Global Minimum Tax: Are Multinationals Ready?

In October 2021, the OECD/G20 Inclusive Framework (IF) presented its “Statement on a Two-Pillar Solution to Address the Tax Challenges Arising from the Digitization of the Economy” at the G20 Leaders Summit in Rome. The G20 leaders promptly approved it in their Summit Declaration that same month. Since then, the Statement has been joined by 138 out of 142 Inclusive Framework members, representing 94% of global GDP. Since then, the OECD has issued detailed guidance and model rules supporting the two initiatives. One of the two pillars—Pillar Two—appears to be well on its way to implementation.

The Two-Pillar Solution is aimed at the fiscal and economic challenges created by the “digitization” of the global economy. Digitization, broadly understood to refer to disintermediation of markets through the use of technology, can be leveraged to minimize income tax by creating technology platforms in low-tax-rate jurisdictions. When carefully planned and executed, the result can be a business with the requisite economic substance to defend the allocation of most group income to the technology platform operator in the low-tax-rate jurisdiction. At the same time, that technology platform requires no taxable presence (permanent establishment) in the market jurisdictions they serve—no brick-and-mortar presence is required, as the technology platform facilitates direct sales to end customers. This fact pattern has at least two major drawbacks for higher-tax-rate jurisdictions:

1) Employment and tax revenue associated with traditional brick-and-mortar selling and distribution activities are lost; and

2) Establishment of new digitized businesses will follow the same pattern in order to be competitive, creating pressure to reduce tax rates to attract/foster these businesses.

Pillar One responds to the loss of tax revenue by creating a new taxing right for “market jurisdictions” (taxing jurisdiction of the purchasing customer). It carves out a portion of the income of the world’s largest multinational enterprises (above EUR 20 billion in annual revenue) and allocates that income to market jurisdictions, without the necessity of a physical (taxable) presence of those companies in those countries. Pillar One is intended to offer a compromise to jurisdictions which have already responded to the supposed loss of tax revenue by implementing Digital Services Taxes (DSTs). DSTs tax the gross receipts of digitized businesses in the market jurisdictions, and while they have been effective at replacing lost revenues, they are considered discriminatory because they only apply to specific businesses following the digitization business model. The U.S., which is home to most of the major digitized businesses, has threatened to levy retaliatory tariffs against trading partners who have instituted them. Pillar One taxing rights are offered in lieu of DSTs, and under the OECD rules, DSTs must be scrapped before the new taxing right can be applied.

Pillar Two responds to the problem of tax competition by creating a 15% minimum global effective tax rate, thereby putting a floor on the so-called “race to the bottom” in national corporate tax rates. Under the Pillar Two initiative, the OECD has created the Global Anti-Base Erosion Model (GloBE) Rules, which allow the tax jurisdictions of ultimate parent entities (UPE) to collect a “top off tax” whenever a group subsidiary entity fails to achieve a 15% local effective tax rate, and also fails to collect the “top off tax” (to get to 15%) itself. To the extent that both the UPE and the local subsidiary fail to collect the top up tax, an intermediate parent entity may collect the top off tax.

While Pillar One and Pillar Two are linked in their intent to address digitization, they each stand on their own as separate initiatives. It is perhaps, therefore, not surprising that Pillar One has progressed slowly, as some countries mull the prospect of replacing one source of revenue (DSTs) with new Pillar One taxing rights (even in the face of potential U.S. trade sanctions), while Pillar Two has progressed rapidly, as taxing jurisdictions look to add a new tax, which, by inaction, might be ceded to other jurisdictions.

Indeed, Pillar Two implementation proceeds apace: The European Union adopted a unanimous measure in December 2022 by which its member states all agreed to establish implementing legislation in 2023 effective in 2024. The UK, South Korea and several other countries have already implemented part of the model the GloBE Rules, which specify the minimum rules required for a country to be considered GloBE compliant. U.S. support for the Two Pillar Solution bounced back in 2021 after the Trump administration withdrew support in the midst of the global pandemic in 2020, but the U.S. failed to follow up with implementing legislation in 2022, and now the earliest realistic chance of U.S. legislation will be in 2025, after the 2024 national elections. Nevertheless, the rest of the world is acting on the apparent global political consensus that was signaled in October 2021 by the G20 leadership. GMT is well on its way.

