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Freshfields Risk & Compliance

| 8 minutes read

The OECD’s Pillar One proposal: where are we now?

The OECD’s Pillar Two proposal to introduce a global minimum tax is undoubtedly a hot topic in the corporate tax world at the moment. With significant aspects of the Pillar Two rules coming into force from January 2024, multinationals’ attention is understandably focused on the practical impact of these rules (see our previous blog post here on the expected M&A impact). 

But where do things currently stand in relation to the other part of the OECD’s two-pillar initiative?

Pillar One: a refresher

The OECD’s Pillar One proposal is designed to address a concern that the traditional international tax rules (broadly) requiring physical presence to allocate taxing rights are not fit for purpose in a globalised and digitalised economy where businesses no longer need to be physically present in a jurisdiction to do business there. 

In broad terms, Pillar One comprises two sets of measures:

  • Amount A: designed to give ‘market jurisdictions’ (ie jurisdictions in which goods and services are used or consumed) a new taxing right over residual profits of very large multinational groups, with no prerequisite of that group having a physical presence there. These rules are intended to replace the growing number of domestic digital services taxes and similar measures (DSTs) which have been implemented unilaterally in recent years and typically seek to tax multinational groups that derive large revenues from users of digital services (eg social media platforms and online marketplaces) in the market jurisdiction (see here for further details); and
  • Amount B: designed to introduce a new standardised (and simplified) transfer pricing methodology in respect of ‘baseline marketing and distribution activities’.

Amount A: a new taxing right and removal of domestic DSTs

How is Amount A intended to work?

The Amount A rules are very detailed and technically complex (as illustrated in a recent OECD technical webinar). To give a sense of this, a high-level summary of the Amount A calculation rules is set out below:

  1. Determine whether the multinational group is in scope of Amount A (ie has annual revenues in excess of €20 billion and profitability exceeding 10% (noting that revenues and profits from extractives and regulated financial services are excluded));
  2. Determine which market jurisdictions are eligible to tax a portion of that group’s residual profits under Amount A by applying both revenue sourcing rules and financial scoping rules (ie jurisdictions from which the group derives annual revenues of more than €1 million (€250k for jurisdictions with a GDP below €40 billion));
  3. Determine the relevant measure of profit for that group (by making various adjustments to the group’s annual profit as per its consolidated financial statements);
  4. Determine the Amount A profit for that group (ie 25% of the above-mentioned profit in excess of 10% of the group’s annual revenues);
  5. Allocate that Amount A profit to each eligible market jurisdiction (in proportion to the amount of the group’s annual revenues that are derived from that jurisdiction, and then adjusted downwards under the Marketing and Distributions Profits Safe Harbour (MDSH) to reflect any existing taxing rights); and
  6. Eliminate any double taxation (by identifying relieving jurisdictions, calculating jurisdictional relief obligations by reference to each jurisdiction’s aggregate ‘return on depreciation and payroll’ (RODP), and then attributing those jurisdictional obligations to specific entities).

What is the current status of Amount A?

Unlike Pillar Two, Amount A is not designed to impose additional taxation on in-scope multinational groups; instead, it seeks to reallocate taxing rights between jurisdictions. The new taxing right needed to achieve this reallocation would require the existing double tax treaty network to be modified – and the OECD intends for such modifications to be introduced through a Multilateral Convention (MLC). (Where there is no relevant double tax treaty between two jurisdictions to be modified, the MLC is designed to itself implement Amount A.) 

According to the Outcome Statement published in July 2023, the intention is for the MLC to be open for signature by the end of 2023, before entering into force in 2025. For reasons discussed below, it seems unlikely this timetable will be met. 

Although the draft text of the MLC has now been published, it is not yet open for signature. This is because its contents have not yet been fully agreed. According to the OECD, there remains “different views on handful of specific items… by a small number of jurisdictions, who are constructively engaged in resolving these differences”. However, recent comments from other stakeholders suggest that these open points may be much more fundamental: we understand that the MDSH remains a point of contention, and noting that this is one of the most complicated aspects of Amount A, a prompt resolution is far from certain.

Even if the MLC wording is agreed, there is no guarantee that it will come into effect. To come into force, the MLC must be ratified by 30 jurisdictions together accounting for at least 60% of the ultimate parent entities of the groups expected to be in-scope for Amount A purposes (the threshold level) and it is not a given that this requirement will be met. As noted above, the Amount A rules are not straightforward and the length and scale of negotiations on these rules implies that various compromises have already been made. This combination of factors may well mean that some jurisdictions may, for political and/or fiscal reasons, simply opt not to implement Amount A. For example, the African Tax Administration Forum (ATAF) published a Communication in response to the Outcome Statement, noting that African jurisdictions that signed the Outcome Statement are not necessarily committed to implementing the Amount A rules and expressing concern that, as currently envisaged, Amount A will only lead to a very limited reallocation of profits to African countries.

