OECD DIGITAL TAXATION INITIATIVE - TWO-PILLAR SOLUTION
Circular Ref: A(21)196
Issue Date: 27 Oct 2021
We are writing to update you on the development of the subject matter. Members may be aware that in March 2019, the Organization for Economic Co-operation and Development (OECD) launched a major public consultation on the development of a multilateral digital taxation framework for global application. Although initially aimed at multinational enterprises operating in a highly digitalised ecosystem, it was decided to broaden the scope to potentially include all international businesses.
This is a mammoth project involving 136 countries/jurisdictions (out of 140), aimed at reforming the entire international tax system. Needless to say, such an initiative would have far-reaching implications for the shipping industry, operations of which are global and transcend various jurisdictions.
The shipping industry operates under the accepted practice (enshrined in Article 8 of the existing OECD and UN Model Tax Conventions) of international trade being taxed only in the "home" jurisdiction. The industry has been working to achieve a ‘carve out’ for shipping from the OECD’s proposed global digital tax regime, which threatens the established principle that shipping companies should only be taxed in their home country/jurisdiction.
Two main pillars have been identified as a basis for the new OECD agreement:
Pillar 1 seeks to introduce a framework to determine where tax should be paid and on what basis. This includes what portion of profits should be taxed in those jurisdictions where customers are located.
Pillar 2 seeks to develop a system to ensure that companies or industries to which the tax applies, should pay a minimum level of tax.
On 8 October, the OECD issued its latest formal ‘Statement on the Two-Pillar Solution to Address the Tax Challenges Arising from the Digitalisation of the Economy’ (available here), complemented by a press release announcing the agreement, a Q&A document and a Highlights brochure.
The new statement and agreement build on a previous OECD statement, released on 1 July, outlining the key elements of both pillars One and Two of the initiative.
The new statement and agreement build on a previous OECD statement, released on 1 July, outlining the key elements of both pillars One and Two of the initiative.
G20 Finance Ministers are now expected to endorse the agreement in Washington D.C this week, ahead of final approval at the G20 Summit in Rome (30-31 October).
The below, provides some insight into the status of the shipping industry within this initiative, following the political agreement and release of the new statement.
Status of shipping under Pillar One
It will be recalled that under Pillar One, which would assign taxing rights to every country in the world where a company has customers the OECD Inclusive Framework – based on Article 8 of the OECD Model Tax Convention (MTC) – had initially recognised the longstanding global principle, included in virtually all bilateral tax agreements, that taxation of shipping company profits is assigned to the company’s country of residence (as with aviation). This was subsequently reinforced through the OECD Pillar One blueprint published last year (2020).
However, in its formal statement on 1 July, the OECD Inclusive Framework stipulated that only ‘Extractives and Regulated Financial Services’ were excluded from the scope of Pillar One. The 8 October statement builds on this determination, adding the new text in bold/italics/underlined below. To date, no further information has been provided about this so-called ‘averaging mechanism’.
“In-scope companies are the multinational enterprises (MNEs) with global turnover above 20 billion euros and profitability above 10% (i.e. profit before tax/revenue) calculated using an averaging mechanism with the turnover threshold to be reduced to 10 billion euros, contingent on successful implementation including of tax certainty on Amount A, with the relevant review beginning 7 years after the agreement comes into force, and the review being completed in no more than one year. Extractives and Regulated Financial Services are excluded.”
Under Pillar One, a new ‘special purpose nexus rule’ will be implemented, permitting allocation to a market jurisdiction “when the in-scope MNE derives at least 1 million euros in revenue from that jurisdiction. For smaller jurisdictions with GDP lower than 40 billion euros, the nexus will be set at 250 000 euros. The special-purpose nexus rule applies solely to determine whether a jurisdiction qualifies for the […] allocation. Compliance costs (incl. on tracing small amounts of sales) will be limited to a minimum”. As regards the ‘quantum’, for in-scope MNEs, “25% of residual profit defined as profit in excess of 10% of revenue will be allocated to market jurisdictions with nexus using a revenue-based allocation key”.
