The international tax reform has been discussed for many years. However, we are now entering the year of its suspected implementation. So, what is the international tax reform, what will it mean for businesses, and what is still being debated on it?
At the start of 2021, 130 countries and jurisdictions within the Organisation for Economic Cooperation and Development decided to agree on a certain tax reform and, after a long process of debating the international tax frameworks, agree on a possible two pillar reformation. By August of 2021, 134 countries and member jurisdictions had joined, amounting to more than 90% of the world GDP.
The reform breaks down into two main pillars. The first pillar of reform surrounds multinational companies that sell to a population/state where they have few to no business operations. Something that has been “increasingly common when firms sell through digital channels,” according to the International Monetary Fund. The current tax framework does not allow a country to tax any profits on these sales when there is an absence of physical factories or territories. The reform allows countries to tax sales where the final consumers are located, not only where the company is located.
Pillar two consists of a global minimum effective tax rate of 15%. This is completed through tax-up tax rules. This is where if one country where the product is sold taxes underneath the 15% rate, the country where the company is headquartered can further tax that company to reach the total minimum of 15%.
The goals of these tax reforms are to fight against certain business norms that are being exploited to promote unethical business practices. With pillar one, the goal is to make the tax system stronger against tax base erosion. In particular, to defend against aggressive tax planning, where companies shift their operations and profits between group entities to lower-tax countries, creating erosion of countries’ tax bases and creating tax competition pressures. For pillar two, addresses what is known as the race to the bottom. The race to the bottom describes a common situation where, according to Investopedia, a “company, state, or nation attempts to undercut the competition’s prices by sacrificing quality standards or worker safety, or reducing labor costs…[sometimes this can be done] between governments to attract industry or tax revenues [as well].” Pillar two aims to lower the toxic competition that leads to unethical business practices, while allowing governments to design better domestic policies, and will cut back on profit shifting towards investment hubs.
The IMF reports that the reform is still very complex and still in need of further discussion and reform, with pillar one only covering just over 100 firms. The implementation of these pillars is still a point of concern as well, but recently this reform has been pushed to become implemented. The fear is that the GDP increase for developing countries may not be seen as fully as expected due to concerns surrounding implementation.
The rollout of these new reforms is set to begin between this year and next (2023-24), meaning that many companies are beginning to gear up for this possible large change amongst the multinational corporation tax system. BDO USA has recommended the alignment of supply chain and tax strategies, a complicated issue that will only continue as these changes continue to be implemented and debated over the next few years.