In recent years, countries have debated significant changes to international tax rules affecting multinational companies. In October 2021, after negotiations at the Organisation for Economic Co-Operation and Development (OECD), more than 130 member jurisdictions agreed to an outline for new tax rules.
Large companies would pay more taxes in countries where they have customers and less in countries where they have headquarters, employees, and operations. Additionally, the agreement sets out a global minimum tax of 15 percent, which would increase taxes on companies with earnings in low-tax jurisdictions. Several dozen governments are currently implementing the minimum tax rules.
The OECD proposal follows an outline that has been discussed since 2019. There are two “pillars” of the reform: Pillar One changes where large companies pay taxes (impacting roughly $200 billion in profits); Pillar Two introduces the global minimum tax (increasing tax revenues by an estimated $220 billion, globally). A draft of the multilateral treaty for Pillar One was published in October 2023, and a deadline of June 30 for a final agreement has come and gone. The agreement between the US and several nations with discriminatory digital services taxes has also lapsed. Canada, which was not part of that agreement, has implemented its own digital services tax. The implementation of Pillar Two is happening in 2024 for the earliest adopters.
Understanding Lease Agreements
When it comes to understanding what is a lease, it’s essential to grasp the lease meaning and lease definition. A lease is a contractual arrangement where one party, the lessor, allows another party, the lessee, to use an asset in exchange for periodic payments. This agreement outlines the terms and conditions under which the lessee can use the asset, typically including the duration of the lease, payment amounts, and any restrictions or obligations.
The lease definition encompasses various types of leases, such as operating leases and finance leases. An operating lease is generally short-term and does not transfer ownership rights to the lessee, whereas a finance lease is long-term and often results in the lessee gaining ownership of the asset at the end of the lease term.
In business contexts, leases are commonly used for real estate, equipment, and vehicles. They provide flexibility for companies to use assets without the need for large upfront capital investments. Understanding what is a lease is crucial for businesses to manage their finances effectively and make informed decisions about asset utilization.
Impact on Multinational Companies
Pillar One contains “Amount A” which would apply to companies with more than €20 billion in revenues and a profit margin above 10 percent. For those companies, a portion of their profits would be taxed in jurisdictions where they have sales; 25 percent of profits above a 10 percent margin may be taxed. After a review period of seven years, the €20 billion threshold may fall to €10 billion.
Amount A is a limited redistribution of tax revenue from countries where large multinationals operate to countries where they have customers. US companies constitute a large share of these companies. The Joint Committee on Taxation in the US Congress has estimated that the US would likely lose some tax revenue due to Amount A. Their preferred single year estimate is $1.4 billion. They also estimate that approximately 70 percent of the potential profits to be reallocated under Amount A is generated by US domestic multinationals.
The proposed multilateral convention outlines where companies will pay taxes under Amount A. The rules include approaches for identifying final consumers even when a company is selling to another business in a long supply chain. The rules also allow companies to use macroeconomic data on gross domestic product to allocate their taxable profits when the location of final customers cannot be identified.
Pillar One also contains “Amount B” which provides a simpler method for companies to calculate the taxes on foreign operations such as marketing and distribution. Amount B is expected to be incorporated in transfer pricing guidelines when a final version has been agreed to.
Pillar Two: The Global Minimum Tax
Pillar Two is the global minimum tax. It includes three main rules and a fourth for tax treaties. These rules are meant to apply to companies with more than €750 million in revenues. Model rules were released in December 2021.
- The first is a domestic minimum tax which countries could use to claim the first right to tax profits currently being taxed below the minimum effective rate of 15 percent.
- The second is an income inclusion rule, which determines when the foreign income of a company should be included in the taxable income of the parent company. The agreement places the minimum effective tax rate at 15 percent, otherwise additional taxes would be owed in a company’s home jurisdiction.
- The third rule in Pillar Two is the undertaxed profits rule, which would allow a country to increase taxes on a company if another related entity in a different jurisdiction is being taxed below the 15 percent effective rate.
Together, these rules create a minimum tax both on companies investing abroad and foreign companies investing domestically. They are all tied to the minimum effective rate of at least 15 percent and would apply to each jurisdiction in which a company operates.
The fourth Pillar Two rule is the “subject to tax rule,” meant to be used in a tax treaty framework to give countries the ability to tax payments that might otherwise only face a low rate of tax. The tax rate for this rule would be set at 9 percent.
For Pillar One to work, all countries must adopt the rules in the same fashion and override their existing tax treaties. This would avoid companies dealing with different approaches across the globe.
Pillar Two is more optional. The outlined version of Pillar Two is like a template that countries can use to design their rules. If enough countries adopt the rules, then a significant share of corporate profits across the globe would face a 15 percent effective tax rate.
Both Pillar One and Pillar Two represent major changes to international tax rules. Agreement on Pillar One would remove several specified digital services taxes
The 27 European Union member states are in the process of implementing the Pillar 2 rules in line with a unanimously agreed directive. Companies with an annual turnover of at least €750 million will begin to pay the 15 percent minimum rate starting in 2024. This includes wholly domestic groups that meet the revenue threshold.
Member States with more than 12 in-scope multinational groups must implement the income inclusion rule from 31 December 2023, and the undertaxed profits rule from 31 December 2024. Those Member States with fewer than 12 can elect to defer implementing both rules for six years. According to reports, these include Estonia, Latvia, Lithuania, Malta, and the Slovak Republic.
As of 7 June 2024, 45 countries have either introduced draft legislation or adopted final legislation transposing Pillar Two’s model rules into their national laws. An additional 10 jurisdictions intend to implement Pillar Two, although they have not proposed legislation to do so.
So far, the US Congress has chosen not to implement changes in line with the global tax deal. Though the Biden administration supports the agreement, Congress left those changes out of the 2022 Inflation Reduction Act (IRA). Furthermore, Chairman of the House Ways and Means Committee, Representative Jason Smith (R-MO), recently introduced retaliatory legislation that would counter laws adopted by foreign countries applying minimum tax rules to American multinationals.
If US policy does not shift, US companies will be caught in a confusing web of minimum taxes including Global Intangible Low-Tax Income (GILTI), the Base Erosion and Anti-Abuse Tax, the new Corporate Alternative Minimum Tax from the IRA, and likely some portion of the global minimum tax rules. Recent guidance on Pillar Two means that US GILTI would apply after foreign minimum taxes, reducing US tax revenues from the tax on GILTI.
The structure of the rules means adoption in the 27 EU countries, Japan, Korea, the United Kingdom, and a number of other significant jurisdictions will dramatically impact 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.
The rules clearly incentivize government subsidies to businesses to offset some of the increased costs from the minimum tax. This is because standard tax credits are at a disadvantage relative to government grants and refundable credits.
Undoubtedly, this is a step change in the level of complexity for corporate tax both for governments in their legislating and enforcement roles and taxpayers and their compliance burdens.
The agreement represents a major change for tax competition, and many countries will be rethinking their tax policies for multinationals. If Pillar One implementation fails, a return to a world of distortive European digital services taxes and retaliatory American tariffs could be on the horizon.
