The unanimous approval of a European Union (EU) directive by the EU Council of Ministers on 12 December 2022, that will write Pillar 2 of the OECD’s BEPS model into European law, will force accountants to reassess the tax liability of their largest clients.
The law imposes a 15% minimum tax rate on multinationals’ operations in the EU and applies to groups whose annual turnover exceeds €750m, and which have either a parent company or a subsidiary in an EU member state.
'This agreement is a win for fairness, a win for diplomacy and a win for multilateralism'
The global BEPS (Base Erosion and Profit Shifting) system was first mooted in 2015 by the OECD and the G20 amid public anger that multinationals were avoiding tax through manipulating conflicting national tax rules. BEPS’ two key pillars were accepted in principle in November 2022 by 135 countries and jurisdictions supporting a new two-pillar plan.
Pillar 1 is a country-by-country tax system calculating where multinational tax liability is located – implementing legislation is still being reviewed by the European Commission, the EU executive.
But with the EU now approving a Pillar 2 law, the formal countdown to when BEPS becomes mandatory has begun – the directive must be implemented by the 27 EU member states by 31 December 2023, less than one year away.
‘The directive fulfils the EU’s commitment to implement the agreement on global tax reform,’ states a Deloitte note. Also commenting, EU economy commissioner Paolo Gentiloni says: ‘This agreement on minimum corporate taxation is a win for fairness, a win for diplomacy and a win for multilateralism.’
IASB changes
The looming agreement of the directive had already jump-started work at the International Accounting Standards Board (IASB), which is now considering how to amend IAS 12, Income taxes to comply with Pillar 2 – draft changes are open for comment until 12 March 2023, having been released in January.
Assuming the IASB goes ahead with these changes, it will have a worldwide impact, given more than 120 countries and reporting jurisdictions permit or require its international financial reporting standards (IFRS) for domestic listed companies.
The revised standard, according to an IASB note, was expected to include a temporary exception from accounting for deferred taxes arising from Pillar 2 rules and targeted disclosures requirements for affected companies.
'Though the Biden administration supports the agreement, Congress left those changes out of the Inflation Reduction Act which passed in August'
Despite this progress, a global adoption of Pillar 2 rules may still hit turbulence in the US, which still largely relies on USA GAAP, and which has yet to approve laws implementing either BEPS pillar.
A note from US tax think-tank the Tax Foundation states: ‘Though the Biden administration supports the agreement, Congress left those changes out of the Inflation Reduction Act which passed in August.’
With the opposition Republicans now in control of the House of Representatives, bi-partisan support will be needed for Pillar 2 to become US law.
The EU action will increase pressure on the US to follow suit, a December paper by the Congressional Research Service notes, which stresses that Pillar 2 laws were also now under formal consideration in Australia, the UK, Japan and Switzerland. ‘An [Biden] administration official has indicated the need to undertake reforms in light of the adoption of Pillar 2 by the European Union,’ states the paper.
The EU and these other BEPS-backing jurisdictions will be hoping the US does follow their lead, given that the Congressional report stressed US companies reported earning profits of $1.2 trillion abroad in the tax year 2019.
Cross-border impact
Even though Pillar 1 has yet to be implemented in law, the details of how Pillar 2 will operate already show how charging minimum tax rates will have cross-border implications.
The EU directive allows member states to increase the tax rates charged on their national wings of multinationals to make up for under-taxing outside the EU. This includes where a parent is in a non-EU country failing to order these holding companies to pay extra tax to make up for lower taxation charged elsewhere – following the BEPS income inclusion rule (IIR).
‘The structure of the rules means EU adoption dramatically impacts multinationals across the globe. It also creates pressure for other countries to adopt some version of the rules or make other changes to their tax codes,’ concludes the Tax Foundation.
'BEPS is a strong incentive for other countries to adopt global minimum taxes'
The EU law also introduces some innovations that contrast with the OECD BEPS models that might be considered by other jurisdictions – beefing up taxation powers on major local companies.
The KPMG EU Tax Centre stressed how the EU law applies 15% minimums to domestic groups as well as multinationals. And it requires that the IIR rule could increase taxation on local group companies if their rates also fall below the minimum 15% rate.
The law does not apply to government-owned multinationals, international organisations, non-profit organisations, pension funds and investment funds or real estate investment vehicles that are an ultimate parent entity.
US response
While the European Commission this year continues to work on a Pillar 1 law, a key focus will be on the US response. That could be especially tricky for Pillar 1 rules, which the Tax Foundation says will require tax treaty ratification in the US Senate – needing 67 votes of 100, and another tough bipartisan deal.
Speaking in November 2022, according to a note from EU accounting federation Accountancy Europe, Czech finance minister Zbyněk Stanjura, whose country held the EU presidency until 31 December 2022, said several EU member states fear the US will not implement the BEPS agreement. He warned the EU would resurrect talks on a digital services levy ‘if a global deal on the taxation of corporate giants fails’, ensuring US tech giants paid more tax in Europe.
Will that happen? US Treasury Secretary Janet Yellen has written that claiming the BEPS system could be revenue neutral for the USA. But that would require non-US jurisdictions to insist their multinationals pay more tax in the US, if they benefit from low tax regimes.
BEPS is a ‘strong incentive for other countries to adopt global minimum taxes, thus protecting the US minimum tax on global intangible low-taxed income’, writes Yellen. Whether her arguments carry weight in a politically divided US Congress remains to be seen.
