What is BEPS 2.0? OECD two-pillar plan and possible impacts

We explain what BEPS 2.0 is, its framework for a more equitable distribution of global taxing rights, especially with regard to large multinational companies, and China’s exposure to these reforms on international taxation.

To address the risks of base erosion and profit shifting (BEPS) resulting from the digitization of the global economy, the Organization for Economic Co-operation and Development (OECD) has published a declaration July 1, 2021 on the overhaul of the framework for international tax reform.

Commonly referred to as BEPS 2.0, the new framework aims to ensure a more equitable distribution of taxing rights with respect to the profits of large multinational enterprises (MNEs) and to set a global minimum tax rate.

As of July 9, 132 member jurisdictions out of 139 accepted the Inclusive OECD / G20 Framework on BEPS, including mainland China and Hong Kong.

Such a broad consensus on the BEPS 2.0 framework marks a significant breakthrough in the work of the OECD over the years. The organization is now looking to finalize the technical details of the BEPS 2.0 package by October 2021 and implement the package in 2023.

BEPS 2.0 represents the “first substantial overhaul of international tax rules in almost a century” and is expected to have a significant impact on many “tax-friendly” countries and multinationals.

What is BEPS 2.0? Understanding the two-pillar plan

The BEPS 2.0 package consists of two parts, also called the two pillars:

• The first pillar focuses on the distribution of benefits and the link; and
• The second pillar focuses on a global minimum tax.

Pillar 1 – profit distribution and link

Simply put, the purpose of the first pillar is to make multinational enterprise groups pay taxes in countries where they have users, even if there is no commercial presence.

Initially, the first pillar focused on the taxation of highly digitalized businesses, which provide cross-border digital services. The scope was then broadened to include some consumer oriented businesses.

Now it targets the largest and most profitable multinationals. According to the OECD statement, all multinational groups with global turnover exceeding 20 billion euros and profitability above 10% (profit before tax) are covered by the first pillar. (The threshold will be reduced to 10 billion euros after seven to eight years subject to successful implementation. Extractive industries and regulated financial services are excluded from the scope of the first pillar.)

The key elements of the first pillar can be grouped into two elements: a new right to tax for market jurisdictions (where clients are based) on a share of the residual profit calculated at the level of the multinational group (“Amount A”) and a fixed return for certain basic routine marketing and distribution activities (“Amount B”).

The plan proposed that a certain portion (20 to 30 percent) of the residual profit (with profit exceeding a 10 percent margin) of these multinationals be taxed in market jurisdictions.

The first pillar is estimated to impact 78 of the world’s 500 largest companies. Large international tech companies will account for about 45% – or US $ 39 billion – of the estimated total profit allocation of US $ 87 billion (amount A) that will come under scrutiny under the first pillar.

Previously, EU countries struggled to reach consensus on unified digital tax rules, and more than 20 countries around the world have either proposed, announced or adopted their own digital services tax (DST) to tax overseas tech giants.

Thus, the OECD statement confirms that the first pillar will replace unilateral measures by countries on the implementation of the DST. However, the statement is silent on when the removal of all DSTs should take place.

Pillar 2 – overall minimum taxation

The second pillar sets a minimum overall tax rate (at least 15%) and targets large multinational groups with global turnover exceeding 750 million euros.

In the second pillar, if the jurisdictional effective tax rate of a multinational group is lower than the global minimum tax rate, its parent company or its subsidiaries will be required to pay additional tax in the jurisdictions where they are located to compensate the deficit.

Pillar Two consists of a set of Global Anti-Base Erosion (GloBE) rules, comprising:

• Two national rules:
• An income inclusion rule (IR), which would impose current tax on the income of a foreign-controlled entity or foreign branch if that income was otherwise subject to an effective rate below a certain minimum rate; and
• An under-taxed payment rule (UTPR) that would deny a deduction or impose withholding on base-eroding payments, unless that payment is subject to tax at or above a minimum rate specified in the jurisdiction of the beneficiary.
• A treaty-based rule, known as the Tax Liability Rule (STTR), which ensures that treaty benefits for certain related party payments (especially interest and royalties) are only granted in cases where an item of income is subject to tax at a minimum rate in the receiving jurisdiction.

The Declaration confirms that MNEs could see an overall minimum tax at a rate of at least 15% (for IIR and UTPR) from 2023. It also specifies that the minimum rate for STTR will be between 7.5 % and 9%.

The Declaration suggests that the second pillar should enter into force in 2022, to enter into force in 2023.

Possible impact of global minimum taxes on countries and businesses

Although detailed implementation plans for the global minimum tax (as part of the BEPS 2.0 package) are not yet finalized, countries and multinationals are already assessing the possible impact.

The minimum tax rate can benefit most developing countries, which impose higher corporate taxes, but it could blunt the appeal of some other countries, including tax havens. For example, Ireland in the EU is home to the headquarters of several tech giants, including Facebook, Google and Apple, and offers a corporate tax rate of 12.5%. So far, the country has held firm by signing the OECD proposal.

Among major Asian economies, Singapore’s corporate tax is set at 17%, Hong Kong’s at 16.5%, and Macau’s at 12%, lower than most Asian economies. Due to the various tax incentives available in these jurisdictions, the effective corporate tax rates in these regions may be even lower.

National corporate tax rates in Asian countries

Mainland China and Hong Kong tax rates

What is China’s exposure to new international tax rules being developed under BEPS 2.0?

In comparison, China, with a national corporate tax rate of 25%, is less exposed.

However, China is implementing a wide range of tax incentives. For example, some high-tech enterprises, enterprises engaged in industries promoted in the western regions of China, as well as some enterprises registered in Hainan Free Trade Port may be able to benefit from an effective corporate income rate of less than 15 percent.

Large multinational companies in China must measure the thresholds (their levels of global turnover) at which the minimum tax rule is applied to assess whether they fall within the scope.

Chinese tech giants, such as Alibaba and Tencent, which have divisions in the Cayman Islands, could also be affected by the two-pillar approach.

Multinational enterprises should carefully consider the main design elements agreed in the OECD statement to determine how the proposals would impact their operations and multi-jurisdictional tax obligations, including whether sector-specific exemptions in a region could. lead to a fiscal deficit in terms of global fiscal obligations.