OECD releases Pillar Two model rules

On 20 December 2021, the OECD published model rules to assist in the domestic implementation of the Pillar Two minimum global tax rate of 15%. The Pillar Two model rules are designed to provide governments with a template for implementing Pillar Two of the agreement reached by 137 countries and jurisdictions under the OECD/G20 Inclusive Framework on BEPS to address the tax challenges arising from digitalisation and globalisation of the economy.

Pillar Two is a key component of the overall plan to address the challenges of globalisation and digitalisation of the economy and is intended to ensure that large multinational enterprise pay a minimum level of tax on the income arising in each of the jurisdictions where they operate. These rules are intended to be implemented as part of a common approach and to be brought into domestic legislation as from 2022 and take effect from 2023.

Background

Discussions have been taking place for several years at the OECD concerning fundamental changes to the international tax landscape to deal with problems created by the digital economy. The publication of a Policy Note and a Public Consultation in 2019 led to a number of proposals for reform, grouped under two "pillars": revised profit allocation and nexus rules (Pillar One); and a global anti-base erosion proposal for a minimum level of taxation (Pillar Two). A public consultation document on Pillar Two, seeking solutions to the ongoing risks from structures which allow MNEs to shift profits to low tax jurisdictions through additional global anti-base erosion (GloBE) proposals, was published in November 2019.

In January 2020, the OECD delivered an update, "Statement by the OECD/G20 Inclusive Framework on BEPS on the Two-Pillar Approach to Address the Tax Challenges Arising from the Digitalisation of the Economy", setting out the progress that had been made and this was followed in October 2020 by the publication of two blueprints for Pillar One and Pillar Two. Political agreement was reached in June 2021 on the two pillar approach and in October 2021 the OECD published details of the agreement in a Statement on the Two-Pillar Solution containing broad details of the agreed components of the Pillars and an implementation plan.

Pillar Two

The overall design of Pillar Two consists of:

• two interlocking domestic rules (together the Global anti-Base Erosion Rules (GloBE) rules): (i) an Income Inclusion Rule (IIR), which imposes top-up tax on a parent entity in respect of the low taxed income of a subsidiary entity; and (ii) an Undertaxed Payment Rule (UTPR), which denies deductions or requires an equivalent adjustment to the extent the low tax income of a subsidiary entity is not subject to tax under an IIR; and
• a treaty-based rule (the Subject to Tax Rule (STTR)) that allows source jurisdictions to impose limited source taxation on certain related party payments subject to tax below a minimum rate. The STTR will be creditable as a covered tax under the GloBE rules.

For further details of the rules see our article OECD announces international agreement on taxation.

The Pillar Two Model rules cover the implementation of the GloBE rules and provide further details of each aspect of the rules. The document is split into a number of Chapters, each dealing with separate aspects of the rules as follows:

• Chapter 1 defines the scope of the GloBE Rules.
• Chapter 2 determines the constituent entities in the group that are liable for any top-up tax and the portion of any top-up tax charged to any such entity.
• Chapters 3 and 4 set out the components of the effective tax rate calculation under the GloBE Rules. Chapter 3 determines the income (or loss) for the period for each constituent entity in the MNE Group and Chapter 4 then identifies the taxes attributable to such income
• Chapter 5 aggregates the income and taxes of all constituent entities located in the same jurisdiction to determine the effective tax rate for that jurisdiction. If the effective tax rate is below the minimum rate, the difference results in a top-up tax percentage which is applied to the
  jurisdictional income to determine the total amount of top-up tax. The top-up tax is pro-rated amongst the constituent entities located in that jurisdiction and then charged to the constituent entities liable for any top-up tax in accordance with Chapter 2. Chapter 5 also includes an elective substance-based income exclusion that may reduce the amount of profits subject to any top-up tax.
• Chapter 6 contains rules relating to acquisitions, disposals and joint ventures.
• Chapter 7 deals with the application of the GloBE Rules to certain tax neutrality and other distribution regimes.
• Chapter 8 covers administrative aspects of the GloBE Rules including information filing requirements as well as the application of any safe-harbours.
• Chapter 9 sets out certain transitional rules.
• Chapter 10 sets out defined terms used in the GloBE Rules.

The GloBE rules will have the status of a common approach. This means that Inclusive Framework members:

• will not be required to adopt the GloBE rules, but, if they choose to do so, they will implement and administer the rules in a way that is consistent with the outcomes provided for under Pillar Two, including in light of model rules and guidance agreed to;
• will accept the application of the GloBE rules applied by other members.

Next steps

In early 2022, the OECD will release the Commentary relating to the model rules and address co-existence with the US Global Intangible Low-Taxed Income (GILTI) rules. This will be followed by the development of an implementation framework focused on administrative, compliance and co-ordination issues relating to Pillar Two.

The Inclusive Framework is also developing the model provision for a Subject to Tax Rule, together with a multilateral instrument for its implementation, to be released in the early part of 2022. A public consultation event on the implementation framework will be held in February and on the Subject to Tax Rule in March.

The full text of the model rules, an overview and FAQs can be found on the OECD website here.