This week in tax: the OECD’s pillar two model rules have been leaked

The EU and other jurisdictions were relying on digital services taxes (DSTs) to mitigate losses to national budgets from the COVID-19 pandemic. Yet with DSTs likely to be revoked in favour of the OECD agreement, governments will be seeking revenue from alternative taxes based on the OECD’s model rules for pillar two. 

Details around how companies will have to calculate a multilaterally agreed global minimum tax are nearly finalised, as a document leaked this week shows.  

The document, which was circulated to 140 countries on December 2, is a model for implementing the 15% global minimum tax. The model answers questions that have lingered since countries agreed on the global tax in October, including how the rules will deal with timing differences between when profits are recorded and when taxes are paid.

The EU will release a directive on December 22, requiring its 27 member countries to implement the rules themselves by 2022.

The OECD model answers key questions about carve-outs, including what income, payroll costs, and tangible assets companies would be able to exclude from the minimum tax rules. Eligible payroll costs include salary and wages, health insurance, pension contributions, and payroll taxes. 

Eligible tangible assets include items located in a jurisdiction, such as property and natural resources, as well as tangible assets that have been leased. Certain government licenses, including ones to exploit natural resources, are also eligible for exclusion.

Tax directors from the Confederation of European Business (BusinessEurope) have shared concerns with ITR over the imminent release of an EU directive on pillar two. 

Director General of BusinessEurope Markus Beyrer even requested the European Commissioner of the Economy Paolo Gentiloni to delay the EU directive. Beyrer criticised the short timeline for government experts to analyse the directive’s legislative language, after the model rules are released.

“A rushed implementation in the EU could be exploited by third countries to gain an economic advantage,” said Beyrer. “Any deviation of the rules outside the EU, now or in the future, could have a significant impact on EU-competitiveness and the fairness of the system as a whole.”

The first test that the global minimum tax implementation will face will come from the EU’s directive. The directive could put European businesses on the back foot in terms of competition, if international trade and tax are impacted by wide jurisdictional differences in the technical approach.

The UK tax authority HM Revenue and Customs’ (HMRC) latest transfer pricing (TP) consultation demonstrated an appetite for stronger OECD-aligned guidelines. Yet the changes will also increase the burden of proof for large businesses.

HMRC will require multinational groups in the UK in scope of the country-by-country reporting (CbCR) standard to provide a master file, local file, and summary audit trail from April 2023, following a public consultation launched in March this year.

Multinational enterprises (MNEs) that are within scope are likely to be well prepared, due to complying with jurisdictions’ increasing alignment with OECD guidance in recent years. Yet tax directors say an evidence log would have provided HMRC with more detailed TP information.

“The UK has been an outlier for years in not having an obligation for multinationals to prepare OECD-compliant TP documentation on a contemporaneous base,” said Tim Sarson, value chain management partner and head of tax policy at KPMG UK.

“Pretty much all large businesses prepared local files in the UK anyway, because that’s what the OECD guidelines told them to do, but there wasn’t a statutory basis or need to do it,” added Sarson.

UK businesses within scope will continue to adopt the requirements of Action 13 of BEPS from the OECD: a standard that requires a local file and a master file to be provided to tax authorities. These businesses will have different local files and master files in place depending on whether they are headquartered in or outside of the UK. If MNEs are foreign based, it is likely they will already have a master file in place in countries that require this.

Local files are not as common. For instance, if the MNE is US-based and follows CbCR standards, the tax team will likely have a local file ready. However, Philip Roper, TP technical leader at KPMG UK, warned that some businesses could only have local files for countries mandating the requirement.

The latest outcome from the European Court of Justice (CJEU) on a directive 2018/822 (DAC6) case shows that companies can avoid penalties for intrusive data inquires when EU tax authorities target individuals over groups.

The CJEU ruled in favour of the taxpayer in its preliminary decision in État du Grand-duché de Luxembourg (Luxembourg State) v L C-437/19. The case concerns a DAC6 inquiry in which French tax authorities asked Luxembourg tax authorities to share data related to shareholders of a certain Luxembourg company. It was thought that the shareholders may have property tax liabilities in France.

The Luxembourg company appealed against the data request order from local authorities as well as the penalty for non-compliance, on the basis that the information was not relevant to the minimum compliance standards under DAC6. Additionally, none of the shareholders were named in the DAC6 filings and the local tax authorities did not explain why the additional data was requested in the first place.

“It would be biased to target individual companies over groups with the DAC in these fishing expeditions,” said one tax manager at a media company in Germany. “The decision is a good one since it restricts authorities to simply targeting wider schemes that are harmful.”

The ITR team will be analysing the model rules after they are released by the OECD on December 20. Many tax advisors expect the EU Commission to move forward in releasing their draft directive on pillar two on December 22 as the model rules will corroborate the directive’s legislative language and underpin the implementation of a global minimum tax by 2022 in multiple countries.

Meanwhile, the team is putting together a roundup of TP trends expected in 2022, including the consequences of remote working on budget conditions, the technical consequences tied to pillar one and pillar two, and how increased deal-making activity will change the TP landscape.

Additionally, ITR will be producing a series of newsletters featuring our most-read content across direct tax, indirect tax, and transfer pricing throughout 2021. Some highlights include in-house features on hiring trends in the market, diversity in tax, and noteworthy tax court cases. 

Readers can expect these stories and plenty more next week. Don’t miss out on the key developments. Sign up for a free trial to ITR.