BEPS 2.0: Pillar 1 and Pillar 2 Update

published on 13 July 2022 | reading time approx. 3 minutes

Base erosion and profit shifting (BEPS) is a tax planning framework introduced by the OECD to target gaps and inconsistencies in tax legislation, which mean large multinationals underpay or avoid paying tax.

One of the primary issues is that developing countries disproportionately rely on corporate income and suffer the bulk of the 95 € - 230 € billion lost yearly.

The first phase, BEPS 1.0, created 15 staged BEPS Actions to address cross-border taxation, with (currently) 141 participating countries agreeing to minimum standards. Now, BEPS 2.0 looks to go further, and deal with the challenges of taxing an increasingly digital economy, split into two pillars.

The Background of BEPS 1.0

The BEPS 1.0 initiatives have created considerable change in international tax rules, focusing on mitigating profit-shifting opportunities. Led by the OECD and G20 countries, the action plans were published in 2015 following a series of revelations around aggressive tax planning and tax evasion, coupled with the 2008-2009 financial crisis.

However, the limitation of BEPS 1.0 is that it does not comprehensively address digital transactions, which are increasingly prevalent in almost all industries, particularly in service delivery and online retail. Individual countries have introduced a range of new tax laws in the interim, addressing trading entities involved in online sales or platforms. These companies are subject to new digital service taxes, which previously did not exist.

BEPS 2.0 is intended to consolidate those unilateral taxation regimes into an overall consensus between BEPS participant countries (the Inclusive Framework) to avoid double taxation or inconsistent tax treatments.

What Is the BEPS 2.0 Reform Package?

The expanded BEPS framework attempts to modernise tax rules, and the Inclusive Framework, or IF, agreed on the main content of the package in July 2021. A more detailed agreement was released in October 2021, with model minimum tax rules published in December 2021, which gives more detail about the content of BEPS 2.0 and how it will be introduced.

There are two BEPS 2.0 pillars, which together comprise the global action plan:

Pillar 1 focuses on rules for taxing profits and rights, with a formula to calculate the proportion of earnings taxable within each relevant jurisdiction.
Pillar 2 looks at global minimum tax levies of 15% to discourage companies from shifting profits to lower-tax countries through international trading structures.

Now that there is the basis of an agreed global framework, reactions will vary between countries, depending on the extent of the impact and how this will slot into existing tax regimes. Some countries may need to adjust tax incentive schemes to encourage foreign investment or change initiatives to replace tax allowances with grants or other financial incentives.

Compliance will also likely command greater investment in resources, resulting in increased budgets spent on updating tax functions, which will impact both organisations and governmental tax offices.

BEPS 2.0 Pillar One

Pillar One involves a new taxation methodology aimed at digitised companies and consumer-serving organisations that trade or communicate with customers through a digital format. Revenues generated from consumers in one country or from consumer data extracted from that country will be subject to tax regardless of whether the organisation has a physical presence in the jurisdiction.

As Pillar One has progressed, it has changed somewhat from the original scope, and while regulated financial services are not expected to be included, most other industries will be.

In summary, Pillar One means that:

Taxing rights will belong to the country where the company's customer is located.
Organisations with revenues of €20 billion or more and a profit margin of 10% or greater will be subject to the new rules.
Over time, the threshold for inclusion will drop to €10 billion in annual revenue.

Profit allocations between countries will rely on a formulaic approach, a significant change from the current transfer pricing regulations.

BEPS 2.0 Pillar Two

Pillar Two is equally far-reaching and introduces global tax reforms that aim to end the competition between countries to offer the lowest possible corporation tax rates to attract foreign investment. The primary factor in Pillar Two is a set of rules called GloBE (Global anti-Base Erosion).

Those rules mean that the largest multinationals, with a revenue of €750 million or more per annum, should pay a minimum effective tax of 15% in every jurisdiction in which they trade. Countries will be permitted to apply top-up tax rates where a multinational in their jurisdiction is taxed below the minimum threshold.

There are some exclusions to GloBE, for:

Countries where a multinational group has a revenue of below €10 million and profit of under €1 million (according to the GloBE calculations).
Groups beginning an international expansion, with less than €50 million in tangible assets held overseas and a presence in no more than five additional jurisdictions.
Pension funds, governmental and intergovernmental organisations and investment entities.

To determine the top-up tax payable, GloBE will test the effective tax rate in each country, define the additional tax payable to reach 15%, and allocate that amount through a top-up tax. Although the OECD doesn't wish to mandate a minimum tax rate, the concept is that foreign income received through branches or foreign subsidiaries of a multinational group will face a minimum taxation rate.

Along with additional parent company tax charges for low-taxed foreign revenue, Pillar Two allows for taxation at source for low-tax paying organisations.

How Will BEPS 2.0 Impact EU Member State Tax Regimes?

BEPS 1.0 may have changed some international taxation rules but did not introduce a minimum rate. Hence, BEPS 2.0 seeks to make tax regimes less of a deciding factor for multinationals deciding which jurisdictions to trade or invest in.

The effect on EU economies will differ considerably, depending on the nature of the economy. For example, some countries such as Ireland and Luxembourg have established competitive economies, partly owing to tax regimes that attract multinational regional hubs.

European member states have vastly contrasting tax rates, from average rates in France and Germany of around 30%, compared to an Irish statutory 12.5% rate and a very low 9% tax level in Hungary. Average tax rates across the EU sit at between 20% and 25%.

Interestingly, Hungary has - as yet - blocked the required unanimous vote to pass the 15% minimum corporate tax rate into EU law, citing the potential to deter foreign investment.

As part of an impact analysis, the OECD anticipates that global tax revenues will rise by 4% due to BEPS 2.0 and will most affect economies with the largest volumes of direct investment. The expectation is that BEPS 2.0 will be implemented from 2023 onward, although likely in a phased integration.