In 2021, 140 countries reached political agreement on a global corporate tax reform. Now, a few years later, the implementation is proving to be a challenge, perhaps even to the point of the initial agreement’s collapse. What happened?
Introduction
In 2021, around 140 countries reached political agreement within the OECD/G20 Inclusive Framework on Base Erosion and Profit Shifting (IF) on a global reform of the international profit tax system. The agreement addresses the tax challenges of the digitalizing economy along two pillars: Pillar One and Pillar Two, or the Two-Pillar Solution. Pillar One envisages a redistribution of the corporate profits of the approximately 100 to 125 largest companies worldwide towards market jurisdictions. Pillar Two introduces an alternative profit tax, the so-called Global Minimum Tax (GMT). This obliges large companies – having an annual turnover of more than €750 million – to pay at least 15% minimum profit tax. This tax must be paid in the country where these companies carry out their business activities, or else in one of the other countries in which they operate.
Now, a few years later, the implementation is proving to be a challenge. The two-pillar reform aims to tax multinationals more fairly, in the right place and at the right rate. The measures aim to put a floor on the possibilities for countries to compete with each other fiscally. Around 60 countries, including all Member States of the European Union (EU), have implemented the Pillar Two agreements in their national legislation or are in the process of doing so. Simultaneously, several countries are reviewing their tax incentives to mitigate the impact of Pillar Two on their competitive position. Some countries have not moved, or at least not yet, amongst others the United States and China. The agreements on Pillar One still need to be further fleshed out. Progress there seems to have stalled since the summer of 2024. At the same time, the pressure to find a sustainable solution remains undiminished.
A changing tax landscape
Transparency, coherence and substance
Our thinking about the taxation of multinationals has changed considerably in recent years. Earlier, it was mainly about tackling tax havens and letterbox companies. The launch of the Organisation for Economic Co-operation and Development (OECD) Base Erosion and Pofit Shifting (BEPS) project in 2012, at the invitation of the G20, led to several measures in 2015. These focused on tax information exchange (transparency), tackling tax avoidance (coherence) and ensuring that taxation takes place where the commercial value is created (substance). Examples of anti-BEPS measures within the EU can be found in the Anti-Tax Avoidance Directive (ATAD) and the Directive on Administrative Cooperation (DAC). The ATAD measures seek to close tax gaps and strengthen the integrity of the international profit tax system. The DAC measures focus on administrative cooperation between tax authorities.
Not: where to tax and how much to tax
The 2015 anti-BEPS measures do not address the underlying questions of where companies should pay their corporate income tax and how much tax they should pay. While an opening for more fundamental reform lay in one of the focus areas, the taxation of the digital economy (BEPS Action Point 1), for practical reasons OECD countries deviated to best practices within the framework of countries’ existing tax systems. While some believe this explains the success of the BEPS project, it also led to criticism. Criticism came mainly from developing countries and emerging economies. Several countries felt that they were not sufficiently heard within the IF, the consultation platform for countries for the formation and implementation of international tax policy organized by the OECD at the invitation of the G20. Tackling tax avoidance within the existing tax framework means that the tax base is mainly concentrated in countries where companies make their highest-quality investments. In practice, these are mainly the developed countries. At the same time, countries compete with each other for companies’ investment location decisions through their tax and subsidy systems. Incentives in developed countries, such as patent boxes, focus on high-tech investments. By comparison, developing countries focus their ‘tax holidays’ mainly on investments in production and assembly. In the meantime, tax revenues must be generated to finance public services. There’s tension there.
Unilateral measures and countermeasures
In the search for tax revenues, several countries reacted to the 2015 BEPS results by introducing unilateral measures. Several countries have taxed foreign technology companies that serve their markets without physically establishing themselves there, such as companies providing online services in the field of social media platforms, trading platforms and/or search engines. The initiatives became known as digital services taxes (DSTs). Well-known examples of countries that introduced DSTs are Canada, France and India. This led to political tensions, especially in relation to the United States (US) which sees this as discriminatory tariffs to the detriment of American business and especially the famous tech giants. The U.S. responded with retaliatory measures, trade sanctions, and threats of them.
Pillar One stagnates
The momentum for change led to the first steps within the IF in 2019 towards what would later become the two-pillar solution (BEPS 2.0). Unlike the BEPS measures from 2015, the new plans did address the question of where multinationals should pay tax (Pillar One) and how much tax this should be (Pillar Two). The developments led to the political agreement in 2021. While the Global Minimum Tax from Pillar Two came to fruition, in the summer of 2024 the Pillar One plan to partly shift taxation to countries where companies sell their products stagnated because countries could not come to an agreement on the content. The final version of the developed Pillar One treaty has yet to be published. The success of Pillar One hinges on the willingness of the US to ratify the treaty. This requires a two-thirds majority within the U.S. Senate. For the time being, there is none. Part of the agreements is the reversal of the previous digital services taxes. This agreement expires at the end of 2024. It is expected that previously reversed unilateral measures will be revived in several countries. This may very will trigger retaliatory responses in others. Canada, for example, did not agree to an extension of this agreement and introduced a digital services tax as early as the summer of 2024. This has led to some tensions in the business relationship with the US.
