OECD Pillar One and Pillar Two: how they affect Transfer Pricing strategies and compliance?
RoyaltyRange
In an increasingly interconnected global economy, multinational enterprises (MNEs) face complex challenges in aligning their tax strategies with international regulatory frameworks. The OECD’s BEPS (Organisation for Economic Co-operation and Development Base Erosion and Profit Shifting) initiative has introduced significant reforms to ensure fairer tax competition and transparency. Central to these reforms are Pillar One and Pillar Two, which seek to address issues of profit allocation and global minimum taxation, respectively.
Pillar One targets large multinational corporations, reallocating portions of their taxable income to the countries where their markets are located. This shift affects their effective tax rates, cash tax obligations, and existing Transfer Pricing structures. Businesses must evaluate the long-term effects of these changes, as the OECD plans to progressively expand the scope of entities governed by Pillar One. Specifically, Amount A of Pillar One targets MNEs with consolidated group revenues exceeding €20 billion and an overall profit margin above 10%. Under this system, it is proposed that 25% of profits exceeding the 10% margin may be taxed by the market countries. This new framework is designed to replace existing digital services taxes.
The changes introduced by Pillar One have a global reach and, though simplified compared to earlier proposals, still entail considerable technical complexity. The agreement sets the repeal of digital services taxes and similar measures, but the specifics of their identification and the timeline for their removal are not yet defined. Initially focused on highly digitalized business models, the scope of Pillar One has significantly broadened. While extractive industries and regulated financial services are exempt, most other sectors are generally included under its competence.
Pillar Two establishes a global minimum tax system with a lower threshold than Pillar One. Generally, it applies when group companies with global annual revenue of 750 million euros are taxed at rates below 15%. Under-taxed profits will then be subject to taxation either in the country of the ultimate parent company or, if the ultimate parent jurisdiction does not impose this tax, in the countries where other group companies operate.
The framework aims to enforce the minimum tax rate through global anti-base erosion (GloBE) rules, consisting of three main components. First, the qualified domestic minimum top-up tax (QDMTT) allows MNE with an effective tax rate below 15% to impose their top-up tax to comply with Pillar Two. Second, the income inclusion rule (IIR) permits an Ultimate Parent Entity (UPE) in another country to levy a top-up tax if the MNEs are not paying an effective tax rate of 15% in their respective jurisdictions. Finally, the undertaxed profits rule (UTPR) serves as a safeguard, enabling other constituent entities, including the UPE, to impose a top-up tax on an entity that does not meet the 15% effective tax rate threshold and is not already subject to the IIR.
It’s important to note the “once out, always out” rule. If an entity in a jurisdiction fails to match one of the three tests in any given year, it will be permanently disqualified from using the safe harbor in future years. When a jurisdiction passes one of the simplified safe harbor tests, it avoids the top-up tax for that year. These safe harbor rules are typically based on Country-by-Country reporting (CbCr), though there are some exceptions. If a jurisdiction cannot utilize the safe harbor calculation, it must resort to the full GloBE calculations to determine if it is liable for a top-up tax under either the Income Inclusion Rule (IIR) or the Undertaxed Profits Rule (UTPR).
MNEs must adopt a holistic approach to Transfer Pricing, considering the combined impact of both Pillar One and Pillar Two. This involves revising pricing policies, reallocating functions, and adjusting profit margins to align with the new international tax framework. A thorough understanding of each jurisdiction’s tax regulations and effective tax rates is essential.
Given the increased complexity and scrutiny, MNEs need to invest in enhanced compliance infrastructure. This includes sophisticated tax reporting systems, comprehensive documentation processes, and ongoing training for tax professionals to stay updated with the latest regulatory changes.
Strategic long-term planning is critical to navigate the evolving tax environment. MNEs should conduct detailed impact assessments, scenario analyses, and risk evaluations to proactively manage potential tax liabilities and compliance risks. Engaging with tax advisors and leveraging technology solutions can further streamline compliance efforts and reduce risks.
The OECD’s Pillar One and Pillar Two initiatives require significant adjustments to Transfer Pricing strategies and compliance practices. By adopting a proactive and comprehensive approach, MNEs can navigate these changes effectively, ensuring alignment with the new international tax standards and minimizing compliance risks.
Sources:
https://www.oecd-ilibrary.org/sites/23ce5d0f-en/index.html?itemId=/content/component/23ce5d0f-en
https://kpmg.com/us/en/articles/2023/pillar-impacts-for-caos.html
https://kpmg.com/xx/en/home/insights/2020/10/beps-2-0-pillar-one-and-pillar-two.html
https://www.deloitte.com/cbc/en/services/tax/services/oecd-pillar-one-and-pillar-two-modeling.html