BACKGROUND

On October 9th, 2019 the Secretariat released a public consultation of the proposed “Unified Approach” under Pillar One. Following this release, the Secretariat issued another public consultation document focused on comments on the Pillar Two of the Programme of Work2. That document focuses specifically on the technical issues of the GLoBE proposal, primarily on three technical aspects of it:

1. The use of financial accounts
   to determine the tax base
2. The extent of blending low and
   high-tax income
3. Views on carve-outs and thresholds
   considered for the GLoBE proposal

For purposes of this summary, first a review of Pillar Two is be
provided.

Pillar Two, also referred to as the GLoBE proposal,
seeks to develop a co-ordinated set of rules to address ongoing concerns
arising from multinational structures that allow profit shifting to
jurisdictions where income is not taxed or is taxed at a very low level.

The proposed set of rules are intended
to modify at a certain
level domestic laws and
tax treaties, with the objective of implementing a minimum rate of tax on all income and therefore deterring MNE’s from
engaging in profit shifting. The components of the GLoBE proposal are:

1. The Income Inclusion Rule: operates as a minimum tax rate MNE’s on
   their global income. The aim is to establish a floor for tax rates without
   regards of where the MNE is headquartered. In other words, this rule acts as a
   top up on that income which was taxed at a rate
   below the minimum rate established.

1 Public
Consultation Document, Addressing the Tax
Challenges of the Digitalization of the Economy, 13 February – 6 March
2019.

2 Public
Consultation Document, Global Anti-Base
Erosion Proposal GLoBE, 8 Novemeber 2019 – 2 December 2019.

• Undertaxed Payment Rule: this rule would deny a deduction or imposed
  a source-based taxation on payments made to related
  parties if such payments
  are not subject to a tax at the minimum rate
  established.

• Switch-Over Rule: this rule would be introduced into tax treaties
  and would allow resident jurisdictions to impose a credit method on profits
  attributable to PE’s or other types of profits that are subject to a tax rate
  below the minimum rate established.

• Subject to Tax Rule: this rule would act as a complement to the
  undertaxed payment rule and would modify certain tax treaty’s articles to limit
  their benefits on certain
  items of income,
  primarily focused on interest and royalty
  payments.

As a whole, the GLoBE proposal suggests that with the
absence of low taxing rates and the standardization of a minimum rate, the
playing field is leveled for both, taxpayers and tax jurisdictions.

CONSIDERATIONS FOR PILLAR TWO

However, just like for Pillar One, the Secretariat calls
for comments and suggestions from the public
on several design issues that need to be dealt with in order to achieve
a coordinated effort that is based on simplicity, minimum
administrative burden, and eliminates the risk of double taxation.

There are several technical and design aspects of the
GLoBE that depend on policy choices and these include:

1. Determination of the tax base
2. Blending
3. Carve-Outs

Determination of the Tax Base

The PoW starts from the idea that the tax base should be determined according to the CFC rules that jurisdictions already apply or Corporate Income Tax rules of the shareholder’s residence jurisdiction.

However, this would imply that all subsidiaries of an MNE would have to recalculate their income using the rules of the parent jurisdiction, causing not only significant administrative costs but also leading to potential risks that a highly taxed subsidiary is treated as a low taxed entity.

In order to avoid such complications, the PoW explores
simplifications like setting financial accounting rules subject to certain
specified adjustments when calculating the tax base. This would eliminate the
risk of mis-calculating the tax base and therefore mis-calculating the rate at
which that income was taxed merely because different accounting standards are
employed.

Once the tax base is determined, that tax base would have to be analyzed in order to determine if it was taxed above the
minimum tax rate (according to the income inclusion rule)3. Once again, a consensus must be reached to determine whether to
use a fix rate or a minimum tax based on a percentage of the jurisdiction CIT rate.

Blending

Blending is the mixing of income that is taxed at high
and low rates within the same entity.

Because the GLoBE proposal is surrounded by the idea of
a minimum tax rate, determining how to calculate such rate is crucial. The PoW,
under the public consultation, seeks to gather opinions
on the best way to calculate the minimum rate, including the level of blending
income that MNE should be allowed to
use. This public consultation names
three types of blending, each with its own pros and cons. The three types of
blending are:

1. Worldwide blending: this type
   of approach would require MNE’s to aggregate its total foreign income and the
   tax on such income and compare the rate paid to the minimum rate established.

3 Consideration is
placed in terms of replacing CFC rules with the Income Inclusion Rule.

The difference
between the tax effectively paid and the minimum rate would

the MNE’s tax
liability under the GLoBE proposal.

• Jurisdictional blending: the
  approach would require MNE’s to distinguish income between the different jurisdictions where they have presence or where they are
  taxed. If in a certain jurisdiction
  the total amount of income attributable to such jurisdiction is taxed below the
  minimum rate, then the MNE’s liability would be that amount necessary to bring
  the total amount of tax up to the minimum rate.

• Entity blending: such approach
  would require each entity within an MNE to determine its income and tax. If the
  effective tax rate of a foreign branch or foreign entity was below the
  established minimum rate, then the MNE would be subject to tax.

Each approach represents a unique policy and while some
are more specific than others, they also represent more challenging and
burdensome approaches. Choosing the
appropriate blending will also require to consider the challenges that arise
from other design aspects, like determining the proper tax base. Issues like
the use of financial accounting principles or the effects of timing issues can
have effects on the calculation of the effective tax rate in any of the three approaches.

Carve-Outs

The PoW also considers the possible application of
carve-outs and thresholds to restrict the application of the GLoBE proposal to only scenarios where it is deemed to be best applicable.

As a start, the
mentioned carve-outs include:

1. Regimes complaint with BEPS Action 5.

• Return on tangible assets

• Controlled corporations with a level of related
  part transactions below a specific threshold.

The public discussion also addresses the exploration of
thresholds for the application of
the GLoBE proposal:

1. A threshold based on turnover
   or other financial indicator of the size of the group

• A threshold to exclude entities
  with a minimum amount of profit or intercompany transactions.

• Specific industry or sector carve-outs.

It is emphasized that carve-outs and thresholds would
undermine the policy intent and impact compliance and administration costs. The
design or implementation of carve-outs and thresholds can be circumstance-based
or objective (based of certain measurable criteria).

Conclusions

As part of the BEPS project, both Pillar One and Pillar Two seek to close gaps in the international tax spectrum. However, despite the consensus reached and the work done by members of the Inclusive Framework, there are still several topics that need to be discussed and polish further.

From the allocation of taxing rights to the development of a co-ordinated strategy to regulate and tax international profits, these challenges and issues make the path to reach a consensus agreement a challenging one. It is important to remember that a solution much be reached by the end of 2020. As such, it is expected that numerous more documents will come to light in the near future, as the stakeholder in the matter, including G20 Finance Ministe, world leaders and the OCDE work jointly to develop a solution that tackles effectively the challenges arising from the Digitalization of the Economy and the Erosion of Profits

Jose Miguel Rodriguez, Auren Mexico.