February 07, 2020

OECD Takes Important Steps in Advancing Pillar One, Progress Noted on Pillar Two


Taxing the Digital Economy

On January 31, 2020, the OECD reported significant steps in advancing Pillar One, its approach for the taxation of the digital economy. At its January 29 and 30 meeting, the OECD Inclusive Framework (“IF”)1 endorsed the Pillar One approach and approved an architecture for negotiating the final Pillar One principles by the end of 2020.

Accompanying the IF’s Statement reporting the outcome of the meeting, the OECD released important guidance in connection with key issues associated with the implementation of Pillar One. A revised Programme of Work was also issued outlining the remaining work to be done.

At the same time, the OECD noted continued progress on Pillar Two, the global base erosion (“GloBE”) project. The IF notes that, as with Pillar One, Pillar Two is on a similar timetable with release of the final principles also scheduled for year end.

The IF has reaffirmed its commitment to reach comprehensive consensus based solutions to the taxation of the digital economy and countering global base erosion. As discussed in greater detail below, the IF is working under a very aggressive timetable with important updates scheduled for March and early-July 2020.

Obtaining consensus among 137 countries will be a significant challenge, but the IF has already shown that it is capable of coming together to move the project forward. If a consensus is ultimately reached, Pillar One and Pillar Two would represent profound changes in the taxation of multinational companies. Coupled with US Tax Reform, the EU Anti-Tax Avoidance Directives (“ATAD I” and “ATAD II”), as well as the implementation of the rest of the BEPS Action Plans, Pillars One and Two will require multinationals to make critical decisions on their international structures.

Pillar One

In May, 2019, the IF issued a detailed Programme of Work (“PoW”) to push Pillar One forward. At that time, the IF noted that its members had proposed a variety of diverse proposals for the taxation of the digital economy. In order to facilitate a consensus-based solution, the OECD Secretariat developed an approach built upon the commonalities identified in the PoW (the so-called “Unified Approach”) and scheduled a Public Consultation in October, 2019.

The Unified Approach creates a new nexus standard (i.e., a new taxing right) by which a country will be able to tax profit earned by a multinational without regard to whether the multinational has a physical presence in the country. In this regard, Pillar One represents a groundbreaking diversion from traditional concepts of taxation. By endorsing the work of the OECD Secretariat, the IF has agreed that Pillar One will comprise the architecture on which a consensus based solution will be negotiated. In other words, the IF has approved Pillar One as the blueprint for negotiating a new model of international taxation.

Under Pillar One, an in-scope multinational will be subject to an income tax in a market jurisdiction2 on a deemed residual profit on in-scope activities (“Amount A”) less a fixed return for routine marketing and distribution functions taking place in that country (“Amount B”). “Amount C” represents the adjustments that will be made through binding dispute resolution mechanisms between the countries to ensure proper allocations of Amounts A and B to each country and to allocate additional profit to a country where local functions exceed the baseline amount compensated under Amount B.

As noted in the original OECD Public Consultation, Pillar One raises numerous issues which must be addressed by the IF by year end. A number of these issues are discussed below.

MNEs Covered by Pillar One

Pillar One is designed to apply to a large multinational which has “sustained and significant” involvement in a jurisdiction. Many commentators, including Mayer Brown, suggested the use of the Euro 750 million gross revenue threshold used for country-by-country reporting (“CBCR”) purposes as the gateway threshold for Pillar One to apply. The IF Statement strongly indicates that the CBCR threshold will be the relevant threshold for Pillar One purposes as well.

If the multinational enterprise (“MNE”) has gross revenues in excess of the CBCR threshold, the next question is whether the MNE has “sustained and significant” involvement. The IF Statement suggested that the generation of in-scope revenue over a period of years would be evidence of “sustained” involvement. While no period was given by the IF, Mayer Brown and others suggested a three-year testing period.

The IF Statement indicates that a specific minimum in-scope revenue threshold will be provided as evidence of “substantial” involvement. The Statement indicates that the minimum threshold would be commensurate with the size of the market but an absolute minimum threshold will also be provided. Mayer Brown suggested the use of a $50 million three-year moving average threshold.

Finally, the IF Statement notes that a de minimis threshold will also be provided so that large domestic facing businesses with minimal foreign income would be excluded from Pillar One.

In-Scope Businesses

Pillar One is intended to focus on consumer facing businesses that transact on a digital basis. In the original Public Consultation, Pillar One was focused on consumer-facing businesses. The OECD received numerous comments on which businesses should be in-scope with particular emphasis on the distinction between B2C and B2B businesses. The IF Statement provides further guidance on in-scope activities by identifying two broad categories of businesses that will be covered.

