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Analysis: Pillar one crucial for $200bn in tax revenue gains

OECD pillar one - 4.jpg

The OECD’s two-pillar solution may increase global tax revenue gains by more than $200 billion a year, but pillar one is the key to such gains due to its fundamental changes to taxing rights.

Pillar one could unlock greater tax revenue for many countries around the world, but there is still plenty of work to do to secure an international agreement on its final details by mid-2023.

In a webinar yesterday, January 18, the OECD presented its analysis of the economic impact of the two-pillar solution, including how changes to the design of pillar one have increased revenue estimates from $125 billion in 2020 to $200 billion in 2021.

Meanwhile, pillar two is projected to raise about $220 billion – 9% of global tax revenues – based on 2018 data. This is up from $150 billion in global revenue based on 2017 data.

In addition, in-scope residual profit has risen from an estimated $363 billion in 2016 to $454 billion in 2020 and $790 billion in 2021.

This increase is partly due to scoping changes in the OECD proposals, as well as the expansion of technology industries and digital economic growth. As a result, the number of multinational enterprises (MNEs) in scope has increased over time.

Pierce O’Reilly, head of the business and international taxes unit at the OECD, said: “We estimate that there are at least 100 MNEs in scope, maybe a little more.”

This number has increased from around 80 in 2017, and this may be set to expand as more companies undergo digitalisation in the coming years.

Digital MNEs accounted for 52% of total residual profit in 2021. However, residual profit is also highly concentrated in sectors such as broadcasting, electronics, pharmaceuticals and telecommunications.

Design details

The OECD has made a series of important changes to its three-tier profit allocation rules under pillar one since it began its work on digital tax. These changes may go on to become driving factors behind global tax revenue growth.

Amount A would mean a reallocation of 25% of corporate residual profits to market jurisdictions, but the scope of this is determined by two tests setting standards including a $20 billion global revenue standard and a 10% revenue profitability threshold. Financial services and extractive industries are excluded.

At the same time, the OECD has set a lower nexus threshold for low-income countries as defined by GDP below €40 billion ($43.2 billion). The tail-end service provisions were drafted as part of sourcing Amount A revenue for consumer-facing businesses.

The Paris-based organisation has drawn up rules on elimination of double taxation (EoDT) to minimise the risk of companies being hit with multiple tax bills on the same income. This approach is based on return on depreciation and payroll and de minimis provisions.

Developed countries hoping for a safe harbour provision, including the US, would have a marketing and distribution safe harbour rule under pillar one. This would help reduce double counting between transfer pricing and Amount A allocations.

Some features have different outcomes to others and the OECD highlighted the aspects that may drive revenue growth for middle-income and low-income countries. These features include the EoDT rules, alongside the nexus threshold and tail-end service provisions.

A deal on pillar one may be much more difficult to secure than on pillar two, but many of the details have either been settled or will be soon. The next six months will decide its fate.

What about pillar two?

There are still unanswered questions about the impact of pillar two on tax revenue. The OECD acknowledged in the webinar that it still has no estimates on revenue impact for different groups of jurisdictions, i.e. developing and developed countries.

Rasmus Corlin Christensen, political economist at the Copenhagen Business School, pointed out on Twitter that this is going to be an issue for countries drafting legislation for a minimum corporate tax rate.

During the webinar, deputy director David Bradbury explained that the OECD is still working on pillar two impact analysis, particularly with regard to qualified domestic minimum top-up taxes (QDMTTs).

The QDMTTs will play a decisive role in minimum taxation once pillar two is in place. This complicates the analysis because of the inevitable variations by jurisdiction. However, there are big-picture approximations available.

Pillar two was projected to raise between $141 billion and $211 billion in 2017. The OECD settled on the figure of $175 billion, but these gains increased to a maximum sum of $261 billion in 2018. A revised estimate puts the number at $220 billion.

The success of pillar two partly rests on pillar one, but also previous reforms such as country-by-country reporting which will improve access to tax data worldwide. A full analysis is set to be published in the coming months at a crucial time for the implementation process.

Nevertheless, governments around the world are committed to the global minimum corporate tax rate and many countries are drafting legislation to implement the 15% rate in the near future.

Winners and losers

Although the OECD’s analysis finds that high-income countries do not face major losses, investment hubs may stand to lose the most tax base and revenue. Meanwhile, low-income countries may still gain the most in tax revenue.

Most tax professionals expect pillar one to create ‘winners’ and ‘losers’ in the global economy, but many tax experts believed the changes to international taxing rights would result in bigger losses to high-income countries.

One tax director at a US pharmaceutical company suggests that the most powerful countries have supported pillar two strongly as an alternative to pillar one.

“My sense from talking to a number of governments is that the exporter counties and the G7 countries are going to lose revenue as a result of pillar one and they are pushing the minimum tax approach in pillar two in response,” he tells ITR.

However, the OECD analysis suggests that the jurisdictions to lose the most from pillar one are investment hubs, whereas other high-income countries could stand to gain revenue. Low-income countries still might benefit the most from the two-pillar solution, but they aren’t the only winners.

The Paris-based organisation is determined to secure an international agreement on new taxing rights this summer. It may be a difficult task, far more complicated than securing pillar two, but this does not mean it is impossible.

“Many governments may be thinking they will have to accept pillar one or not be a part of a future system at all. Many of the large markets and export countries will want it and the rest will go, ‘why not?’” adds the tax director.

This is why OECD secretary-general Mathias Cormann has stressed the need for widespread implementation of pillar one and pillar two to stabilise the global tax system.

“This new economic impact analysis again underlines the importance of a swift, efficient and widespread implementation of these reforms to ensure these significant potential revenue gains can be realised,” said Cormann.

“Widespread implementation will also help stabilise the international tax system, enhance tax certainty and avert the proliferation of unilateral digital services taxes and associated tax and trade disputes, which would be bad for the global economy and economies around the world,” he added.

Pillar one may be crucial to the success of pillar two. An incomplete series of reforms could mean the problem of unilateral measures will go unsolved and the digital services tax will become a long-term feature of international policy.

Countries can use the two-pillar solution to stabilise the tax system and make greater gains in corporate tax revenue. The case for pillar one may be even more important in 2023.

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