OECD Pillar One

The Organisation for Economic Co-operation and Development (OECD) has been targeting proposals to reduce incentives for tax planning and avoidance by US and foreign multinational companies by limiting tax competition and changing where companies pay taxes. OECD Pillar One would expand a country’s authority to tax profits from companies that make sales into their country but don’t have a physical location there. This was decided as part of the OECD/G20 Inclusive Framework. However, Pillar One remains only a proposal; it has not been adopted by any country.

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What Is the OECD Global Tax Deal?

The OECD’s global tax deal is a significant shift in international tax rules. The OECD Base Erosion and Profit Shifting (BEPS) project began in 2015 by providing template actions for participating countries to adopt that might harmonize tax rules or facilitate dispute resolution. Many of these ideas have been adopted by a large number of participating countries.

However, two more ambitious proposals to overhaul global corporate income tax rules have taken significantly more time to develop and have also been more controversial. The OECD has named these agreements Pillar One and Pillar Two. Pillar One’s impact would result in some companies paying more taxes in the countries where end users for a company’s products are located or digital users are, even if the company has no permanent local establishment in that country. Pillar Two would establish a global minimum tax.

What Is the Aim of OECD Pillar One?

Many countries are home to end consumers of large foreign global tech companies, but few are home to large global tech companies themselves. The former have sought to change the global corporate income tax system to allocate profits more to where digital services are consumed, rather than where they are produced. This is known as a “destination base,” which is a valid choice as part of a broad and neutral tax system, like a value-added tax (VAT), but not traditionally the way corporate income has been taxed.

In recent years, many countries have adopted digital services taxes (DSTs) aimed at (generally American) technology companies that operate in their jurisdiction. Unlike broad VATs, DSTs create a patchwork and discriminatory system that applies to arbitrary industries and at arbitrary thresholds.

The OECD has discussed a more permanent and effective plan to change tax rules for large companies and continue to limit tax planning by multinationals. Pillar One is focused on changing where companies pay taxes.

For companies with global revenues of more than €20 billion ($26.4 billion) and profitability above 10 percent, 25 percent of profits above 10 percent would be taxed according to a new formula based on where a company’s customers are located.

Pillar One would also include dispute resolution processes meant to improve tax certainty for companies.

According to an initial analysis of the original proposals, Pillar One and Pillar Two would increase the effective average tax rate by around 0.7 percent across all jurisdictions. Pillar One is responsible for only .1 percent of this increase.

How Could This Impact US and Foreign Multinationals?

The plan would have some benefits; it might limit tax planning and provide some degree of stabilization by establishing a more orderly system than the patchwork of discriminatory DSTs. However, the US does not necessarily benefit from a tax system based on consumer location rather than other measures, such as headquarter location, that are more US-favorable. The US has the lion’s share of the world’s largest global corporations, and may favor other systems, such as residence-based or source-based taxation, more.

In some cases, tech companies, especially US companies, may have new responsibilities in determining customer location, making the tax burden more complex to comply with. And new cross-border taxes may discourage foreign direct investment (FDI) and other forms of cross-border trade, slowing economic growth.

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