The first category is known as “automated digital services” (“ADS”) which are provided on a standardized basis to large populations of consumers in multiple jurisdictions. Examples of an ADS business include:

  • Online search engines
  • Social media platforms
  • Intermediation platforms
  • Digital content streaming
  • Online gaming
  • Online advertising
  • Cloud computing

The definition of ADS in the IF Statement can be seen as an expansion of the types of businesses intended to be covered by Pillar One. The inclusion of cloud computing is of particular interest because cloud computing is generally considered a B2B service which may or may not facilitate B2C activities. The IF Statement notes that “further work” is still required on the definition of ADS “especially for business models that deal mostly with other businesses….”

The second category of in-scope businesses are consumer-facing businesses, namely the generation of revenue from the sale of goods or services directly to consumers. The IF Statement identified an important exclusion to this category of in-scope business where the MNE is selling “intermediate” products, i.e., products and components that are incorporated into a finished product sold to consumers, except where the component itself is branded and commonly purchased by consumers directly. Many commentators recommended that the sale of intermediate component products or services be excluded from Pillar One.

The IF Statement also identified a number of industries that are expected to be excluded from Pillar One. These include the extractive industry and certain aspects of the financial services sector which were identified in the original Public Consultation.

The IF Statement also identified the shipping and airline businesses as additional industries to be excluded. As the Statement notes, the long-standing internationally accepted approach for the taxation of these industries is to assign exclusive taxing rights over the profits of shipping and airline companies to the residence countries of such companies. This policy is already reflected in nearly all bilateral tax treaties. In response to comments by industry groups, the IF correctly concluded that it would be inappropriate to include these businesses in Pillar One.3


Many MNEs conduct multiple businesses, some of which may be in-scope for Pillar One and some may not. As a result, many commentators including Mayer Brown noted that segmentation will be essential to ensure that Pillar One only applies to relevant businesses. We suggested that segmentation be elective by the MNE subject to a requirement to use that segmentation for an agreed period of time. We discouraged giving market jurisdictions the right to unilaterally determine the segmentation of an MNE.

The IF Statement indicates that segmentation will apply and further work is necessary to determine what level of segmentation is practicable and verifiable.

Double Taxation

When an Amount A is allocated to a market jurisdiction, that amount is effectively surrendered from one taxing jurisdiction (the “surrender country”) to the market country. To prevent double taxation, some mechanism will be necessary to adjust the tax position in the surrender country. The IF Statement notes that there are several options to mitigate double taxation including a foreign tax credit, an exemption or a deduction. Mayer Brown recommended that taxpayers be able to elect between a deduction or credit mechanism.

The IF Statement notes that further work is still required on this point but it is important to note that the IF recognizes the significance of this issue.

Dispute Resolution

Pillar One is intended to reallocate global profit between jurisdictions. It is not intended to create additional profit to be allocated to a market country. The dispute resolution mechanisms of Amount C are intended to be the tools by which countries agree to the global allocation. The effectiveness of these tools is critical to mitigate double taxation. The IF Statement proposes the creation of a new multilateral instrument (“MLI”) that would contain all the rules needed to implement Pillar One. This new “Pillar One MLI” would be agreed by all IF members and supersede the relevant provisions of existing bilateral treaties, in particular the permanent establishment and business profits articles. The IF Statement notes that securing agreement on a new Pillar One MLI requires a “strong impetus at the highest political level….”4

Spill-Over Effects of Pillar One

As noted, Pillar One creates a new nexus standard subjecting an MNE that otherwise does not have a local presence to local income tax. Mayer Brown and others argued that this new nexus should only apply to Pillar One and not create nexus for other purposes including VAT, customs duties, local levies or any non-tax purpose. The IF Statement acknowledges this issue and notes that the rules will be designed to avoid such spill-over effects.

Digital Services Taxes and Other Unilateral Measures

An important objective of Pillar One is to create a global consensus among the 137 countries in the IF on the taxation of the digital economy. At present, there are numerous digital services taxes and other unilateral measures in force or pending which countries have enacted to tax the digital economy. Numerous commentators including Mayer Brown noted that an important condition to Pillar One should be the repeal of all DST’s and similar unilateral measures. The IF Statement recognized this point noting that “it is expected that any consensus based agreement must include a commitment by [the IF] members…to “withdraw relevant unilateral actions and not adopt such unilateral actions in the future.” The emphasis on the word “relevant” in the quotation is significant as it may give a country the opportunity to retain a DST-like tax on the grounds that it is not a relevant unilateral measure. For this reason, Mayer Brown recommended that the final document include a list of all DST’s that must be repealed as part of the agreed package.