While shipping still does not have an explicit exemption under this pillar following the political agreement, this is by no means the end of the process. There is some significant technical work still to be done, including to provide further clarity on the potential application of the re-allocation of taxing rights rules to shipping, in the new Convention being developed for implementation of this Pillar. The Multilateral Convention (MLC) through which the Pillar One framework is expected to be implemented, is intended to be finalised and made available for signature in 2022, with 2023 set as the year for entry into effect of the new Convention, “once a critical mass of jurisdictions as defined by the MLC have ratified it”.
The OECD ‘Task Force on the Digital Economy’ (TFDE), a subsidiary body of the OECD Committee on Fiscal Affairs (CFA), has been given a mandate by the Inclusive Framework “to define and clarify the features of [the Pillar One framework] (e.g., elimination of double taxation, Marketing and Distribution Profits Safe Harbour) and develop the MLC and negotiate its content, so that all jurisdictions that have committed to the Statement will be able to participate. The TFDE is anticipated to conclude the text of the MLC and release an
‘Explanatory Statement’ by early 2022 (potentially February 2022). The OECD has provided a detailed implementation plan for this Pillar, set out in the Annex of the new Statement.
During this process, we understand that the ICS, ECSA, WSC and CLIA will continue to advocate for an industry exemption, to the extent possible. They will also highlight the need for ‘simultaneous ratification’, to safeguard certainty and stability, in a way that does not distort the level playing field, consistent with the objectives of the agreement. Simultaneous ratification should ensure that shipowners benefit from mutual interpretations of shipping income, distribution models, etc. Given that any tax re-allocation model, which might eventually be applied to shipping, is expected to be complex and have an economic impact on some shipping companies, it will be equally important to advocate for a robust ‘impact assessment’, which should hopefully provide concrete evidence to inform and support any decision-making process.
Status of shipping under Pillar Two
This second Pillar aims to ensure that a minimum level of tax is paid on the profits of a multinational group of companies. The core component is that parent companies ‘in-scope’ will be required to pay a 15% ‘top-up tax’ to its headquarters jurisdiction, in respect to a foreign subsidiary’s profits, if the subsidiary is not subject to this agreed ‘minimum tax level’. It will be recalled that in its formal statement on 1 July, the OECD Inclusive Framework stipulated that “The GloBE rules also provide for an exclusion for international shipping income using the definition of such income under the OECD Model Tax Convention”.
This determination has been reaffirmed by the 8 October statement. However, the OECD continued its work on the design of the shipping exemption under Pillar Two, with ICS-ECSA-WSC-CLIA having made an additional informal submission to the OECD Secretariat on 15 September, containing inputs and suggestions about the design of the shipping exemption. In due course, the industry will seek an update from the OECD, regarding the status of this important technical work.
The Pillar Two framework is intended to be brought into law in 2022 and enter into effect in 2023, while the ‘Undertaxed Payments Rule’ (UTPR) is expected to be effective from 2024. The OECD has provided a detailed implementation plan for this Pillar, set out in the Annex of the new Statement.
Status of shipping under Pillar One
It will be recalled that under Pillar One, which would assign taxing rights to every country in the world where a company has customers the OECD Inclusive Framework – based on Article 8 of the OECD Model Tax Convention (MTC) – had initially recognised the longstanding global principle, included in virtually all bilateral tax agreements, that taxation of shipping company profits is assigned to the company’s country of residence (as with aviation). This was subsequently reinforced through the OECD Pillar One blueprint published last year (2020).
However, in its formal statement on 1 July, the OECD Inclusive Framework stipulated that only ‘Extractives and Regulated Financial Services’ were excluded from the scope of Pillar One. The 8 October statement builds on this determination, adding the new text in bold/italics/underlined below. To date, no further information has been provided about this so-called ‘averaging mechanism’.
