June 23, 2021

One Small Step but (Perhaps) One Giant Leap for Global Tax Reform: The G7 Agrees on a Broad Framework for Pillar One and Two


On June 5, 2021, the Finance Ministers and Central Bank Governors of the G71 countries issued a Communiqué announcing their agreement on the conceptual framework for a substantial revision to global tax policy (the “Communiqué”). The Communiqué puts the G7’s stamp of approval on recent efforts by the OECD (supported by a big push by the Biden administration) toward finalizing the broad architecture of the OECD’s Pillar One and Two models.2 The Communiqué will form the basis of continued negotiations by the Inclusive Framework (IF) on June 30 and July 1, followed by final negotiations by the G20, which meets on July 9 and 10, at which time the G7 hopes that a final agreement will be reached.

As discussed below, there is still much work to do to flesh out the details of the framework. Moreover, there is considerable skepticism as to whether a final agreement can be reached, whether it can be implemented legislatively or by multilateral treaty in the United States and abroad, and whether countries that have enacted (or are considering enacting) digital services taxes (DSTs) and similar unilateral measures will find the proposed framework sufficiently revenue-generating to repeal their DSTs.3

The 20-paragraph Communiqué contains only one paragraph on taxes, but that paragraph is dense with respect to the agreements reached on Pillars One and Two. In this Legal Update, we unpack that paragraph and provide our perspective on what has been agreed to and our observations on what issues remain and whether they can be resolved.

Note: On July 15, we will be hosting a webinar to discuss these developments and an analysis of the Biden administration’s international tax proposals that complement some of the G7 proposals.

Pillar One and Two Background

When the OECD developed its 15 Action Plans as part of its Base Erosion and Profit Shifting (BEPS) initiative, Action 1 was “Tax Challenges Arising from Digitalisation.” While significant progress was made on the other 14 Action Plans, the OECD recognized that the pervasive nature of the digital economy created considerable difficulties in trying to isolate and separately tax profits associated with a digital business.

The OECD’s initial work on the 14 BEPS Action Plans (commonly referred to as “BEPS 1.0”) led to significant changes in the global tax landscape, ushering in such new concepts as the DEMPE (development, enhancement, maintenance, protection, and exploitation) standard with respect to intangibles, Country-by-Country Reporting, and rules to prevent abuses of hybrid entities and instruments.4 However, despite the progress made as a result of BEPS 1.0, none of the 14 Action Plans had the effect of taxing a multinational company on sales made in a country where that company did not otherwise have a taxable presence.

Many countries grew impatient with the BEPS process and the failure to reach consensus on how to tax a digital business. A number of countries enacted DSTs, which impose a revenue or other gross-basis tax on in-country digital sales. Unlike BEPS 1.0, which was the result of a consensus reached by over 80 countries, these taxes are unilateral and vary considerably around the world.5 The United States has labeled a number of DSTs as discriminatory and has proposed retaliatory tariffs.6

Faced with mounting trade disputes and an unravelling consensus around taxation, the OECD decided to try again to develop a framework for how to tax a digital business. In May 2019, the OECD announced a work plan around a two-pillar framework that would provide (i) a basis for a new taxing right for market or destination countries (Pillar One) and (ii) a new set of minimum taxation rules to prevent global base erosion (Pillar Two). The two-pillar approach became known as “BEPS 2.0.” In October 2020, the OECD released its Blueprints for both pillars, which were approved by the G20 in December 2020. At that time, the OECD initiated a public consultation process on the final documents.

A Breakthrough on Pillar One

Pillar One proposes a new taxing right that enables market countries to tax an in-scope company on an allocated portion of the company’s profit. The allocable portion (Amount A) would be a portion of the company’s global profit apportioned to the country above a routine return on baseline marketing and distribution activities (Amount B).

One of the key challenges in Pillar One is defining an in-scope business. Pillar One is meant to apply to “consumer facing businesses” (CFB) and “automated digital services” (ADS). In addition to the definitional challenges around these terms, many companies conduct businesses that are both in scope and out of scope. As a result, some segmentation mechanism was needed to ensure that only the in-scope business was covered by the new taxing right. Moreover, because most of the large multinationals conducting CFB and ADS businesses were US multinationals, Pillar One was criticized as discriminatory against the United States.

Recognizing the challenges in defining a consumer facing business and automated digital services as well as the criticism that Pillar One discriminated against US technology giants, the Biden administration proposed a change in approach. Rather than focusing on the types of businesses that should give rise to enhanced nexus, it proposed a new approach based on size and profitability. Instead of trying to define CFB and ADS, the new approach essentially says that if you are big enough and profitable enough, you should be paying some tax in the countries where you sell your product regardless of whether you have a taxable presence there.

This new approach formed the basis of the agreement reached by the G7. The Communiqué indicates that market countries will now be able to tax the “largest companies” on “at least 20% of profit exceeding a 10% margin.” In exchange for this new taxing right, countries will be required to repeal any DSTs.

The “Largest Companies”

It has been widely reported that the G7 expects that roughly 100 companies will meet both the size and profitability criteria. With respect to size, when the Biden administration proposed the revised scoping methodology, it was reported that annual revenue in excess of $20 billion would be the relevant threshold. For comparison, a company with $20 billion in annual revenue would rank around #500 on the Forbes Global 500 list. A question that will need to be addressed as the details of the G7 proposal are fleshed out is the mechanism used to determine which of the “largest companies” are subject to the new taxing right for any given year as this is not a static list year over year.

At Least 20% of Profit”

A key driver of the revised approach is a focus on profitability. Only the largest and most profitable companies are meant to be in scope. The assumption underlying the focus on profitability is that intangibles drive premium profits, and since intangibles do not require a physical nexus with a market country, another mechanism (i.e., Amount A) is required to enable a market country to tax the business.