UN Framework Convention on Tax Cooperation
Dissatisfaction among developing countries about the outcomes of the consultations within the IF led to the adoption of a resolution within the United Nations (UN) in 2023 on the development of a UN Framework Treaty for International Tax Cooperation. In the summer of 2024, the first steps were taken towards further concretization. The UN Framework Convention should become a reality in 2027. The aim is to develop fairer taxation of profits, with a focus on more market-oriented approaches to the distribution of tax bases between countries. The aim is to organize a more inclusive and representative consultation platform within the UN context, also for the benefit of developing countries. There is tension here too. The EU Member States, the United Kingdom, the US and several of the other most developed countries see a particular role for the IF in this respect.
Intra-EU tax integration
Within the EU, the Global Minimum Tax from Pillar Two has been introduced through an EU directive, the EU Pillar 2 Directive. This is in line with the long-standing ambitions within the EU institutions to further integrate the corporate tax systems of the EU member states. The European Commission’s proposals in this direction, in addition to the EU Pillar 2 Directive, such as the 2023 proposal for a BEFIT (Business in Europe: Framework for Income Taxation) and before that the 2011 and 2016 proposals for a Common Consolidated Corporate Tax Base (CCCTB) are attempts to achieve this. These proposals are aimed at the development of a European tax base for large companies within the EU, which would be distributed among the Member States according to a formula. This, instead of the arm’s length principle (transfer pricing) as it is currently applied. The proposals aim to establish a harmonized approach within the EU, in order to strengthen the internal market and create a level playing field. The integration promises a more streamlined and efficient tax environment. This should improve European competitiveness. The plans also include the use of European tax incentives and the creation of own resources to finance the EU budget. In the case of the CCCTB, the EU Member States were unable to reach an agreement. One of the key issues involved the tax base distribution key. The BEFIT proposal is also politically difficult. Tax reform is also proving difficult to implement within the EU.
Draghi report
Recently, on September 9, 2024, former President of the European Central Bank Mario Draghi published an influential report for the European Commission. The report provides an economic vision for the future of the EU. It stresses the need for the EU to attract investment and provide tax incentives. The report outlines the importance of European cooperation in the current international political arena and the competition with the US and China. The report argues that the EU needs to spend a lot of public money to achieve its strategic policy objectives, such as the energy transition and promoting technological innovation. The EU needs to invest to promote the strategic independence and resilience of Member States.
It will be interesting to see how the European fiscal stimulus measures from the Draghi report will take shape. Within the internal market, state aid rules apply. With the Foreign Subsidies Regulation (FSR), the EU is also trying to impose a level playing field on third countries. EU Member States will have to coordinate their incentives in order not to infringe state aid rules. This is important in view of, for example, the outcome of the recent Apple state aid case. The Court of Justice of the European Union upheld the European Commission’s decision on the basis of which EU member state Ireland was obliged to recover tax state aid of more than €13 billion granted to the famous American tech company.
In addition, the Global Minimum Tax from Pillar Two does not give the individual EU member states and the EU as a whole much room for tax incentives and subsidies. A rationale under the global 15% minimum tax system is that when countries fall below the minimum rate, other countries levy additional taxes to neutralize the effects of the incentives. Tax competition reduction is one of the core objectives of Pillar Two, but tax subsidies and tackling tax competition are difficult to reconcile.
Pillar Two under pressure
The Global Minimum Tax is also under pressure. The US and China have not introduced the 15% minimum tax in the Pillar Two agreement. They subsidize their businesses substantially. For a number of years now, the US has had its own light version of the minimum tax rules, in line with US interests. The U.S. thinks that’s more than enough. The U.S. Congress explicitly opposes both Pillar One and Pillar Two, especially when the rules developed within the IF work against American business. While the U.S. may be the most vocal here, it is not actually alone. Other countries also continue to use their profit tax systems to compete with each other for companies’ investment location decisions. Several countries, both developed and developing, are resorting to subsidy measures to mitigate the implications of Pillar Two additional taxes. China is still keeping its cards close to its chest, it seems. All this puts pressure on the sustainability of the Pillar Two reforms.
