Towards a “more stable and fair international tax architecture”: Perspective of the Latin American countries

1. Introduction

Based on the agreement reached at the G7 at the beginning of last June, the BEPS Inclusive Framework (BEPS IF) of the OECD and G20 has issued a declaration (07/01/21) recently approved at the G20 meeting in Venice, to provide a common solution that addresses the tax challenges of the digitalization of the economy. 132 countries have adhered to date,[1] which constitutes a milestone in international taxation, allowing a hopeful glimpse of the long-awaited international consensus.

The countries of Latin America were not indifferent. The Latin American members of the Inclusive Framework that joined the Declaration are Argentina, Brazil, Chile, Colombia, Costa Rica, Haiti, Honduras, Mexico, Paraguay, Peru, the Dominican Republic, and Uruguay. It should be remembered that some of these countries have carried out tax reforms to tax the digital economy, although mainly in the Value Added Tax.

 

2. Agreed aspects of Pillar One.

  • Scope

Multinational companies (MNEs)[2] with a worldwide turnover of more than 20 billion euros and profitability of more than 10% (profits before taxes/revenue). The turnover threshold will be reduced to 10 billion euros, depending on a successful implementation[3]. It would reach the 100 most profitable companies in the world[4], with half of the world’s profits.

  • Nexus rule

There will be a new “special purpose” nexus rule that will allow the allocation of the so-called “Amount A” to a market jurisdiction, when the MNE obtains at least 1 million euros in revenue in that jurisdiction. For the smaller jurisdictions[5], the nexus will be set at 250,000 euros. The rule applies only to determining whether a jurisdiction qualifies for the Amount A allocation.

  • Quantification

Between 20 and 30% of the “residual profit” – profit greater than 10% of the income – will be allocated to the market jurisdictions, using an income-based rule.

  • Revenue Sourcing

Revenues will be allocated to end-market jurisdictions, where the goods or services are used or consumed, with detailed rules for specific categories of transactions. To this end, the MNE must use a reliable method, based on specific facts and circumstances.

  • Tax base determination

The relevant measure of profit or loss will be determined by reference to the accounting income, with minimum adjustments. Losses will be carried forward.

  • Segmentation

Segmentation will occur only in exceptional circumstances where, based on the segments disclosed in the accounting, a specific segment complies with the scope rules.

  • Safe harbor of marketing and distribution benefits

When the residual profits of MNE included are taxed in a market jurisdiction, a “safe harbor” rule on trading and distribution profits will limit the residual profits allocated to the market jurisdiction through Amount A.

  • Marketing and distribution profits safe harbor

Double taxation of earnings assigned to market jurisdictions will be alleviated by the exemption or credit method. The entity (or entities) that assumes the tax obligation will extract it from those that obtain a residual profit.

  • Tax certainty

MNEs will benefit from dispute prevention and resolution mechanisms, which will avoid double taxation for Amount A, including all issues related to Amount A (for example, disputes over transfer pricing and business profits), on a mandatory and binding basis. Disputes over whether the issues may be related to Amount A will be resolved on a mandatory and binding basis.

Considerations will be given for an elective binding dispute resolution mechanism on issues about Amount A for developing countries eligible for deferral of their review of BEPS Action 14 and have low or no levels of disputes.

Regarding the so-called “Amount B”, the application of the “arm’s length” principle to the commercialization and distribution activities based in the country will be simplified, with special attention to the needs of low-capacity countries. This work will be completed by the end of 2022.

  • Tax Management

Tax compliance will be simplified (including filing obligations) and will allow MNEs to manage the process through a single designated entity.

  • Unilateral measures

The package will provide proper coordination between the enforcement of the new rules and the removal of all taxes on digital services and other similar measures. Taxes established by Peru, Uruguay, and Paraguay, for example, could qualify.

  • Implementation

The multilateral instrument through which Amount A is implemented will be developed and opened for signature in 2022 and will enter into force in 2023.

3. Agreed aspects of Pillar Two.

  • Overall design

Pillar Two consists of two interlocking domestic rules (against base erosion, GloBE):

  • Undertaxed payment Rule (UTPR), which denies deductions or requires an equivalent adjustment, to the extent that an incorporated entity’s income is not subject to tax under an IIR

It also includes a rule based on a tax treaty (the “Subject to tax rule”, STTR) that allows originating jurisdictions to impose limited source taxes on certain taxable related party payments below a minimum rate. The STTR will be creditable as a covered tax under the GloBE rules.

  • Rule status

GloBE rules will have the status of a common approach, Inclusive Framework members are not required to adopt them, but, if they choose to do so, they will implement and administer them in a manner consistent with Pillar Two. Likewise, they will accept the application of those applied by other Inclusive Framework members.

The GloBE rules will apply to MNEs that meet the € 750 million thresholds[6], affecting fewer than 10,000 companies.

Countries are free to apply IIR to MNEs based in their country even if they do not meet the threshold[7].

