Digitization and globalization have had a major impact on the economies and lives of people around the world, and that impact has only accelerated in recent years. These changes brought with them challenges to the rules of taxation of income from international business, which prevailed for more than a hundred years and led to multinational companies not paying their share of taxes despite the huge profits many of these companies made to become interconnected.

Now, 136 countries and jurisdictions, which account for more than 90% of global GDP, are establishing a new framework for international tax and agreeing on a detailed implementation plan that envisions implementing the new rules by 2023. A small number of 140 members of the Inclusive Framework have not yet joined this solution, which lists two possible solutions.

The first pillar of the solution

The two solutions consist of the first and the second pillar. The first pillar aims to ensure a fairer distribution of profits and tax rights among countries compared to the largest multinational companies that are leaders in globalization. Tax security is a key aspect of the new rules, which include a mandatory and binding first pillar dispute resolution process, but with a warning that developing countries will benefit from the electoral mechanism in certain cases, ensuring that the rules are not too burdensome for low capacity countries.

The first pillar redistribution agreement includes the abolition and suspension of the Digital Services Tax (DST) and other relevant, similar measures, thus halting trade tensions stemming from the instability of the international tax system. It will also provide a simplified approach to the application of the arm’s length principle in specific circumstances, with particular emphasis on the needs of low-capacity countries.

The second pillar of the solution

The second pillar puts tax competition on income tax through the introduction of a global minimum income tax rate of 15% - which countries can use to protect their tax bases (GloBE rules). The second pillar does not eliminate tax competition, but imposes multilaterally agreed restrictions on it.

Tax incentives provided to encourage significant economic activity will be made possible by allocations. The second pillar also protects the right of developing countries to tax certain infringing payments (such as interest and royalties) when they are not taxed up to a minimum rate of 9%, through the “Subject to tax rule” (STTR).

Benefits for developing countries

Developing countries make up a large part of the Inclusive Framework membership and their voices were active and effective during the negotiations. The OECD estimates that, on average, low, middle and high-income countries would experience an increase in income as a result of the first pillar, but these gains would be expected to be higher (as a share of current income tax revenues) among low-income jurisdictions. In general, GloBE rules will ease the pressure on developing countries to provide overly generous tax incentives to attract foreign investment.

The second pillar focuses on activities with actual content. Special benefits targeted at developing countries include:

• Taxation Rule (STTR), which prevents companies from evading taxes on their earnings in developing countries by making deductible payments such as interest or royalties that benefit from reduced withholding tax rates and are not taxed (or taxed at a low rate) under the tax laws of the contracting partner
• A simplified approach to the application of the arm’s length principle to basic marketing and distribution activities within the country, as low-capacity countries often struggle with the administration of transfer pricing rules, will benefit from a formal approach.
• During the lowering of the threshold for determining the redistribution of profits from the first pillar to smaller economies, the OECD will provide tailor-made technical assistance to support all aspects of the implementation of the two-pillar solution.

Data source: OECD (https://www.oecd.org/tax/beps/brochure-two-pillar-solution-to-address-the-tax-challenges-arising-from-the-digitalisation-of-the-economy -october-2021.pdf)