“In-scope companies are the multinational enterprises (MNEs) with global turnover above 20 billion euros and profitability above 10% (i.e. profit before tax/revenue) calculated using an averaging mechanism with the turnover threshold to be reduced to 10 billion euros, contingent on successful implementation including of tax certainty on Amount A, with the relevant review beginning 7 years after the agreement comes into force, and the review being completed in no more than one year. Extractives and Regulated Financial Services are excluded.”
Under Pillar One, a new ‘special purpose nexus rule’ will be implemented, permitting allocation to a market jurisdiction “when the in-scope MNE derives at least 1 million euros in revenue from that jurisdiction. For smaller jurisdictions with GDP lower than 40 billion euros, the nexus will be set at 250 000 euros. The special-purpose nexus rule applies solely to determine whether a jurisdiction qualifies for the […] allocation. Compliance costs (incl. on tracing small amounts of sales) will be limited to a minimum”. As regards the ‘quantum’, for in-scope MNEs, “25% of residual profit defined as profit in excess of 10% of revenue will be allocated to market jurisdictions with nexus using a revenue-based allocation key”.
While shipping still does not have an explicit exemption under this pillar following the political agreement, this is by no means the end of the process. There is some significant technical work still to be done, including to provide further clarity on the potential application of the re-allocation of taxing rights rules to shipping, in the new Convention being developed for implementation of this Pillar. The Multilateral Convention (MLC) through which the Pillar One framework is expected to be implemented, is intended to be finalised and made available for signature in 2022, with 2023 set as the year for entry into effect of the new Convention, “once a critical mass of jurisdictions as defined by the MLC have ratified it”.
The OECD ‘Task Force on the Digital Economy’ (TFDE), a subsidiary body of the OECD Committee on Fiscal Affairs (CFA), has been given a mandate by the Inclusive Framework “to define and clarify the features of [the Pillar One framework] (e.g., elimination of double taxation, Marketing and Distribution Profits Safe Harbour) and develop the MLC and negotiate its content, so that all jurisdictions that have committed to the Statement will be able to participate. The TFDE is anticipated to conclude the text of the MLC and release an
‘Explanatory Statement’ by early 2022 (potentially February 2022). The OECD has provided a detailed implementation plan for this Pillar, set out in the Annex of the new Statement.
During this process, we understand that the ICS, ECSA, WSC and CLIA will continue to advocate for an industry exemption, to the extent possible. They will also highlight the need for ‘simultaneous ratification’, to safeguard certainty and stability, in a way that does not distort the level playing field, consistent with the objectives of the agreement. Simultaneous ratification should ensure that shipowners benefit from mutual interpretations of shipping income, distribution models, etc. Given that any tax re-allocation model, which might eventually be applied to shipping, is expected to be complex and have an economic impact on some shipping companies, it will be equally important to advocate for a robust ‘impact assessment’, which should hopefully provide concrete evidence to inform and support any decision-making process.
Status of shipping under Pillar Two
This second Pillar aims to ensure that a minimum level of tax is paid on the profits of a multinational group of companies. The core component is that parent companies ‘in-scope’ will be required to pay a 15% ‘top-up tax’ to its headquarters jurisdiction, in respect to a foreign subsidiary’s profits, if the subsidiary is not subject to this agreed ‘minimum tax level’. It will be recalled that in its formal statement on 1 July, the OECD Inclusive Framework stipulated that “The GloBE rules also provide for an exclusion for international shipping income using the definition of such income under the OECD Model Tax Convention”.
This determination has been reaffirmed by the 8 October statement. However, the OECD continued its work on the design of the shipping exemption under Pillar Two, with ICS-ECSA-WSC-CLIA having made an additional informal submission to the OECD Secretariat on 15 September, containing inputs and suggestions about the design of the shipping exemption. In due course, the industry will seek an update from the OECD, regarding the status of this important technical work.
The Pillar Two framework is intended to be brought into law in 2022 and enter into effect in 2023, while the ‘Undertaxed Payments Rule’ (UTPR) is expected to be effective from 2024. The OECD has provided a detailed implementation plan for this Pillar, set out in the Annex of the new Statement.
We shall keep members updated on this matter as it develops and takes shape.