Overcoming tax challenges in the digitalized economy: Introducing the two-pillar solution

In addition to the BEPS Action Plan, the OECD/G20 has been actively involved in international efforts against tax evasion and avoidance through the Inclusive Framework on BEPS. It is important to note that developing countries, which heavily rely on corporate income tax as a revenue source, also experience the negative effects of BEPS. Therefore, global collaboration is essential to address BEPS and restore trust in domestic and international tax systems.

The OECD/G20 Inclusive Framework on BEPS brings together more than 135 countries and jurisdictions, working collectively to implement 15 Actions aimed at tackling tax avoidance, improving the coherence of international tax rules, ensuring tax transparency, and addressing the tax challenges arising from digitalization. The framework aims to ensure that the BEPS package effectively addresses tax avoidance, promotes collaboration, and creates a more transparent tax environment.

Numerous countries, including those in Africa, have joined the inclusive framework to address the tax challenges posed by digitalization. The framework introduced a Two-pillar plan to reform international taxation rules and ensure that MNEs pay their fair share of taxes regardless of their presence in specific jurisdictions. Currently, over 135 countries/jurisdictions participate in the agreement.

The rationale behind the two-pillar plan includes the following objectives:

Ensuring a fair distribution of profits and taxing rights among countries concerning the largest MNEs, including digital companies.
Reallocating taxing rights over MNEs from their home countries to the markets where they conduct business activities and earn profits, irrespective of physical presence.
Establishing a global minimum corporate tax rate (Pillar Two) to curb competition over corporate income tax and protect tax bases.

While the two-pillar solution is still subject to agreement among members of the OECD/G20 Inclusive Framework on BEPS, a comprehensive plan for implementation, including model legislation, guidance, and a multilateral treaty, was developed in 2022, with implementation set to commence in 2023.

The key components of each pillar are as follows:

Pillar One:

Scope: Multinational enterprises are included, with a global turnover threshold of 20 billion euros (to be reduced to 10 billion euros) and a profitability threshold of 10%.
Nexus: A special purpose nexus rule is introduced to allocate profits to market jurisdictions based on revenue thresholds.
Amount A: A reallocation mechanism that allocates a percentage of MNEs' profits exceeding 10% of revenues to market jurisdictions based on revenue sourcing rules.
Tax certainty, administration, and other aspects are also addressed.

Pillar Two:

Quantum: Between 20-30% of residual profit (profit in excess of 10% of revenue) is allocated to market jurisdictions using a revenue-based allocation key.
Revenue sourcing: Revenue is sourced to end market jurisdictions where goods or services are used or consumed, with specific source rules for different transaction categories.
Tax base determination, segmentation, safe harbor for marketing and distribution profits, elimination of double taxation, and administration are also covered.

The strategic approach of the two-pillar solution aims to address gaps in existing rules that allow MNEs to avoid tax payments. Each pillar focuses on different aspects to ensure fair taxation and profit allocation.

In conclusion, the international community recognizes the need to address international taxation challenges posed by MNEs. The OECD/G20 Inclusive Framework on BEPS, with over 135 participating countries and jurisdictions, aims to implement the two-pillar solution to ensure fair taxation, reallocation of profits, and a transparent tax environment. By working together, countries can combat tax avoidance, promote tax transparency, and create a more equitable international tax system that adapts to the digitalized economy.