Finding Certainty Under New Rules

Guiding compliance is a critical issue when legislation changes. Pillar 1 & 2 rules, while on the surface designed to clarify, streamline and standardise tax law, are far more complex when exposed to the real world. Given the complexity of tax calculation internationally, most multinational businesses will still be dealing with the transition. The legislation has now been given time to settle in and while the industry is still waiting for it to mature, there are clearly operational changes at hand. For Praxity member firms, this means that the rules have drastically changed for some of their largest clients.  

Profit shifting practices bring in different jurisdictions in complex ways. Some factors will be more or less pertinent in different regions, and what seems to be across-the-board legislation will present itself differently. Even within the G20 economies, a universal rule will never be that, and there are significant differences in how the rules manifest themselves on the ground.  

If the legislation is watertight, the obfuscation of profits that some businesses have taken part in will no longer be possible. This implies a further question; how do businesses do the right thing? Compliance is an important area of practice and guiding it for clients is not only crucial, it’s lucrative. The sheer complexity of managing taxation across borders is partly what Pillar 1 and Pillar 2 rules are designed to address, but dealing with the subtleties makes accountants ever more valuable. 

Pillar 2 contains three transitional safe harbours to assist business in its introductory period. Providing that a business entity is operating in low-risk countries and meets one of three requirements, they are relieved from having to report Pillar 2 calculations until Dec 31^st, 2026.  

To qualify for the transitional Country-by-Country Reporting (CbCR) Safe Harbour, a “low-risk” jurisdiction should meet one of the following tests: 

1. De minimis test: total revenue in the CbCR is less than €10 million and profit before income tax is less than €1 million 
2. ETR test: the simplified Effective Tax Rate (ETR) is greater than or equal to 15% (2023-2024), 16% (2025) 17% (2026)
3. Routine profits test: the profit before income tax is equal to or less than the substance-based income exclusion amount, as calculated under the Global Base-Erosion (GloBE) model rules.

This gives important capacity to businesses who need to implement new processes, especially in the most complex cases. 

The EU 

The European Union has made a point of moving as one on Pillar 1 and 2, reflecting the bloc’s central role in defining the legislation. This has allowed the most developed economies in Europe to trade and to legislate as one in this area, closing tax loopholes that previously existed cross-border.  

Ireland 

Ireland is a good case study for the Pillar 1 and 2 rules, with the country’s economy making full use of its status as an EU member and an attractive country to invest in; the country is host to over 12,000 foreign-owned multinational enterprises as of 2021. This represents just 3.4% of enterprises in the Irish Economy, while generating 72% of both total turnover (€798.8bn) and total Gross Value Added (€266.7bn). Only one shareholder is required for incorporation into the Irish economy, which demonstrates the problem that the country has had with base erosion and profit shifting. For example, one effect of this is to artificially inflate the US-EU trade deficit.  

Pillar 2 rules have been enacted in Ireland as of 18th December 2023, taking effect for in-scope businesses at the end of that month. Their implementation closely follows the EU minimum tax Directive and the OECD Guidance released to date. 

James McMahon, Partner, MC2, Ireland states, “The practical impact on the majority of businesses in Ireland has been relatively limited due to the narrow targeting of the OECD’s measures at only the largest multinational corporations. For the wider business environment, it’s primarily a matter of monitoring developments rather than adjusting to direct regulatory changes."

"While the framework represents a global shift in tax norms, Ireland’s tax landscape remains stable for most businesses, with its competitive 12.5% corporate tax rate remaining attractive for a wide range of businesses and foreign direct investment. For most companies, the new global minimum tax of 15% under Pillar 2 represents a modest increase that is unlikely to drive significant operational changes. These measures are aimed at a small subset of globally significant corporations. For most clients, it’s been a matter of awareness rather than immediate compliance, given the highly targeted scope of the new rules. 

The Pillar 1 and Pillar 2 rules are a step towards addressing tax base erosion globally, but their effectiveness will likely depend on continued international cooperation and uniform application across jurisdictions. While the rules have potential to create a more consistent framework for the largest corporations, they are still new and may require adjustments as governments and companies interpret and implement them.”