A question that will need to be addressed as the details of the G7 proposal are fleshed out is how profit margins will be determined, in particular whether they are based on financial accounting (book) methodology or tax methodology. The difference between book income and taxable income is an important distinction in the development of tax policy, and the role of book income continues to take on increasing importance. Indeed, one of the proposals in the Biden tax plan is a 15% alternative minimum tax on book income as a backstop to perceived corporate tax abuses.

There are numerous material differences between book income and taxable income, one of which is the treatment of stock options. The book/tax differential associated with stock option costs is often the most significant item in the corporate tax rate reconciliation and the major reason why effective tax rates for highly profitable multinational technology companies are relatively low.

“Exceeding a 10% Margin”

It should be observed that some of the companies that one would expect to be subject to the new taxing right do not have overall profit margins exceeding 10%, although certain segments of their businesses exceed this threshold significantly. During the development of Pillar One, much work went into the segmentation issue, namely determining which portions of a business were to be included or excluded in CFB or ADS and thus subject to tax. One of the criticisms of Pillar One was its complexity, and the need for segmentation contributed to that. That complexity is here to stay if the G7 wants to enable market countries to tax some of the most high-profile US technology companies.


An important issue in the development of the final Pillar One Blueprint was determining which industries should be carved out because of the nature of the industry, how the industry is regulated, or the existence of special tax regimes already in place. Considerable analysis went into the Pillar One discussions as to which industries should be excluded, and the final Blueprint provided that natural resources, construction, international shipping, financial services, and certain real estate businesses are excluded from Pillar One.

The Biden scoping proposal and the Communiqué are silent on exclusions. However, the considerations that formed the basis for the industry exclusions in the Pillar One Blueprint are equally relevant under the G7 approach, so it would be logical for the same industries to be excluded under the new model (even though the exclusion for businesses in other industries that are not consumer facing would presumably be eliminated).

Repealing DSTs

A key political condition to reaching agreement at the G20 level will be securing a commitment that repeals DSTs. This was a lynchpin of Pillar One, and a resolution on how DSTs will be repealed will be essential to obtaining consensus.

The Communiqué provides for “the removal of all Digital Services Taxes, and other relevant similar measures, on all companies (emphasis added).” A threshold issue in this regard is whether DSTs need to be repealed altogether or repealed only with respect to the 100 companies that are in scope. At a recent conference, one of the IF Steering Group members made clear that DSTs must be repealed in their entirety.

Another issue is the timing of repeal. As discussed below, even assuming an agreement is reached by the G20 in July, there is still considerable work to be done before the new rules are in place around the world. It is unlikely that a country will agree to repeal its DST before the new rules are effective. As a result, even if there is an agreement, DSTs will be around for some time. This could create another barrier to concluding negotiations as countries may look for guarantees about repeal of DSTs versus implementation of any agreement by individual countries.

Pillar Two – Global GILTI, Global SHIELD

The overarching objective of Pillar Two is to ensure that a minimum level of taxation is paid by a multinational company and ensure that deductible payments by such companies are subject to a minimum rate of tax in the hands of the recipient. The final Pillar Two Blueprint accomplished this through a series of complex rules that combine elements of the US GILTI regime and the SHIELD regime as proposed by the Biden administration.

The G7 agreement enshrines the objective of Pillar Two by establishing a global minimum tax rate of at least 15%. Importantly, the 15% threshold would be tested on a country-by-country basis to eliminate the ability of multinationals to average high-tax and low-tax country profits.

The G7 agreement dovetails with the Biden administration tax proposals that would raise the tax on GILTI income to 21%, test GILTI on a country-by-country basis, and eliminate the GILTI benefit for a 10% return on tangible property constituting qualified business asset investment (QBAI). Moreover, the Biden administration proposes to reconfigure the BEAT regime by denying deductions to related parties where the recipient or a member of the recipient’s group is not subject to a minimum level of taxation.7

The Biden proposal uses 21% as the minimum rate threshold for GILTI. Although the proposed 21% predates the G7 agreement, the Biden administration has recently reiterated that it intends to pursue a rate of 21% in US legislation.8 In contrast, for SHIELD, the Biden proposal would explicitly adopt the agreed-to Pillar Two rate (i.e., 15%) as the relevant rate threshold and only use a 21% rate in the absence of such an agreement.

The Way Forward

The G7 agreement represents an important step on the path to global tax reform. But, however significant, that step is only one of many before a global consensus is reached, an implementation framework is agreed-to, and the new rules are in effect around the world.

Consideration will be given to whether the revised Pillar One rules can be implemented through a new multilateral instrument (MLI) and, if so, whether countries will sign onto it. It should be observed that the United States is not a signatory to the current BEPS MLI, preferring to negotiate tax treaties on a bilateral basis only. If the United States takes the same approach with respect to a new MLI, it could be quite some time before the new rules apply to US-based multinationals, especially considering the US Senate’s recent history with tax treaty ratification. Additionally, the United States and many other countries will need to amend national laws as well as treaties, which could raise a variety of implementation issues and challenges.

As noted, the next step is continued negotiations by the 139 members of the IF on June 30 and July 1. If agreement is reached there, the proposal passes to the G20 for approval at their meeting on July 9 and 10.

Please join us for our July 15 webinar, during which we will discuss these developments and the outcome of the G20 meeting.

1 Canada, France, Germany, Italy, Japan, the United Kingdom, and the United States.

5 At its inaugural meeting in Kyoto, Japan in 2016 there were 82 IF members, and today there are over 135 members.

8 Testimony of Secretary Janet Yellen at the US House of Representatives, Committee on Ways & Means, June 17, 2021.

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