Podcast transcript: What the BEPS October 2021 Pillar 1 and 2 Statement means for Oceania multinationals

Andrew Nelson: Hi, welcome to the EY Oceania BEPS 2.0 podcast series. My name is Andrew Nelson an international tax partner in our Australian practice and I'll be hosting today's podcast. Joining me today are three of my colleagues.

Firstly, Matt Andrew is our Asia Pacific Tax Policy Leader. Matt joins us direct from the OECD where, as many of you will know, Matt was a Senior Advisor and most recently was the leader of the Pillar One project within the OECD BEPS group. We're incredibly fortunate to have Matt today and to be able to draw on Matt's unique insider's perspective.

Also joining us today is Tony Merlo, a Partner in our Asia Pacific Policy group, based out of Melbourne and Dean Madsen, an International Tax Partner in our New Zealand practice.

Before we launch into today's discussion, I'll just outline what we are aiming to achieve with this and future podcasts. These are designed to provide you with a means of accessing, in a regular and brief format, key developments and insights on the OECD BEPS 2.0 project as it progresses.

As we will cover today, the BEPS 2.0 project has kicked up another gear with a key milestone being achieved on Friday. However, at the same time, we have a long journey ahead of us throughout this year and 2022/23 as we move from design to implementation. There'll be lots of bumps and bends in the road to navigate, we're sure. Occasionally we'll undertake more detailed communications, including webcasts and some of you will have participated in some of our webcast events over the last 18 months. But otherwise, we'll be aiming to send out these podcasts regularly, aiming for every month or so, but flexible depending on developments as they occur.

Hopefully you will tune in and find these podcasts a useful resource as a way of filtering out all the noise, and drawing out key takeaways that you can use for yourself and your organization.

The other point I wanted to highlight is that of course BEPS 2.0 is a global project, but we want to provide a distinct Oceania touch point for you, our Australia and New Zealand clients.

Matt, over to you: can you give us the big picture view on what happened on Friday, and what it all means?

Matt Andrew: Yeah, thanks very much, Andrew.

Look, I think there's sort of three or four sort of key points in relation to the OECD/G20 Inclusive Framework announcement, which came out on the eighth of October 2021. And this is in no particular order. But I think of the 140 countries of the inclusive framework, 136 have signed up, noting that Kenya, Nigeria, Pakistan and Sri Lanka have not in terms of the statement, but noting also that Ireland, Hungary and Estonia have now joined the Statement in October. And that means all the EU and the OECD countries have now agreed to the Statement. And I think that's very important.

I think also in terms of Pillar Two, there has been an agreement in terms of the minimum rate of 15%. And Tony will comment on this more.

In terms of Pillar One, there are a couple of important points to note. I think the first being that the profits subject to reallocation under Pillar One has now been agreed as 25% of the excess above the 10% profit before tax, and that's changed from the 20-30% range in the July Statement.

In relation to unilateral measures, a paragraph has been added, noting a Multilateral Convention will require all parties to remove DSTs and other relevant similar measures and commit to not introducing such measures in the future. And I think it's important for a couple of reasons, it sort of indicates that unilateral measures may apply beyond just vanilla DSTs. And I note the words here, ‘other relevant and similar measures’ and effectively DSTs are stood still from now. And I think that's a great outcome in terms of the Statement. And lastly in terms of the key points, the timeline for 2023 has largely been retained, so Pillar Two model rules will be developed by November 2021, to be implemented by 2023, noting that the UTPR (the under-taxed payment rule) is 2024 in terms of implementation, and the Pillar One Multilateral Convention is to be developed in early 2022 with a target signing in mid-2022 to be implemented in 2023. So we're still on track in terms of a 2023 implementation for both Pillar One and Pillar Two. Back to you Andrew.

Andrew Nelson: Thanks, Matt. A true or false question: most of our Australian and New Zealand clients do not meet the thresholds for Pillar One to apply, and therefore don't need to consider it?

Matt Andrew: Look from my perspective, Andrew, that's true in connection to Amount A and the listeners will know that in terms of Amount A, we have very high thresholds of 20 billion Euro in terms of revenue and 10% PBT (profit before tax). And so I think that's true in terms of Australia and New Zealand and Oceania for Amount A, but that not true in terms of Amount B. If you remember what Amount B is, it relates to all marketing and distribution entities regardless of thresholds. So for those Kiwi and Aussie multinationals which have distribution and marketing entities offshore, Amount B could potentially apply regardless of thresholds.

Andrew Nelson: Yeah, thanks, Matt. Maybe one other question on Pillar One, before we go to Pillar Two. There are carve outs for Amount A – Matt, can you talk to those and perhaps just clarify whether those carve-outs apply for Amount B?

Matt Andrew: Yeah, thanks very much. I think that's a good question Andrew, and the answer is the financial services and extractives carve outs are for Amount A. So regardless of threshold for Amount A, there are certain industries or activities which are carved out, which are regulated financial services, and also extractive industries, particularly oil and gas and mining. The exact nature of those carve-outs is yet to be decided, but I would note that those carve-outs do not relate to Amount B. Amount B, as I've mentioned, has no thresholds in terms of quantum and at the moment has no scope limitation in terms of specific industries being carved out as well. Back to you, Andrew

Andrew Nelson: Tony, where are we at with Pillar Two?

