MNCs should pay taxes in each country where they operate

Pillar 1 is part of Action 1 of the OECD’s base erosion and profit shifting project “Addressing the tax challenges arising from the digitalisation of the economy”.

Amount A introduces a new taxing right over a portion of the profits of the largest and most profitable companies in the world. 

The move demonstrates that the OECD and the international governmental community continue to move forwards with their desire to implement the first part of Pillar 1, which is aimed at ensuring multinational companies pay more tax where their customers are located or goods and services are supplied, rather than where their companies are tax resident.

The guidance issued by the OECD does not mean the MLC can be signed at this point, as certain matters remain outstanding. The MLC will not come into force until sufficient countries have signed it and so the implementation of the MLC remains outstanding. Based on this however, it is worth considering the implications now as companies and their advisers plan their 2024 tax strategy.

The new BEPS regime – what, why, who?

The OECD estimates that the practice of BEPS, where MNCs exploit gaps in global tax rules to avoid paying tax by moving profits to lower-tax jurisdictions, costs countries up to $240bn every year in lost tax revenue. 

There are two fundamental pillars to this action of the BEPS project: Pillar 1 applies to the biggest and most profitable MNCs, and potentially changes where they pay taxes, by reallocating a portion of profits to the countries where they have sold products or provided services (that is, where their customers are based); Pillar 2 applies to a much broader range of MNCs and imposes a global minimum corporate tax rate of 15 per cent.

The OECD estimates that the practice of BEPS, where MNCs exploit gaps in global tax rules to avoid paying tax by moving profits to lower-tax jurisdictions, costs countries up to $240bn every year in lost tax revenue

Moreover, the overall BEPS project includes a series of 15 Actions that target the key tactics that businesses may use to shift profits. 

This is part of an increasingly sophisticated international programme to limit profit-shifting exercises by businesses, including through the creation of offshore trusts, shell companies, and other complex financial intermediary structures. While Pillar 1 is aimed only at the very largest MNCs, the overall regulatory focus means that any business that operates across multiple jurisdictions needs to be aware of its obligations and best practice. 

Assessing the commercial impact

Many MNCs and digital businesses will continue to come under the scope of the BEPS project. Even where digital enterprises have no physical presence at all in countries where they do business, they will still be required to comply with the tax laws in multiple jurisdictions. 

Businesses must be aware of the new rules and ensure they are compliant — or could risk costly tax penalties. Now is the time to assess operations, ownership and organisational structures to determine whether the current structure and operations are compliant with developing international regulations.

The evolution of the BEPS project may increase MNCs’ tax liabilities in certain jurisdictions. Compliance is likely to raise costs, as groups are required to keep abreast of potentially changing tax rules in each country where they operate.

Small and medium-sized enterprises that may be indirectly impacted will have to ensure compliance on much more limited budgets than the bigger multinationals that have the benefit of economies of scale.

Avoidance activities in the spotlight

Companies and their tax advisers also need to take note of the various specific actions that the BEPS package of measures contains, to ensure that they stay on the right side of the rules. These 15 Actions currently standardise compliance requirements and give governments the tools they require to tackle tax-avoidance activities.

Some of the most important developments to note are those that:

• Put boundaries around the digital economy. It is commonly agreed that a tax system designed for a “bricks-and-mortar” world is no longer sufficient for a digital economy where physical presence is not necessary to trade and where geographical borders are transcended, so the “nexus” rules require an overhaul. Action 1 is designed to ensure that MNCs with a significant digital presence in a country pay taxes in that country, even if they do not have physical premises there.

• Eliminate the tax benefits of hybrid mismatch arrangements, where structures may exploit differences between tax regimes in multiple jurisdictions. To counteract such moves, Action 2 aims to create model treaty provisions and contains recommendations as to how domestic rules should be designed.

• Prevent the shifting of income into a controlled foreign company. Action 3 calls for the design of more effective CFC rules to discourage companies from moving profits into offshore structures. This includes defining what a CFC is and how CFC income should be calculated and attributed. This aims to ensure that CFCs are subject to a minimum level of taxation in the country where their parent company is located.

• Target preferential tax regimes, which are seen as ways for companies without any real economic substance in a country to reduce tax bills, to the detriment of the tax base in other countries (Action 5). To ensure economic substance is sufficient, companies must have adequate presence and/or carry-on economic activities in the jurisdiction in which they are claiming tax residency.

• Close loopholes in tax treaties, which can lead to ‘treaty-shopping’ and other treaty abuse strategies to minimise tax liabilities (Action 6).

• Strengthen standards on transfer pricing, to ensure that tax outcomes are more aligned with an MNC’s true value creation profile. As intra-group trade has grown, this has become a critical issue. Actions 9 and 13 include guidance on how to determine the transfer prices for goods and services between related entities, and how the transfer of valuable intangible assets such as patents, trademarks and copyrights will be taxed.

Getting BEPS-ready 

While continual development of the BEPS project should ultimately give MNCs greater clarity and certainty in the long run, the changes the project ushers in are significant and ever evolving. Navigating them, in the short term at least, is likely to be a complex task, especially for SMEs that may not have in-house tax expertise. 

International tax advisers will have a critical role to play in guiding businesses through this continually evolving regulatory landscape, acting as a valuable resource in helping to plan ahead to achieve tax efficiency and meet regulatory requirements. 

By reviewing how the business is structured, advisers can assess a group’s global tax affairs and tax risk and help plan for any areas that need to be addressed. 

International tax advisers will have a critical role to play in guiding businesses through this continually evolving regulatory landscape

Businesses may also need support with the development of a transfer pricing policy that aligns with OECD guidelines. This will require a review of the functions of a group and its intra-group activities, followed by benchmarking analysis. Transfer pricing documentation is a requirement of many jurisdictions and penalties for non-compliance can be severe. 

Understanding what your company needs to record and disclose, and when, is likely to require professional expertise. However, the data collated from all this activity will prove extremely valuable in terms of the visibility and oversight it should deliver into a company’s global operations and effective global tax rate. 

With all this in mind, it has never been more important for MNCs to take international tax advice.

The future of international taxation

While the exact shape some of these rules will finally take is yet to become fully clear, what is certain is that major changes are ongoing. Policymakers are pushing forward on addressing what they see as an urgent need to create an international tax framework that is fit for purpose in today’s globalised digital world, to ensure profits are taxed where economic activity and value creation actually take place.

They do not just have the biggest MNCs in their sights — any business with cross-border sales needs to take note. With professional help, those companies can get ahead of the curve.

Mark Taylor is global tax chair at Kreston Global