MEXICO & LATAM

"Mexico is something of a special case within the G20, with its position so near the US and its tradition of American businesses siting operations within its territory. As such, the Mexican government already has measures in place for this. Mexican law follows the “place of effective management” criterion to determine tax residency. This refers to the location where key decision-makers, who control, manage, and operate the entity and its activities are based. A foreign entity is only deemed a Mexican taxpayer if its place of effective management is in Mexico.”

While this allows for offshoring and for foreign capital entering the Mexican system, the law also allows for taxes on passive income and inflation on a global basis. Tax treaties are in place with many countries, e.g. Germany and the United States, and mostly follow this same framework with certain caveats.

Montserrat Colin, Tax Partner, JA Del Río, Mexico comments, “Pillar 1 will likely lead to more tax revenue for Mexico from digital companies, especially those with significant sales but no physical presence. Mexico will need to analyse the possibility to adjust its tax treaties and possibly phase out its Digital Economy taxes. For Pillar 2, Mexico’s existing corporate tax rate (around 30%) already exceeds the global minimum tax of 15%, so it won’t face additional tax burdens. The new legislation will require Mexico to enhance its compliance framework to closely monitor multinational companies and prevent profit-shifting to low-tax jurisdictions. At the same time, Mexico will need to balance these changes with maintaining an attractive investment climate, adapting its regulatory framework to meet international standards while protecting its competitiveness."

"The International Tax team has received specialised technical training on Pillar 2 rules and compliance procedures, to be aware of changes in the OECD guidelines and the future implementation of the law in Mexico. We have also formed multi-disciplinary tax and transfer pricing teams to analyse the current global structures of our clients and, through the application of technology, manage the tax documentation and ensure compliance.

Pillars 1 and 2 provide a solid framework for increasing tax fairness but pose significant implementation challenges. While the principles behind the pillars are strong, their effective application in Mexico will depend on administrative capacity and international collaboration.”

Elsewhere in Latin America

Writing in 2023, Ignacio Gepp, Tax Partner at Puente Sur in Chile, points out the difficulties in approaching the Pillar 1 & 2 rules outside the remit of the G20 countries.

When the OECD’s Pillar Two was announced Latin American countries were at the forefront, with a vast majority of political leaders supporting it. This is unsurprising, as South America alone has the highest average statutory corporate income tax rate globally at 28.32%.

So how harmful could it be to adhere to a modest minimum 15% effective tax rate applicable to multinational enterprises with a global revenue over 750 million euros ($819.6 million)?

While Pillar Two intended in its inception to stop the race to the bottom—having countries compete for business by offering increasingly more attractive tax incentives—its configuration under the Global Anti-Base Erosion rules has been described as  “a shortcut taken by capital exporting nations,” that is “eliminating the few competition tools that capital importing nations have, and who have to sustain over 90% of the world population.”

This highlights a tug-of-war that is going on between nations over what investment truly constitutes. For example, the EU’s view is, publicly at least, that the money raised from the new tax rules will protect both the capital-exporting nation from tax avoidance, and the capital-importing country from economic exploitation. From the other side, this could be seen to make further development by capital importers more difficult, as their tax base is eroded, and their economies struggle to compete as a result.

Firstly, to ensure that their model is compliant, a business must find ways to account for all profit across jurisdictions. Finding these numbers to comply with legislation is necessarily as complex as the business model itself, with profits often shifted within legal frameworks to pay the optimum rate of tax. As before, while this is theoretically easier and more transparent, the process of enacting it is likely to be anything but. Tax professionals will need to be fully educated in both the cross-border rules and their clients’ business operations. The Safe Harbour system is there to alleviate the administrative burden on some larger companies – if a business falls into this category, there is yet more time to come up with robust operations and reporting systems.  

Secondly, accountants will not be able to take a partial “slice” of tax into account but will instead need to consider how the business is structured and what assets are where. Thirdly, the need to provide guidance for clients opens up an array of opportunities to advise in new areas they may not have seen before. Guiding any entity through changing legislation is likely to require specialist understanding that only accountancy professionals will have. 

Guiding compliance means understanding what both the right moves and the pitfalls look like. Cross-border, this will likely require improved communication and the adoption of frictionless business, regardless of a territory’s borders. For this future, Praxity’s member firms are extremely well-placed to help their clients succeed.

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