measures to preserve the tax base of participating nations. The OECD estimates the annual impact of profit shifting ie, the amount of tax revenue foregone) at US$240 billion.

Described by Treasury Secretary Janet Yellen as “an historic day for economic diplomacy”, in July 2021, 130 countries agreed to implement ‘BEPS 2.0’, a ‘two-pillar’ response to digitisation of business and the use of low-tax jurisdictions. ‘Pillar One’ broadly requires enterprises to allocate their profits to the jurisdictions where their customers are located.  ‘Pillar Two’ imposes, among other things, an effective minimum 15% tax rate on all multinational enterprises with a resident entity or taxable place of business in a participating state.

Of these, the Pillar Two proposal is expected to impact a greater number of enterprises.  Although not limited to highly digitised businesses, Pillar One was originally expected to principally affect groups that generate substantial profit from software or data, where revenue can be earned from customers in a particular region with only a limited (if any) local taxable presence. Some governments have considered this to be a leakage of value from the local economy or a contributor to trade deficits.

Pillar Two, in contrast, may have far-reaching implications for entities that operate in multiple jurisdictions. Minimum taxes as a concept aren’t novel, and the US has imposed a minimum tax in some form since 1970, although the corporate Alternative Minimum Tax was eliminated by the 2017 Tax Cuts and Jobs Act. However, BEPS Pillar Two represents the broadest attempt yet at curbing the use of low-tax jurisdictions and disincentivising targeted tax reliefs. The headline 15% minimum rate to be enforced, although significantly lower than the tax rate typically paid by individuals on their wages, still represents a major increase both on the corporate tax rates imposed by many jurisdictions, and on the effective tax rates that may be available under concessional tax regimes even in G20 economies.

The design of the global minimum tax ensures that it will apply to entire global groups as soon as any part of the group is either resident in, or has a taxable ‘permanent establishment' in, a participating country that's implemented the measures. All group members in participating countries may become liable, not just over profits earned in that country, but in respect of a shortfall in the effective tax rate of the entire global group.

Even non-participating countries will need to consider their response. Where a multinational enterprise will be subject to a 15% global effective tax rate regardless of local tax, governments that decide to impose a lower level of tax are effectively subsidising participating countries, while the enterprise should theoretically be indifferent.

Pillar Two applies, broadly, to corporate groups with global revenues exceeding €750 million. This somewhat arbitrary cliff edge may discourage certain corporate mergers which would have the effect of bringing two smaller groups within the scope of Pillar Two, particularly where either merger party operates in low-tax jurisdictions or benefits from a concessional tax regime.

Proponents of BEPS measures anticipate a wave of onshoring, in which intangible assets and supporting functions will return from low-tax jurisdictions. This may involve significant transfers of staff and other resources: as ‘transfer pricing’ principles typically require that profits between related entities in a global group are recognised only where the entity performed the relevant functions and bore the relevant risks, intangible assets are often held in jurisdictions where sufficient staff and other resources are available to manage, protect and monetise those assets. Now that the tax benefits of those jurisdictions may be eliminated by top-up taxes in other locations (at least, up to the 15% level), it remains to be seen whether enterprises will centralise key assets and teams.

Akash Mehta is a tax associate at Weil, Gotshal & Manges (London) LLP.