Digitalised business and shell companies bracing for dramatic tax changes
In October 2021, a historic agreement was signed by the members of the OECD/G20 Inclusive Framework on BEPS (“IF”) which provided a framework for reform of the international tax rules placed on multinational enterprises (“MNEs”) with a primary focus on addressing the tax challenges of digitalisation of the economy.
The framework sets out key terms for an agreement of a two-pillar approach to reforms, with changes coming into effect in 2023.
To summarise, Pillar one deals with the allocation of taxing rights and profits and proposes new ways of apportioning income such as shifting the tax obligations on jurisdictions where goods and services are used or consumed. As such, highly digitalised businesses may expect additional tax implications especially if their customers are located in multiple jurisdictions.
Further to the agreement in October 2021, it has been confirmed that the focus remains on large and more profitable MNEs and that 25% of their residual profit will be allocated to market jurisdictions with sufficient nexus. Further details on application of these rules are yet to be disclosed.
From a UK tax perspective, the framework outlines a roadmap for transition from the digital services tax to the new OECD-led global tax system. In addition, according to the agreement, the US will not levy tariffs in response to the UK’s Digital Services Tax, which will continue to apply until the Pillar One reforms come into effect.
Pillar two equally has a dramatic effect by imposing global effective corporate tax rates payable by MNEs, by denying deductions, and by imposing withholding taxes on payments made to entities that are subject to low tax rates. Further to the agreement in October 2021, a minimum 15% global tax rate has now been agreed upon. It has also now been confirmed that whilst IF members are not obliged to adopt the Pillar two rules, they must accept the application of the rules if these are followed by other IF members.
In addition to the changes mentioned above there has recently been an increased global focus on economic substance, such as assessing the appropriate levels of employees, premises held, functions performed, and risks undertaken to understand whether there is real economic activity in a jurisdiction. For instance, in May 2021 the European Commission (EC) published its first consultation around rules to neutralise the misuse of shell entities for tax purposes especially where legal entities have minimum or no substance and no real economic activities in a particular jurisdiction.
Given the present uncertainties regarding the radical shift in the international tax landscape, there is clear scope for MNEs especially those in the services industry to review their current group structures and commence discussions with their tax advisors to mitigate the impact of new international tax rules coming into play.