The US Safe Harbor Proposal

On December 3, 2019, US Treasury Secretary Mnuchin sent a letter to the OECD Secretary General supporting the continued work of the OECD to reach a consensus-based solution and urging the suspension of digital services taxes. In that letter, the Secretary noted concerns regarding mandatory departures from the traditional nexus and arm’s length standards. The letter suggested that these concerns could be addressed by making Pillar One a “safe harbor” regime where a MNE could elect into Pillar One on a global basis. In other words, rather than making Pillar One mandatory, it would operate on an elective basis. An electing MNE would benefit from the global dispute resolution mechanisms, including the new Pillar One MLI, in return for agreeing to the application of the new nexus standard and the allocation of income to a market country. A non-electing MNE would be taxed under traditional standards and, presumably, continue to be subject to digital services taxes.

While noting the complexities associated with a safe harbor approach to Pillar One, the IF agreed to consider the US recommendation. The revised PoW notes that further work will be needed to address the feasibility of the approach, its revenue and economic impact at the country level as well as the administrative and dispute resolution implications.

Pillar Two

While further behind, the IF Statement also noted the continued progress in reaching a consensus on Pillar Two. As noted above, Pillar Two is the IF’s global base erosion project (“GloBE”). Pillar Two involves four components designed to ensure a minimum level of tax is paid in each country:

  • An income inclusion rule which would operate similar to a controlled foreign corporation regime and allocate a minimum level of income to each country
  • An undertaxed payment rule which would deny a deduction by a payor entity where a related party recipient is not subject to a minimum level of taxation
  • A “switch over” rule which would deny the benefits of a foreign branch exclusion where the head office is not subject to a minimum level of taxation
  • A “subject to tax” test which would impose a withholding tax or deny treaty benefits on payments that are not subject to a minimum level of taxation in the recipient country

Observers will note that many aspects of these rules have already been incorporated in other BEPS Action Plans. Moreover, many countries have already enacted rules which address some or all of the concerns raised by Pillar Two. For this reason, many commentators, including Mayer Brown, recommended that there should be a carve-out from Pillar Two for any country which has enacted substance-based regimes in a manner consistent with BEPS and the Forum on Harmful Tax Practices. Mayer Brown also recommended that US multinationals subject to the new GILTI regime also be excluded as GILTI is the functional equivalent of the income inclusion rule described above.

As noted in the IF Statement, significant work is still required on Pillar Two in particular on the interaction, coordination and priority of the four components.

What’s Next

Reaching a consensus on Pillars One and Two by the IF can only be achieved if there is an accurate assessment of the economic impact of the proposed rules. The IF, through the OECD, has been working on a detailed analysis of the investment and growth aspects of the proposals.

This will be especially important to ensuring agreement by developing countries participating in the IF and by countries which have DST’s or other unilateral measures in place. A country will only repeal its DST if it expects that it will collect a similar level of taxation under Pillars One and Two. Therefore, the OECD’s work in this regard is critical. The OECD is expected to release an update on this economic analysis in March 2020.

The full IF meets again in early July 2020, at which time they intend to reach agreement on the key policy features of Pillars One and Two, including addressing the issues identified above. As noted, this is an aggressive timetable but still provides a small window of opportunity for multinationals to make their views known to the OECD, the US Treasury Department or local country tax administrations. Given the breadth of issues still to be negotiated, MNEs would be well advised to participate aggressively in the negotiations to help shape the outcome. Mayer Brown has been advising numerous clients and industry groups on the impact of Pillars One and Two on their businesses.

1 The Inclusive Framework is a group of (currently) 137 countries which have agreed to negotiate a unified approach to the taxation of the digital economy and further the broader principles of the BEPS Action Plans.

2 The IF indicates that market jurisdictions not only include jurisdictions where an MNE group sells its products or services, but also, in the case of highly digitized businesses, they include where the MNE group provides services to users or solicits and collects data or content contributions from users.

3 In addition to a submission on its own behalf, Mayer Brown also submitted Pillar One comments on behalf of the World Shipping Council, the trade association of the international liner shipping industry.

4 It will be recalled that the United States is not a signatory to the Multilateral Instrument created as a result of the outcome of BEPS Action 15.

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