Perhaps the biggest hurdle for implementation of Amount A is the position of the US. Given the significant number of expected in-scope groups which are headquartered in the US, the position the US takes on the MLC is of particular importance. The US Secretary of the Treasury has already confirmed that the US will not sign the MLC this year, noting that engagement with stakeholders “to make sure that [Amount A] has solid support in the US” will be required first. More fundamentally, though, any ratification of the MLC by the US President is subject to the approval of two-thirds of the Senate – and a (largely) Republican opposition raises real doubts about whether this threshold can be met during this Congress.

What is the status of domestic DSTs?

As mentioned above, the Amount A initiative is partly aimed at avoiding the proliferation of domestic DSTs. The initial introduction of DSTs in various European jurisdictions led to retaliatory trade actions from the US as the US looked unfavourably on the introduction of (non-US) DSTs, seeing them as targeting the profits of its tech giants. 

As part of the Pillar One negotiations, members of the Inclusive Framework agreed both to refrain from introducing any new DSTs while negotiations are ongoing and to remove any existing domestic DSTs once the Amount A rules are in place. The Outcome Statement provided that this standstill period would be extended to the end of December 2024 for most Inclusive Framework members, but on the condition that the threshold level of jurisdictions sign the MLC before the end of 2023. Given the points set out above, it is not clear this condition will be met, which could give the green light for new domestic DSTs to be introduced in 2024 – unless an extension to the standstill period is agreed in short order.

Demonstrating that the appetite for domestic DSTs has not disappeared, Canada was notably absent from the list of Outcome Statement signatories, and has recently taken steps to introduce its own domestic DST (while also noting it is otherwise supportive of the Pillar One proposals). 

Amount B: streamlined transfer pricing for baseline marketing and distribution activities

How is Amount B intended to work?

In broad terms, Amount B is designed to simplify the application of the arm’s length principle to ‘baseline marketing and distribution activities’ – effectively by setting a fixed return for such activities in transfer pricing methodologies intended to approximate the arm’s length principle without requiring groups to undertake extensive transfer pricing benchmarking analysis. 

Unlike Amount A, Amount B is not limited in scope to very large multinational groups: it is intended to apply to the ‘baseline marketing and distribution activities’ of all taxpayers. The activities which will be in-scope of Amount B remain under discussion, but it is envisaged that the Amount B proposals will capture a range of marketing, sales and logistics functions (including both buy-sell arrangements and sales agency and commissionaire arrangements), provided they meet the ‘baseline’ condition – indicia of which include the absence of economically significant risks being assumed and unique and valuable intangible assets being generated. 

In-scope transactions will then be priced for transfer pricing purposes by reference to a pricing matrix (or internal comparable uncontrolled prices, if available). Again, the details of this framework remain under discussion, but the core idea is that it will provide a set of arm’s length returns expressed as returns on sales, with the relevant ‘return’ for a particular transaction dependent on distributors’ circumstances. 

What is the current status of Amount B?

The intention is for the Amount B rules (including additional documentation requirements) to be implemented through amendments to the OECD’s Transfer Pricing Guidelines (the Guidelines) – a process which may shortcut some of the implementation hurdles faced by Amount A.

However, as noted above, the specific amendments to be made to the Guidelines are yet to be agreed. The OECD launched a second consultation on Amount B in July this year, and published the public comments received in September. As highlighted above, it is clear from these documents that significant differences in stakeholder views on key aspects of the design of the rules remain, and given the scale of the changes Amount B seeks to introduce to transfer pricing methodologies, it is far from guaranteed that agreement will be possible. 

According to the Outcome Statement, the Inclusive Framework plans to approve and publish its final Amount B report later in 2023, with content from this report then incorporated into the Guidelines by January 2024. Noting the lack of consensus on the details of Amount B, it is unclear whether agreement on Amount B will be reached by this deadline. Even if it is, the Outcome Statement stresses that “the timeline for smooth implementation of Amount B will take into account… the interdependence of Amount B and the signing and entry into force of the MLC… [and] the time necessary for some jurisdictions to adopt legislative changes to give effect to the revised [G]uidelines as well as to allow business to be prepared”. As such, the Amount B proposals may well not come into effect for some time in any event.

What’s next?

Although there has been reasonable progress in agreeing the Amount A rules in principle, doubts about successful implementation remain. By contrast, although the Amount B proposals are less advanced at this stage, if agreement can be reached (and that remains a big if), (eventual) implementation seems more likely. 

Given the genesis of the OECD’s two-pillar initiative for global tax reform was to address the challenges of taxing the digitalised economy, it would be ironic for the Amount A proposals to stall and potentially fall away while implementation of Pillar Two rules continues apace. Nor would a (re-)proliferation of uncoordinated domestic DSTs and/or reignition of trade tensions be welcome. 

This all leaves taxpayers providing cross-border digital services in a difficult position. In principle, the very large multinational groups that would be within scope of Amount A would want to assess how the new rules would impact their business models as well as what new compliance processes would be required in order to apply the complex Amount A calculation rules. Those groups (as well as others) also need to consider in parallel how they would deal with multiple different domestic DSTs in the event the Amount A rules are not implemented. However, that exercise will necessarily be uncertain and require ongoing monitoring – a significant compliance burden for taxpayers already grappling with Pillar Two.

If you would like to discuss in further detail any of the points raised in this blog post, please contact the authors or your usual Freshfields contact.


europe, global, tax, uk, us