The Pillar Two rules are also being eroded from within. Within the IF context, the rules are gradually being adjusted, for example to facilitate variants of tax credits – so-called Qualified Refundable Tax Credits (QRTCs) and Marketable Transferable Tax Credits (MTTCs). These are tax rebates and tax refund schemes with a design very similar to those introduced by the US with the Inflation Reduction Act (IRA). The IRA introduced large-scale incentive schemes for corporate America a few years ago. Another example can be found in the additional levy to the minimum level. In order to spare countries where companies have their headquarters, the Pillar Two rules on the additional taxation by other countries have been temporarily softened. This caters to US and Chinese interests where many of the biggest multinational companies are headquartered. The temporary mitigation should expire in about a year. The question is whether this will actually happen or whether we will look forward to extensions. In response to parliamentary questions as to whether this does not actually undermine the idea of Pillar Two, the Dutch State Secretary for Finance indicated that these agreements were necessary to reach an international consensus.
What’s next?
The two-pillar solution promises a fairer international profit tax system. Pillar One should lead to a fairer distribution of the tax base of the largest multinationals. At the same time, we see Pillar One stagnating. Reintroduction of previously reversed unilateral digital services taxes and subsequent retaliatory measures are the possible consequence. Pillar Two aims to tackle tax avoidance and tax competition. Many countries are actually implementing Pillar Two. At the same time, when it comes down to it, we see countries focusing their efforts on securing subsidy measures in order to remain internationally competitive. There is also a political discussion in the Netherlands, for example, whether the innovation box regime should be transformed into a tax credit. Meanwhile, the rules of both Pillar One and Pillar Two have taken on almost mythical proportions in terms of complexity, regardless of whatever OECD officials tell us about this. In the real world this poses some serious challenges for both companies and governments.
Within the EU, the Draghi report calls for the EU to prevent itself from putting itself at a disadvantage both in terms of competitiveness and geopolitics by not following the competition. European industry has previously expressed similar concerns and is calling for action by the EU and its institutions to increase European competitiveness through publicly funded interventions. It’s about investing in innovation, R&D, technology, digitalization, artificial intelligence, and how all of this can be driven to preserve and promote European prosperity. The follow-up question is how to finance this. Discussions about the generation of new own resources and EU budget expansions are politically difficult.
The OECD is working on frameworks within which countries can compete with each other for tax purposes, without conflicting with the minimum tax rules of Pillar Two. Part of this is the so-called No Benefit Rule (NBR), which allows countries to disqualify each other’s Pillar Two rules when countries take accompanying subsidy measures to mitigate the effects of their Pillar Two additional taxes. The scope of this rule is not clear and that is starting to get tricky. Depending on the room for manoeuvre that will be created, the effectiveness of the minimum tax rules will be correspondingly diluted. This, apart from the legal thorny issues that are now emerging in practice around Pillar Two, for instance as to the planning opportunities within Pillar Two and the interactions of the rules with country constitutions, tax treaties, investment treaties and human rights conventions, under all which Pillar Two may potentially fall foul.
What about the developing world? Countries may unilaterally revert to digital services taxes, the withholding tax variant in the UN Model Tax Convention, digital permanent establishments or even unilateral implementation of Pillar One. This, for example, in relation to countries with which no tax treaty has been concluded. A complicating element, apart from the risk of retaliatory measures, is that digital services taxes and withholding taxes increase the cost of doing business. This is in view of their mostly gross basis (no deduction of costs) and cascading nature (multiple taxation within the supply chain). Although difficult to quantify, this can have a depressing impact on the local investment climate. This, in turn, has implications for job creation and prosperity. Incidence issues arise when companies then pass the burdens of these taxes on to consumers and employees through product prices and wage restraints. In addition, no technical solution is yet available to distinguish between digital companies and other companies for tax purposes, as it is the economy that is digitalizing rather than a digital branch of industry has been emerging and which can be ring-fenced for tax purposes. Transformations from tax incentive mechanisms to subsidies mechanisms are difficult to organize for developing countries. These countries do not always have the capacity and resources available to do so. The success of the UN Framework Convention remains to be seen.
Concluding
The route from the two-pillar agreement to its implementation brings a lot of political dynamic. The shift of tax base to market jurisdictions from Pillar One brings winners and losers. The curbing of tax competition from Pillar Two undermines the autonomy of countries to fiscally compete for business investment. The U.S. and China heavily subsidize their businesses. Within the EU, the Draghi report calls for publicly funded interventions to increase European competitiveness. Within the IF, peer review procedures are being developed to regulate fiscal competition. Developing countries feel that they are in a complicated position. The envisaged UN Framework Convention aims to make international tax policy more inclusive and fair. A challenge. The tax landscape of the near future is dynamic and tense, messy, complex, competitive and difficult to navigate legally. For both governments and companies, this is a challenge and a reality to carefully prepare for and take into account. This also is something other than the stabilization of the company tax architecture that the two-pillar solution had promised. This begs the question whether and to what extent the two-pillar solution in today’s Realpolitik world is becoming a two-pillar problem.