  • Rule design

The IIR assigns a supplemental tax based on a “top-down approach” subject to a “divided ownership rule” for interests below 80%.

The UTPR assigns the complementary tax to entities incorporated in low-tax jurisdictions, including those located in the jurisdiction of the ultimate parent entity (UPE), under a methodology to be agreed upon.

  • Calculation of the effective tax rate

The GloBE rules use an effective tax rate test that is calculated on a jurisdictional basis and uses a common definition of covered taxes and tax base determined with reference to accounting income (with agreed adjustments consistent with Pillar Two objectives and mechanisms to address temporary imputation differences)[8].

  • Minimum rate

The minimum tax rate used for the IIR and UTPR purposes will be at least 15%.

  • Exceptions

The GloBE rules will provide a formulated substance exception that will exclude income of at least 5% (in the 5-year transition period, at least 7.5%) of the book value of tangible assets and payroll.

The GloBE rules will also provide a “de minimis” exclusion.

  • Other exclusions

The GloBE rules also provide an exclusion for international shipping revenue under the OECD Model Tax Convention.

  • Simplifications

Administration of GloBE rules will be as specific as possible and to avoid that their compliance and management costs are disproportionate to the objectives, the implementation framework will include safe ports and or other mechanisms.

  • Coexistence with GILTI[9]

Considerations will be made regarding the conditions under which the US GILTI regime. The US will coexist with the GloBE rules, to guarantee a level playing field.

  • Subject to tax rule (STTR)

Inclusive Framework members recognize that the STTR is an integral part of achieving consensus on Pillar Two for developing countries. The members that are applying nominal corporate income tax rates below the STTR minimum rate to interest, royalties, and a defined set of other payments could implement the STTR in their bilateral treaties with developing IF members when requested to do so.

The tax authority will be limited to the difference between the minimum rate and the tax rate on the payment. The minimum rate for the STTR will be 7.5% to 9%.

  • Implementation

Inclusive Framework members will agree and publish an implementation plan that will include GloBE model rules with the appropriate mechanisms to facilitate the coordination of such rules that have been implemented over time, including possible multilateral implementation as with the STTR model. They include also transition rules, including the possibility of a deferred implementation of UTPR. Pillar Two should enter into force in 2022 and start to apply in 2023.

4. Final Words

According to the OECD, the new paradigm of international taxation of corporate income brings important benefits. Under Pillar One, it is estimated that taxation rights in respect of more than $ 100 billion of profits will be reallocated annually to market jurisdictions. In addition, the global minimum corporate income tax under Pillar Two was projected to collect, per year, about $ 150 billion in additional tax revenue. There are also benefits from the stabilization of the international tax system and greater tax certainty.

In this context, the Latin American countries should take advantage of the collection opportunities posed by the new international taxation paradigm, given that they are important markets for MNEs (Pillar One) as well as to counteract the BEPS practices of MNEs and the subsequent collection losses of the corporate income tax, which results from one of the main sources of tax revenue (Pillar Two). Some voices (Latindadd, TJN, Oxfam) warn about the need to raise the minimum rate and also about the privilege that this pillar two would grant to developed countries, headquarters of the main parent companies (IIR rule). The average corporate income tax rate is relatively high (above 15%, except for Paraguay), therefore, incentives to relocate income may persist. Finally, this opportunity will allow countries to compete for investment without sacrificing tax revenue.

[1]The list of subscribers can be consulted at: https://www.oecd.org/tax/beps/oecd-g20-inclusive-framework-members-joining-statement-on-two-pillar-solution-to-address-tax-challenges-arising-from-digitalisation-july-2021.pdf.
[2]Regulated and extractive financial services are excluded.
[3]Including the tax certainty on Amount A, with the relevant review as of 7 years after the entry into force of the agreement and completion of the review in no more than one year.
[4]According to the design in the previously published blueprint in relation to pillar 1, it was estimated to reach 2,300 companies.
[5]GDP less than 40 billion euros.
[6]As determined in BEPS Action 13 (country-by-country reports)
[7]Government entities, international organizations, non-profit organizations, pension funds or investment funds that are ultimate parent entities (UPE) of an MNE Group or any holding vehicle used by said entities, organizations, or funds are not subject to GloBE rules.
[8]With respect to existing tax distribution systems, there will be no additional tax liability if profits are distributed within 3-4 years and are taxed at or above the minimum level.
[9]“Global intangible low-taxed income” seeks to neutralize in some way the exemption on dividends in the cases in which it applies to North American shareholders, who must tax – at a determined effective rate – the “intangible” income – excess of the income obtained above a “tangible” profit, represented by an established return on tangible assets – obtained by foreign corporations at the time of accrual.

Disclaimer. Readers are informed that the views, thoughts, and opinions expressed in the text belong solely to the author, and not necessarily to the author's employer, organization, committee or other group the author might be associated with, nor to the Executive Secretariat of CIAT. The author is also responsible for the precision and accuracy of data and sources.

1 comment

  1. Tripathi Associates Reply

    This is is good and informal site grate …

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