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It has been generally acknowledged that both the sources of international tax system during the last century and some basic concepts of tax residence have been outdated. Business practices are now regularly carried out in “favourable” states without being physically present; the digital transition in economies has also led to new opportunities in manipulating traditional taxation principles through numerous tax planning/facilitating schemes. Current corporate taxation regimes are unable to provide a stable and just system for governments trying to impose counter measures to prevent tax avoidance and evasion. Global and European community is anxious to create a just system through a dual approach to corporate taxation…
For the last decades the general trend in taxation has been towards increased personal taxation and decrease in the corporate one; however, while being successful in addressing specific problems, the trend has introduced even further complexity; particular problems occur in tax heavens.
The need to finance public expenditure after the financial crisis in 2008-09 and multiple tax avoidance scandals, as well as rigorous enforcement of state aid rules triggered global discussions on the reform of the international corporate taxation. The moves accelerated in the early 2010s, leading to the start of the Base Erosion and Profit Shifting (BEPS) project supported by the OECD and G-20: first set of conclusions in 2015 have been implemented in the EU, e.g. through the Anti-Tax Avoidance Directive*).
International discussions are now progressing towards a global solution to reform the outdated international corporate tax system, with action on the reallocation of taxing rights and minimum effective taxation. The substance of these discussions will influence the shape of the EU business tax agenda going forward, regardless of whether a concrete global agreement is reached.
*) Note. See: Council Directive (EU) 2016/1164 of 12 July 2016, laying down rules against tax avoidance practices that directly affect the functioning of the internal market, OJ L 193, 19.7.2016, p. 1.
Global consensus-based solution
On the global scene, most active is the Organization for Economic Co-operation and Development (OECD), which together with the G-20, is working on a global consensus-based solution to reform the international corporate tax framework. Global community is interested in a common consensus in reforming the international system of corporate taxation.
The global discussions focus on two broad work streams: pillar 1 (which includes a partial re-allocation of taxing rights) and pillar 2 (with the minimum effective taxation of multinationals’ profits); the two pillars are addressing different but related issues linked to the increasing globalisation and digitalisation of the national economies.
Two broad directions in the global work-streams have been visible:
First (pillar one), is towards a partial re-allocation of taxing rights aimed to adapt the international rules on taxing corporate profits of the largest and most profitable multi-national companies, MNEs; the approach is generally shared among most states reflecting a changing nature of business models, including the ability of companies to do business without a physical presence. This pillar aims to capture the largest and most profitable multinational enterprises (MNEs) regardless of industry classification or business model, including MNEs with a global turnover above € 20 billion and profitability (profits divided by turnover) above 10%. In seven years, should the implementation of the rules proceed successfully, the turnover would be reduced to € 10 billion, which would increase the number of MNEs concerned.
The Pillar One mechanism envisages a redistribution of a share of excess profits of MNEs to market jurisdictions where consumers or users are located. According to the agreement, jurisdictions will receive a part of the reallocated profits if the MNEs involved derive at least €1 million in revenue from that jurisdiction; for smaller jurisdictions, with a GDP lower than € 40 billion, the amount of revenue derived will be set at € 250,000.
However, the extractive industry and “regulated financial services” are excluded from the first pillar 1.
The share of profits to be reallocated to market jurisdictions will be between 20% and 30% of the ‘residual profits’ of companies in scope, which would be defined as profits above 10% return on sales. The “particular formula” will be used: e.g. if a company has a € 40 billion annual turnover and € 10 billion annual profit, it will be “in scope”, as the profitability is at 25%.
The € 10 billion annual profit turns into € 4 billion “normal” profits and € 6 billion “residual profits”. Of those € 6 billion residual profits, a certain share (of at least 20%, or at least € 1.2 billion) would get redistributed. Where the residual profits of an MNE are already taxed in a market jurisdiction, a “safe harbor” will cap the residual profits reallocated to that jurisdiction. Appropriate coordination will be provided between the application of the new international tax rules and the removal of national digital service taxes and other relevant similar measures.
Once agreed by the global community and translated into a multilateral convention, the application of Pillar 1 will be mandatory for participating countries.
Pillar two deals with the MNEs’ minimum effective taxation of profits; the pillar sets a floor to excessive tax competition and aims to ensure that multinational businesses are subject to a minimum effective level of tax on all of their profits each year. The global minimum effective tax rate will be at least 15%; unlike pillar one, this pillar has no profitability threshold. It would apply to all MNEs groups exceeding a threshold of € 750 million of combined financial revenues. It means, all large MNEs would be covered by the measures on minimum effective taxation.
Moreover, countries are free to apply a top-up tax to a parent entity as a response to the low taxation of a constituent entity even if they do not meet the € 750 million threshold. Government entities, international organisations, non-profit organisations, pension funds or investment funds that are parent companies of an MNE’s group do not fall under the scope of Pillar Two.
Under pillar two, countries will impose a top-up tax – the so-called “income inclusion rule” – on the parent entity of a multinational enterprise resident in their territory to make up for the low taxation of certain subsidiaries of the same group, which are located in another country.
If multinational enterprises are headquartered in countries that do not impose top-up tax on the parent company, their low-taxed subsidiaries will still effectively lose their tax advantages due to the so-called Under-taxed Payments Rule (UTPR), which denies deductions or requires an equivalent adjustment to the extent the low tax income is not subject to a top-up tax.
