Global Tax Reform OECD publishes draft rules on the scope of Pillar One

The OECD has published draft rules to determine which groups will fall within the scope of new rules reallocating taxing rights to market jurisdictions under Pillar One of the global tax reform project.

Pillar One aims to ensure that a proportion of "excess" profits of certain multinational groups may be taxed in countries in which they operate and earn significant revenue, but in which they are not considered under existing rules to have sufficient presence to be taxable. These draft rules are designed to ensure that only profits of very large and highly profitable groups will fall within scope.

There is an extremely tight timeframe for comment on these draft rules, with responses requested by 18 April. This reflects the OECD's ambitious timetable to have the rules come into effect next year. Further 'building blocks' of Pillar One will be released for feedback in due course, notably including consultations on the proposed exclusions for the extractive and regulated financial services industries.

Pillar One

The OECD's Base Erosion and Profit Shifting (BEPS) project resulted in massive changes worldwide to domestic tax systems, ensuring minimum standards in areas such as interest deductions, hybrid mismatches and minimising tax treaty abuse. However, concerns remained that the global tax system has not kept pace with today's digitalised economy, and that the current meaning of "permanent establishment" allows companies to have a significant (non-physical) presence in a market jurisdiction without necessarily becoming liable to tax there.

The OECD's two pillar solution is designed to ensure that multinational enterprises pay a "fair share" of tax wherever they operate and generate profits. Together with Pillar Two's 15% global minimum tax rate for large multinationals, Pillar One of the rules provides for a new taxing right for market jurisdictions over certain profits of the largest multinationals.

This consultation considers how to determine exactly which businesses should be considered to be sufficiently large and profitable to be subject to the rules. Those that are within scope will see 25% of profits above a 10% profit margin (so called "Amount A") reallocated and then subjected to tax in the countries in which they operate and earn revenue of at least €1m per year (or €250,000 for smaller jurisdictions), rather than all taxing rights sitting where the business has physical presence.

Scope of Amount A

A group will be in scope of Amount A where it meets two threshold tests:

1. Global revenue test: the group's total revenues must exceed €20 billion in a period (potentially to be reduced to €10 billion after seven years if implementation of these rules is successful);
2. Profitability test: the group's relative profitability must exceed 10%.

These headline tests have been known for some time, but the current consultation now puts some flesh on the bones as follows:

In order to ensure groups with volatile profitability are not inappropriately brought within scope, the profitability threshold must be exceeded in at least two of the four prior periods, and also on average across those four prior periods and the current period. It has not yet been determined whether these modifications would apply as a permanent feature of the scoping rules or whether they would apply as an "entry test" only. The global revenue threshold is not currently expressed to have equivalent prior period or averaging tests, but this also remains an issue open for discussion.

In limited circumstances, it is envisaged that a disclosed segment of a multinational's business could be brought within the scope of Amount A, on a standalone basis, where that segment meets the revenue and profitability thresholds but the group as a whole does not. Details on this will be released later.
Further details are also awaited on the exclusions that have been identified for the extractive and regulated financial services industries. In the case of groups with mixed activities, the global revenue and profitability tests will still be applied to the group but only after the removal of the excluded revenues and profits (as will be provided for in schedules to be published in due course).

As under the Pillar Two rules, certain entities are excluded such that they cannot be the ultimate parent entity of a group, and their revenues and profits are ignored for the purposes of the threshold tests. These include governmental entities, non-profit organisations, pension funds, certain investment funds and certain real estate investment vehicles.

An anti-fragmentation rule will apply to counter potential planning opportunities for circumventing the global revenue test where the ultimate parent entity of a group is controlled by an excluded entity. Broadly, this will provide for the aggregation of global revenues of all groups remaining under common control of such excluded entities where a principal purpose test is met.

A work-in-progress

It has been made clear that the draft is still very much a work-in-progress which does not, as yet, reflect consensus on the substance of the rules. Pillar One is due to come into effect from next year and, to meet that tight timetable, it is important to obtain public input early in order to help in further refining and finalising the rules.

As well as the general legislative articles setting out the thresholds, definitions and exclusions, there will be a Commentary to further flesh out the operation of the scoping rules. Unsurprisingly, the Commentary has not yet been developed, although there are some notes in this document to indicate where matters have already been identified for inclusion in the Commentary, such as the practical application of the principal purpose test.

The OECD is hoping in particular for suggestions on the additional guidance that would be needed to apply the rules to the circumstances of a particular type of business, as well as input on anything considered to be missing from the draft rules.

Businesses potentially within scope of Pillar One should consider responding to this consultation to ensure that the final rules are sufficiently certain and workable for their purposes. Comments should be sent electronically (in Word format) by email to tfde@oecd.org

You can find a full list of our global tax partners here.