At a webinar on 18 January, the OECD presented its findings on the impact of international tax reform in advance of the full report which will follow in the coming months.
International tax reform is politically and technically complex, but the OECD’s latest impact assessment may persuade some of the sceptics that the effort may in fact be worth it – at least based on the high level of profits upon which the latest modelling is based and assuming implementation of the rules actually happens!
Out of the two pillars, it is Pillar Two which is the most significant revenue raiser (and also the one that the UK, along with various other jurisdictions and the EU, is already in the process of implementing). The global minimum tax rules which form part of Pillar Two are estimated to lead to an annual global increase in tax revenue of USD 220 billion (or 9% of global corporate income tax revenues) based on the data from 2018 (the latest year for which data is currently available for the Pillar Two analysis). This is significantly higher than the estimate the OECD produced in 2020 of USD 150 billion.
Amount A of Pillar One, which applies to the largest and most profitable multinational enterprises (MNEs), is now estimated to give rise to annual global tax revenue gains of between USD 13-36 billion, based on 2021 data. The OECD’s 2020 impact assessment estimated revenue gains of only USD 5-12 billion and developing countries voiced their concerns that they would see little benefit for the cost and complexity of reform.
Changes since the 2020 impact assessment
So why have the estimated annual revenue gains increased so much compared to the 2020 impact assessment? Most of the increase results from design changes in the rules, higher levels of in-scope profit (for Pillar One) and higher levels of low-taxed profit (for Pillar Two), and changes in modelling with improved estimation approaches (for example using more CbCR data). It is important to remember, however, that although the OECD has closely modelled the features of the rules on which agreement has been reached, there are still a number of moving parts and caveats. All estimates remain preliminary while the work is ongoing.
Are there any jurisdiction-level estimates showing winners and losers?
The impact estimates for individual jurisdictions have been modelled for Pillar One but Pillar Two modelling is currently only on a global basis with ongoing work on jurisdiction-level estimates. However, as with the OECD’s 2020 impact assessment, jurisdictional data will only be shared with the public grouped by low, middle and high income jurisdictions. The individual jurisdictions will, however, receive their assessment directly from the OECD.
Pillar One – reallocation of taxing rights and a new taxing right for market jurisdictions
The increased scope of Pillar One (it is no longer restricted to digital services businesses), even with the higher threshold for Pillar One applying, has led to higher profits being identified for reallocation under Amount A. The revised scope of Pillar One targets the largest and most profitable MNEs bringing 82-108 MNEs into scope (2017-2021). The OECD has identified these particular MNEs and built granular MNE-level matrices which enable the impact assessment to analyse the impact of the various policy design features.
The analysis finds that low and middle-income jurisdictions are expected to gain the most as a share of existing corporate income tax revenues. Most high income jurisdictions gain taxing rights, but a small number of high income jurisdictions with in-scope MNEs may see limited gains or small losses.
The OECD’s report will show that more tax revenues will now go to developing jurisdictions because of three design features incorporated since the 2020 impact assessment:
- Special nexus thresholds secure Amount A allocation for smaller jurisdictions.
- Tail-end revenue provisions in the sourcing rules for consumer facing businesses allocate revenues to low-income jurisdictions.
- The elimination of double taxation rules ensure that developing countries are less likely to give up taxing rights (investment hubs, on the other hand, will lose revenues as any double taxation is relieved first in the most profitable entities).
No account is taken in the modelling, however, of the impact of the removal of digital services taxes which will inevitably lead to loss of revenues in some jurisdictions and bring the global gains down. For more details on the progress of the proposal to remove DSTs see Tanja Velling’s blog post on the draft multilateral convention.
In 2021, very high levels of profitability were observed in MNEs in-scope of Pillar One but there is significant uncertainty about whether these high levels will be maintained. In the Covid-19 period, for example, pharma saw a huge increase in profits and high profits were also seen in the digital and electronics sectors which are not expected to be sustained. So it is helpful that the OECD also shared average annual figures for 2017-2021, which are an average annual tax revenue gain of USD 12-25bn and an average annual amount of profits to be reallocated under Amount A of USD 132bn. These average figures may be more realistic for the purposes of estimating future potential revenue gains and profits.
Pillar Two – global minimum tax
The data used is from 2018 as this is the latest available to model the impact of Pillar Two. This does not, obviously, take into account the impact of Covid-19, the war in Ukraine, the 2022 global increase in inflation and the ongoing implementation of some aspects of (and behavioural reactions to) BEPS measures and the US Tax Cuts and Jobs Act.
Modelling work is still ongoing on qualified domestic minimum top-up taxes (QDMTTs) – this is important for the production of accurate jurisdiction by jurisdiction estimates because a QDMTT will change where top-up taxes are collected. It will shift potential revenue gains from Ultimate Parent Entity jurisdictions to affiliate jurisdictions where low-tax profits are currently located.
There is evidence of a high share of low-tax profit located in high tax jurisdictions (tax incentives are a key factor). This will make a QDMTT more attractive for such high tax jurisdictions.