Multinational enterprises (MNEs) must consider the additional workload that will result from the incremental implementation of the 15% Global Minimum Tax (GMT). The current effort to prepare for compliance in 2024 and beyond will require the development of an inventory of data elements and a strategy for how to obtain and store those data elements, even as the GloBE model rules continue to evolve at the OECD and inevitable divergence from those rules crops up in national implementing legislation over time. Current estimates of the number of data points are in excess of 100 per entity, covering all types of data, including legal entity data, accounting data, and tax reporting data, which will need to be collected from various disparate sources and systems. Most MNEs have already started the process of cataloging the data requirements and designing a data acquisition and storage plan.

As with other tax forecasting and provision processes, the GMT will eventually be susceptible to automation, of course, but the GMT will continue to evolve such that data gathering requirements will change, and so GMT is unlikely to be a good candidate for investment in automation projects for the time being as its requirements are refined and institutionalized. GMT implementation efforts are therefore likely to create a deficit in available finance department capacity over the medium term. So how should the finance team respond?

Automation is still the key to success and can create the needed capacity to respond not only to the GMT, but to the plethora of additional regulatory and tax demands which expanding government mandates are likely to bring in the coming years.

MNEs should therefore move now to accelerate their investments in automation across the rest of their finance department in stable areas that have been handled manually for decades and are ripe for automation.

This is particularly true for the controllership and tax areas, which will be most directly impacted by the data gathering and processing requirements of the GMT, and then eventually by the necessity of calculating the tax effects of Pillar One market jurisdiction income allocations, as that initiative begins to progress.

One fruitful area for MNEs to automate is intercompany financial operations, which encompass the often overlooked, but highly dynamic processes associated with billing, accounting for and settling intercompany transactions. These time-consuming processes are driven by the necessities of reflecting the arm’s length results which are the starting point for the application of Pillar One and Pillar Two calculations. They drive an enormous amount of manual activity in the corporate finance department, mostly related to attempts to manually connect the otherwise “disconnected accounting” that generally prevails in intercompany operations.

Consider the life cycle of a typical intercompany services transaction: Expense incurred in one group legal entity is recognized (by Tax and/or FP&A, usually) as creating an economic benefit for another, or many other group legal entities. The transfer pricing team recognizes the value-added nature of the activity associated with the expense and requires an arm’s length markup to be applied. What happens next? A “manual journal entry” with a manually generated invoice. This is transmitted by e-mail to be processed by however many group entities are recognized to have benefited from the original expenditure. And unlike a billing to an unrelated party, where sending the invoice and managing the resulting accounts receivable is a perfectly acceptable approach, in the intercompany scenario somebody must ensure that the intercompany transaction is executed correctly on both sides, with balanced and timely journal entries, an invoice that must comply with indirect tax (e.g. VAT) requirements, correct indirect tax amounts (if any), the correct markup for transfer pricing, and the timely settlement of the resulting intercompany payable/receivable. Sound familiar?

While critical to complying with tax requirements and closing the books, none of this is value-added activity. It is, rather, time-consuming house-keeping—clean-up work often requiring a lot of manual detective work to retrospectively match intercompany seller and buyer journal entries to ensure elimination in the close. It is the kind of work that must be done, but nobody gets accolades for doing it. It does not advance one’s knowledge or career. It is frustrating busy-work borne of impoverished processes. In the meantime, critical, cutting-edge work related to setting up a response to the international tax development of the century goes understaffed, and the organization’s sense of teamwork is damaged as siloed areas struggle to keep up with increasingly unmanageable workloads. Mastering intercompany operations through automation will unleash an organization’s tax and accounting functions, so that they can meet the challenges of the future—including Pillar Two GMT.

BlackLine offers an entire platform dedicated to centralization and automation of intercompany financial operations—a discipline referred to as Intercompany Financial Management (IFM).  Learn more about how IFM can help multinationals gain control and clarity over their intercompany processes, and how an organization can realize potential tax benefits as a result.