Tony Merlo: Thanks, Andrew. I think, as Matt pointed out, I think the most important aspect of Friday's announcement is that Pillar Two is still on track to go live in 2023, despite the fact that certain critical design features won't be known until the end of November. And also that other practical issues and simplifications won't be known until well into 2022.

What we do know is that the minimum tax rate will be 15% rather than at least 15%. But we don't know how to calculate it, which is pretty fundamental. We do know that the denominator for calculating the minimum tax in each jurisdiction is based on accounting profit with certain adjustments. We now know that these adjustments include a formulaic substance-based reduction of the denominator equal to 8% of tangible assets and 10% of payroll in jurisdiction, progressively reducing down to 5% for each of those items over the next 10 years.

Importantly, there’s no additional carve out for items such as R&D and environmental incentives, which many have advocated for. Well, we still don't know, and what is fundamentally important, I think, is how to calculate the numerator of the minimum tax formula: is it calculated according to modified deferred tax accounting rules, or will it be based on current tax payable? And this is a huge issue for businesses across a number of sectors, including the extractives, manufacturing, insurance, construction, that have significant timing differences from items such as tax losses, accelerated depreciation, accounting provisions and revenue recognition. So whilst it's frustrating that this is still not resolved, given the 2023 start date, on the positive side, we should know how to calculate this by the end of November.

Another important mechanism in the minimum tax rules is the Under Taxed Payments Rule. What it does is it denies a tax deduction in the paying jurisdiction, where the Income Inclusion Rule does not apply in the ultimate parent jurisdiction. As Matt mentioned, this rule will be deferred until 2024. And this is good news for business, as not all countries are expected to be early adopters of the Income Inclusion Rule in 2023.

Finally, some other noteworthy elements of Friday's announcement include an exclusion from the rules where operations in the jurisdiction are small, and that's defined as basically revenue less than 10 million Euros and profits of less than 1 million Euros. And agreement has also been reached on a minimum tax of 9% for the Subject To Tax Rule, which is the rule that applies with certain payments, including interest and royalties, for example, are subject to a nominal tax rate of less than 9%. And then finally, various implementation issues and other safe harbors and simplifications will be revealed from the middle of 2022. Back to you, Andrew.

Andrew Nelson: Yeah, thanks, Tony. Dean, maybe throw to you. Given this framework that's been outlined by Tony and Matt, what should clients be doing now?

Dean Madsen: Thanks Andrew. I’ve probably got a couple of reflections and experiences from what our global clients are doing.

First of all, and my view what the latest turn of the OECD’s plan has shown us is that consensus seems to be prioritized over detail. And so what that means is the deadline for the implementation of the rules is not moving. However, some of the quite key details such as the tax base on which to make our calculations is yet to be filled in. So what that means is you do need to start modeling and you do need to do so by making some assumptions. And businesses around the world are starting to click on to that, and just getting on and getting it done, even though some of the detail that we would ideally have at the moment is not forthcoming.

Second point I'd make is that it's a good time to have a look at what I sort of call the ‘low-hanging fruit’. And by that, I mean, do you have some really obvious entities or aspects of your structure that are likely to be adversely impacted? And, for example, do you have low substance or intermediary hubs in your structure that give rise to tax benefits, in entities that are likely to sign up to the new framework? These tend to be relatively easy to unwind, and we are seeing a lot of groups globally, looking at bringing home those non-core functions to their HQ territory, where there's more opportunity to blend them with core functions and avail themselves of other attributes they may have.

And last but not least, I guess, is a real practical one, now's the time to speak to your Board and speak to your C-suite. There is some economic risk for impacted clients, sure, but there's also a lot of reputational risk, particularly given that the media (rightly or wrongly) have hung their hat on this as the ‘White Knight’ to solve imbalances in the international tax system. You need to appraise your boards, you need to appraise your C-suite of the risk, and to really, as the experts within your organizations, to be seen to be driving those discussions. So with risk, it presents an opportunity to elevate the discussions you are having. And again, globally, we're seeing a lot of clients do that and do that quite successfully.

Helpfully, if you do need help on any of that, you have a bunch of really, really smart people at EY who are on this call and around the network. And on that, I'll pass back to Andrew.

Andrew Nelson: Yeah, thanks, Dean. And I think the last thing clients want to hear over and over is consultants telling them they've got to act. But the reality is, I think that time is here, and I think it's starting to become universally agreed that clients need to be prepared to answer the questions from internal and external stakeholders on Pillar One and Pillar Two. So I think that’s where we’re at.

Dean, just picking up on one of the points you made there around modeling. EY does have sophisticated modeling capability; we've got a Pillar One and Pillar Two tool. Some of you would be quite invested already in modeling the outcomes under both Pillars. Some of you might not have given consideration to this. And I think over time, we'll see more and more clients start to try and model the outcomes in a more sophisticated fashion. So please feel free to reach out to any of us on the call today. I can certainly put you in touch with the right people to assist you with that.

With that, I'll just thank you guys. I think we've managed to achieve what we wanted to do is to keep it brief and punchy. Thanks to you for participating, to my colleagues, and thank you all for joining on this call and listening. Please look out for our future podcasts and in the interim, please reach out to any of us. Our contact details are in the email you would have received with this podcast.

Have a good day. Thank you.