A new Two-Pillar Solution from the OECD aims to address the tax challenges arising from the digitalisation of the economy. Aaron Lee and Joseph Lee from DBS Bank recently joined TMI’s Eleanor Hill in the TreasuryCast virtual studio to discuss these reforms and outline actions treasurers should be taking ahead of the 2023 implementation date.
The Organisation for Economic Co-operation and Development (OECD) and G20 Inclusive Framework on Base Erosion and Profit Shifting (BEPS) announced in October 2021 that an agreement had been struck on a Two-Pillar Solution.[1] This initiative sought to specifically address the digitalisation of the global economy and the various tax implications that this new dynamic world has created.
“The solution aims to address the concerns that many countries and authorities have regarding how companies in the digital economy have been able to exercise their reach across countries through multiple mechanisms,” says Aaron Lee, Head of Tax, Institutional Banking and International Centres. “For example, there’s concern about scale without mass, where a company can reach customers in their domestic country without having a footprint there. Other concerns are around generating value through network effects, and companies that place strong reliance on intangibles. The historic international tax architecture has always struggled with these kinds of issues.”
Indeed, international tax structures have traditionally focused on examining companies’ residence in a country and calculating tax based on that residence. The Two-Pillar Solution aims to ensure a fairer distribution of profits and taxing rights. It is also designed to limit the so-called ‘global race to the bottom’ when it comes to tax competition by setting a multilaterally agreed global minimum tax rate.
Understanding the new landscape
Pillar One targets multinational enterprises (MNEs) with a global annual turnover above €20bn and profitability above 10%. It effectively aims to reallocate multinational profits to market jurisdictions – countries where multinational entities actually have their customers. Pillar Two, meanwhile, has a greater scope as it applies to MNEs that meet a €750m annual turnover threshold. This pillar focuses on global minimum tax rules – a floor to the lowest minimum tax rate that corporates should be permitted to use at a jurisdictional level. Both pillars represent significant changes to the existing tax rules within which corporate treasurers are used to working.
The legislative effect and agreement at the country level for these two pillars is expected in the first half of 2022, with implementation planned for 1 January 2023. For such a large project, this is a short timeline for treasurers to get to grips with what the changes entail and how they might impact their business.
Joseph Lee, Group Head of Treasury and Working Capital Advisory and Solutioning, notes there are many companies with centralised operations which may have a potential issue with revenue and tax misalignment when the new tax regulations come into play in 2023. “That’s the first challenge for most corporate treasurers; understanding what would change and the impact of those changes on additional taxes paid in countries where the revenues are generated, and managing the change in processes to ensure timely reporting and payment,” he says. “Corporate treasurers have to work closely with centrally managed, single location operations and in-country key functions of sales, operations, legal, finance and tax to see where the biggest impacts are going to come from. This will then allow for a forecast of tax liabilities (and cash to settle) in countries of impact.”
From here, treasurers can then assimilate the forecast into their operating risk, cash and liquidity treasury framework. Examples of some of the outcomes from the treasury process include; currency risk, funding and liquidity risk, and country risk. These are the basic operations that have to be revisited by corporate treasurers as a result of the Two-Pillar Solution.
Incentives and drawbacks
As well as potentially altering the amount of tax that companies pay, these changes to the global tax landscape may open up a broader question for corporates about the jurisdictions they choose to be based in. It may have a particular impact on low-tax jurisdictions, particularly those that have nothing more to offer beyond a low tax rate.
“One of the fundamentals of successful business is to be close to your customer markets. This practice can take the form of a direct in-country operation for large markets or having a nexus to a hub or cluster of emerging economies,” explains Joseph Lee. “Other considerations of cost, infrastructure and talent availability, and governance and regulatory environment of locations will influence the choice of options in business model and location. Countries or jurisdictions that are nothing more than tax havens without substance are potentially at the highest risk of being displaced.”
Zooming in on treasury operations and shared services centres (SSCs), it is anticipated that the tax changes will have little impact on them in the near term. This is because income from the provision of centralised treasury or finance services are typically based on a ‘cost-plus’ model.
“Take a SSC company operating in a location with a 10% income tax incentive,” Joseph Lee continues. “The negative impact from the new minimum tax of 15% – assuming all other criteria are met – against a ‘cost-plus’ revenue model is unlikely to be high. As such, the costs of relocating a SSC versus the negative impact of 5% incremental tax on income will have more weight in decision making.”
Another aspect of the implementation that treasurers need to follow carefully is the potential for adjustments at domestic tax level. As countries adapt to this change, they will be introducing new legislation that, while not necessarily working around these rules, may operate at a slight tangent to them. Corporates should remain conscious of the potential overall impact of this.
Treasurers should also remain nimble and agile to the local jurisdiction adjustments in reaction to Pillar Two.