The agreed rules will be a “common approach” in the pillar two: i.e. the states are not required to adopt the rules; but if they choose to do so, they will have to implement and administer the rules in a way that is consistent with the agreed outcomes under this pillar. It also means that the “agreed states” will have to accept that other states apply the rules, which in practice implies that multinational enterprises with subsidiaries in countries that operate a rate below the agreed minimum will not avoid bearing the consequences of pillar 2.
Main reference: https://ec.europa.eu/commission/presscorner/detail/en/QANDA_21_3564; 10 July 2021.
Taxation issues in the EU
The EU needs a robust, efficient and fair tax framework that meets public financing needs, while also supporting the recovery and the green and digital transition by creating an environment conducive to fair, sustainable and job rich growth and investment. In the EU’s tax agenda there is a need for a balanced tax revenue mix with a tax system guided by the principles of fairness, efficiency and simplicity.
The EU’s tax agenda contribute to the overall objective of enabling fair and sustainable growth by supporting wider EU policies such as the European Green Deal, the Commission’s digital agenda, the New Industrial Strategy for Europe and the Capital Markets Union amendments. It should also contribute to supporting an inclusive recovery in line with the principles of the European Pillar of Social Rights.
Estimated tax compliance costs for large companies in Europe amount to about 2% of taxes paid, while for SMEs the estimate is about 30% of taxes paid.
Source: https://ec.europa.eu/taxation_customs/sites/taxation/files/resources/documents/tax_survey.pdf ; and Council Directive 2011/16/EU of 15 February 2011 on administrative cooperation in the field of taxation, OJ L 64, 11.3.2011, p. 1.
The international tax reform at OECD-level is complementary to the EU’s tax agenda, which offers solutions that Europe needs in order to support its Single Market and accelerate the post-pandemic recovery. In May 2021, the European Commission published the Communication on Business Taxation for the 21st Century, which set out a long-term vision to provide a fair and sustainable business environment and EU tax system, building on the progress made and the principles agreed in the global discussions.
Besides, the communication sets out a tax agenda for the next two years, with targeted measures that promote productive investment and entrepreneurship and ensure effective taxation.
On business taxation in the 21st century see: https://ec.europa.eu/taxation_customs/sites/default/files/communication_on_business_taxation_for_the_21st_century.pdf.
For a closely integrated EU’s Single Market, it will be important to ensure that the global agreement is implemented in a consistent way across all EU states. For example in the first approach, it will be essential to ensure the compatibility with the Treaties and existing EU legislation; hence, the Commission will present a draft Directive for the implementation of both approaches (described above) in the EU. It has to be remembered that both approaches towards future global tax agreement are in line with the EU’s concept for “business taxation framework in the 21st century”, is seen as a vital step towards the important principles of partial reallocation of taxing rights and a common definition of the tax base.
The EU institutions are working with the member states to ensure that these proposals are implemented with a minimum administrative complexity: e.g. in the European Council’s conclusions (25 March 2021) it was reiterated the EU’s “strong preference for and commitment to a global solution” to be reached on a consensus-based solution by mid-2021 within the framework of the OECD. In order to ensure its consistent application within the EU and compatibility with the EU law, the principal methods of the OECD “model rules” need some adjustments. The implementation of a global agreement on minimum effective taxation will also have implications for existing and pending EU Directives and initiatives.
References to: COM (2019) 640 final; COM (2020) 102 final; and e.g. COM (2020) 590 final.
The Commission will launch a broader reflection, which should conclude in a Tax Symposium on the ‘EU tax mix on the road to 2050’ in 2022; the reflection will take into account the principles set out above and the impact of possible changes to the tax-mix (including possible effects on low-income households).
The issue of reaching a global agreement on international corporate tax reform shall be compatible with the WTO and other international organizations’ rules. For example, existing proposals will differ from the EU’s 2018 proposal for a Digital Services Tax (see COM -2018, 148 final) and for a Significant Digital Presence (see COM-2018, 147 final), which will be subsequently amended.
According to modern data, international tax evasion by individuals results in a tax revenue loss of € 46 billion/year for EU-27.
References to: ECOPA and CASE (2019) Estimating International Tax Evasion by Individuals, –Taxation Papers 76. Moreover, it is estimated that € 35-70 billion is lost each year in corporate tax avoidance in the EU only.
See more on the issue in: Dover, R., Ferrett, B., Gravino, D., Jones, E., and Merler, S. (2015) Bringing transparency, coordination and convergence to corporate tax policies in the European Union, – European Parliamentary Research Service, PE 558.773;
Álvarez-Martínez, M., Barrios, S., d’Andria, D., Gesualdo, M., Nicodème, G., and Pycroft, J. (2018) How Large is the Corporate Tax Base Erosion and Profit Shifting? A General Equilibrium Approach, – CEPR Discussion Papers 12637; and
Tørsløv, T., Wier, L., and Zucman, G. (2018) The Missing Profits of Nations, – NBER Working Paper 24701.
Conclusion
The OECD/G20 framework will take a final decision on the remaining issues and will agree an implementation plan by October 2021; once reaching a consensus-based global agreement on both proposals, the EU will implement measures in the member states in line with the EU’s tax agenda and the needs of the Single Market.
The forthcoming global agreement will mark a decisive step forward in the reform of the international corporate tax system, addressing important challenges related to the allocation of taxing rights and minimum effective taxation at global level.
At the EU level, the ambitious business taxation agenda will ensures fair and effective taxation that supports productive investment and entrepreneurship. Adequate will drive the EU-27 towards a European business tax framework fit for the 21st century challenges towards a well-functioning Single Market.