Digital transformation has triggered the development of new business models that allow multinational enterprises to generate huge profits through using intangible property, such as intellectual property and data, without having any physical presence in the jurisdictions where they operate.
However, the international tax rules that are currently in place are outdated and not equipped to address this new virtual reality, making it a challenge for tax regulators in some jurisdictions to tax the income generated from such intangible property. Through "nexus" and "profit allocation" rules, multinational enterprises are able to avoid paying taxes in the countries where they generate their profits.
The journey to global consistency and transparency
In a bid to establish a consensus on how to tax MNEs in a digital age, the Organization for Economic Cooperation and Development's Inclusive Framework on Base Erosion and Profit Shifting (BEPS), which is a global initiative of more than 150 countries, has worked out an action plan. Through international cooperation and greater transparency, the OECD's Inclusive Framework has suggested that countries can develop more effective rules to minimize tax avoidance in order to ensure that all countries benefit from the economic activity of these companies.
Within this, the Two Pillar Solution aims to ensure that MNEs pay a minimum level of tax on their global profits, regardless of where they are booked, through two core layers: the establishment of a global minimum tax and the subject to tax rule (STTR).
The minimum tax rule will use tax regulation to ensure multinational enterprises pay a minimum tax in each of the jurisdictions where they operate to address profit-shifting practices. This comes with administrative and adoption barriers to implementation as legislative changes to tax laws are required in jurisdictions where the rate of tax is below the minimum.
Through the STTR, the OECD aims to close a loophole that allowed MNEs to conduct intragroup payments in jurisdictions with lower tax rates. This is intended to protect the tax base of developing countries by preventing MNEs from shifting profits to low-tax jurisdictions and promotion of fair taxation of MNEs global profits.
Understanding the Multilateral Convention
In October 2023, the OECD published the Multilateral Convention to Facilitate the Implementation of the Pillar Two Subject to Tax Rule — considered an integral vehicle to concluding Pillar Two's objectives.
What will the Multilateral Convention achieve?
The STTR allows source jurisdictions where a payment originates to "tax back" defined categories of intra-group payments, including interest, royalties and certain specified payments, even if taxing rights over that income have been ceded under a Double Tax Treaty (DTT). This is triggered when the effective tax rate on the covered income falls below 9%, with the top up tax being the difference between the actual tax rate in the recipient country and the 9% minimum threshold.
How will the Multilateral Convention work?
The STTR's implementation is being expedited through a multilateral convention, an international agreement that facilitates simultaneous tax law modifications across multiple nations. This means the STTR MLI can be implemented in existing bilateral tax treaties without the need for bilateral negotiations. This unified approach offers a significantly more streamlined and efficient implementation process compared to individual country-specific alterations. For companies with a fiscal year equal to a calendar year, the impact of the convention is expected to commence Jan. 1, 2025.
While the speedy implementation of the STTR provisions is the right step forward given its support of the overarching Pillar Two initiatives, it has now resulted in the STTR getting a head start toward implementation over the other Pillar Two rules like the income inclusion rule, undertaxed profits rule and the qualified minimum top-up taxes rule.
What are the benefits of the Multilateral Convention?
Accelerating the implementation of STTR: This multilateral convention is important to ensure the quick implementation of STTR regulations, as it allows a source state that has ceded taxing rights under the normal allocation rules of Double Taxation Treaties to reclaim the right back. The convention sets the logic and principles under which such a state can reclaim the taxing rights. Further, members of the OECD Inclusive Framework have committed to implementing the STTR in their Double Taxation Treaties.
Levels the playing field: The STTR will be of benefit to developing countries that can amend their Double Taxation Treaties on several cross-border payments between group companies of multinational enterprises. Unlike the threshold limit of €750 million revenue used elsewhere in Pillar Two, the STTR has no such threshold restrictions of revenue earnings and will apply to all businesses.