Finally, scoping will be an essential consideration to which corporates should pay attention. Pillar Two has a broader scope than Pillar One, covering multinationals with a global turnover of more than €750m. These are the same limits as the previous country-by-country reporting, but some carve-outs have already been suggested.
Aaron Lee continues: “Carve-outs suggested include a ‘de minimis’ level when earning profits of less than €1m in a jurisdiction, or substance exclusions that take a portion of income away from this minimum tax, equivalent to a percentage of tangible assets and payroll in that jurisdiction. The proposed rules are going to be quite complex and the devil will really be in the detail in terms of how countries adapt, as well as how these kinds of rules specifically play out. Multinational corporates have a lot to look at and examine before they make any moves around this.”
Tweaking, adapting, adopting
The OECD’s approach to addressing the digitalisation of the global economy has been to create a new set of rules. While they are leveraging standard accounting rules and standard accounting outcomes, the OECD’s thinking is that Pillar One and Pillar Two amounts will overlay the existing calculations.
Aaron Lee cautions: “This means they’re going to be quite prescriptive about how corporates are supposed to compute the amount of minimum tax, and that amount computed may not necessarily follow what corporates currently arrive at from the general accounting rules perspective.”
As these rules are going to overlay existing tax computations that already have to be done, in-house corporate tax teams will potentially be computing tax liabilities twice, under two different sets of rules. Merely keeping that in mind is going to be a challenge.
“Implementation is due by 2023, but the detailed rules haven’t even come out yet, so that is a pretty short runway,” adds Aaron Lee. “[Considering] the time that we would need to build the necessary systems to ensure that we are going to be able to cope with this through systems and straight-through processing, it’s going to take a little while to make sure that we’ve ramped up enough on infrastructure and on the system calculation.”
Another consideration is that even getting to this point has been a massive political and technical exercise for the OECD and all the inclusive framework countries – reaching a stage where all the countries are willing to agree to a prescriptive set of rules that come up with a minimum tax level. Now we will see whether there is enough political will to take the consensus they have arrived at through local parliaments and legislative bodies to be enshrined in law.
“As those laws pass into domestic legislation, we may see countries tweaking their tax rules to adapt to this change,” notes Aaron Lee. “That’s the part on which we don’t have much clarity at this point. When those tweaks happen, we need to watch how those interplay with the existing rules, and the additional overlay calculation and then map our way through this in the short time we have until 2023. It is going to be challenging.”
Interestingly, an unintended consequence of the Two-Pillar Solution and broader Inclusive Framework may be the impact on how countries approach their ESG responsibilities. While these rules may touch and limit the efficacy of local tax incentives, another way of thinking about this is that governments may end up with more in their fiscal wallet, allowing them to redeploy these additional taxes into targeted ESG investments.
“Having generated more tax, governments may decide to target this into spending on ESG investments, such as building more solar infrastructure, or giving out grants for ESG research and development,” Aaron Lee says.
Preparing for change
With the aforementioned tight timeline until the Two-Pillar Solution is due to be implemented, treasurers would be wise to act now to ensure the smoothest possible transition for their organisation. This starts by familiarising themselves with the likely scenario once these recommendations have passed into law.
Treasurers should identify which changes could potentially cause issues, and what the impact these changes might have, in order to tackle the issue and reduce the impact on the business. It is also important to note that this is not only a treasury issue, and pooling ideas and concerns with colleagues who also have exposure to tax can be extremely beneficial.
“Speaking with internal colleagues and partners, and getting a place at the table to run through the discussions and the scenarios, is vital,” advises Joseph Lee. “That means talking to people in finance, tax, business operations, and sales to understand the situation, to explore the context as to where the impact will come and define what is needed to manage this. Additionally, speak with external people in the network, such as consultants and banks, to understand exactly what people are thinking about this, whether they are taking any action, and what the best course of action to pursue might be.”
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Aaron Lee
Head of Institutional Banking (IBG) and Tax, DBS Bank
Lee is responsible for tax matters across the IBG business, ranging from tax advisory to compliance and dispute resolution. Prior to joining DBS Bank, he held tax positions in the regional and global headquarters of major banks in Hong Kong and London, and a Big Four tax consultancy. Lee is a Fellow Chartered Accountant with the Institute of Chartered Accountants in England and Wales (ICAEW).
Joseph Lee
Group Head, Treasury & Working Capital Advisory and Solutioning, Global Transaction Services, DBS Bank
Lee leads the business consulting unit that collaborates with corporates in reinventing and reinforcing business, finance, and treasury operations through advisory and solutioning.
Current projects include: finance and treasury transformation; optimising corporate balance sheets; building resilient supply chains; and riding current business trends and maximising opportunities (e.g. digital currencies).
Prior to joining DBS Bank, Lee held senior positions in finance and treasury with established corporates across various industry segments.
He holds degrees in accountancy and an MSc in Applied Finance along with several related professional certificates and diplomas.
