RESEARCH PAPER

BASE EROSION AND PROFIT SHIFTING PROJECT (BEPS)

What are the Pillar Two Rules?

The OECD Pillar Two Rules are a set of international tax reforms designed to address global tax challenges, particularly
the problem of profit shifting and base erosion by multinational enterprises (MNEs). These rules are part of the
OECD/G20 Inclusive Framework on Base Erosion and Profit Shifting (BEPS) initiative.

Key Elements of Pillar Two

1. Global Minimum Tax Rate (15%)

o Ensures that large MNEs pay at least 15% in taxes on their profits in every jurisdiction where they
operate.
o If a company pays less than 15% in a specific country, the rules allow other countries to tax the
difference (a top-up tax).

2. Scope
o Applies to MNEs with global revenues exceeding €750 million.
o Certain entities, such as governmental organizations, non-profits, and pension funds, are excluded.

3. Two Key Rules

o Income Inclusion Rule (IIR):
 Parent entities must pay the difference if their subsidiaries in low-tax jurisdictions pay less than
15%.
o Undertaxed Payments Rule (UTPR):
 Acts as a backstop for the IIR. If the IIR doesn't apply, other jurisdictions can tax the undertaxed
income.

4. Subject to Tax Rule (STTR)

o Focuses on cross-border payments like interest and royalties. It allows source countries to tax these
payments at a minimum rate (generally 9%).

5. Effective Tax Rate (ETR) Calculation

o ETR is calculated on a country-by-country basis by dividing the taxes paid by the income earned in each
jurisdiction.
o Taxes include income taxes but exclude items like VAT or sales taxes.

6. Safe Harbors and Simplifications

o Transitional rules and simplified mechanisms are provided to reduce administrative burdens, especially
for smaller entities.

How Does Pillar Two Work?

1. Determine Tax Paid and Effective Tax Rate

o MNEs calculate their tax paid and effective tax rate in each country where they operate.
 2. Top-Up Tax
o If the effective tax rate in a jurisdiction is below 15%, a "top-up tax" is imposed to bring it up to the
minimum.

3. Allocation of Top-Up Tax

o The IIR applies first, allowing the parent company to pay the top-up tax. If not, the UTPR allocates the
tax to other countries where the MNE operates.

Objectives of Pillar Two/Reasons:

 Reduce tax competition between countries by setting a global floor for corporate taxes.
 Address profit shifting to low-tax jurisdictions.
 Increase tax revenue for governments worldwide.

Illustrative Example

An MNE operates in:

 Country A (ETR: 10%): Profits = $100 million, Tax Paid = $10 million.
 Country B (ETR: 20%): Profits = $100 million, Tax Paid = $20 million.

Under Pillar Two:

 The ETR in Country A is below 15%. A top-up tax of 5% (15% - 10%) applies on $100 million, resulting in $5
million additional tax.
 No top-up tax is needed in Country B because the ETR exceeds 15%.

Benefits and Challenges

Benefits

 Ensures a fairer distribution of tax revenues.

 Discourages aggressive tax planning and profit shifting.
 Increases transparency and global tax cooperation.

Challenges

 Complexity in implementation and compliance.

 Potential conflicts between national tax laws and OECD rules.
 Impact on investment decisions in low-tax jurisdiction
 Income Inclusion Rule (IIR)
(Primary Rule)
The Income Inclusion Rule (IIR) is a principle within the framework of international tax law, specifically as
part of the OECD's Base Erosion and Profit Shifting (BEPS) Project—particularly under Pillar Two of the
global minimum tax initiative. The rule ensures that multinational enterprises (MNEs) pay a minimum level of
tax on their income regardless of where it is earned.

Key Features of the Income Inclusion Rule:

1. Purpose: The IIR is designed to counter tax avoidance strategies where MNEs shift profits to low- or zero-tax
jurisdictions.
2. Mechanism:
o It requires the parent company of an MNE to include in its taxable income the profits of its foreign
subsidiaries that are subject to an effective tax rate (ETR) below the agreed global minimum tax rate
(currently set at 15%).
o If a subsidiary in a low-tax jurisdiction pays less than the minimum tax, the shortfall is taxed at the level
of the parent entity.
3. Scope: It applies to large multinational groups with consolidated revenues exceeding €750 million (or an
equivalent threshold in local currency).
4. Coordination with Other Rules:
o The IIR works alongside the Undertaxed Payments Rule (UTPR). While the IIR operates at the parent
level, the UTPR applies to allocate the minimum tax burden across jurisdictions where the parent
company fails to apply the IIR adequately.

When Does the Income Inclusion Rule Apply?

The IIR applies in the following scenarios:

1. Low-tax jurisdiction: The foreign subsidiary's income is taxed at an effective rate below the global minimum of
15%.
2. Eligible taxpayers: It targets only MNEs that meet the revenue threshold and have cross-border operations.
3. Priority rule: The IIR is generally the primary rule, applied before the UTPR.

The IIR is intended to come into effect as part of the OECD's Pillar Two implementation timeline, with many
jurisdictions adopting it starting 2024, though timelines may vary depending on local legislative processes.

Practical Example:

Suppose a multinational company headquartered in Country A has a subsidiary in Country B. The subsidiary's
profits are taxed at an effective rate of 10% in Country B, below the 15% global minimum. Under the IIR:

 The parent company in Country A will be required to "top up" the tax to the 15% minimum on the profits of the
subsidiary in Country B.
 Undertaxed Payment Rule (UTPR)
(Secondary Rule)
The Undertaxed Payment Rule (UTPR) is a mechanism introduced under the OECD/G20 Inclusive
Framework on Base Erosion and Profit Shifting (BEPS) as part of the Pillar Two initiative. This initiative
aims to ensure a global minimum level of corporate taxation, targeting large multinational enterprises (MNEs).

Purpose of UTPR

The UTPR is designed to address situations where multinational companies pay less than the agreed 15%
global minimum tax in certain jurisdictions. It works as a backstop to ensure that taxes not collected in low-tax
jurisdictions are effectively "picked up" by other jurisdictions.

How UTPR Works

1. Global Minimum Tax Rule:

o Pillar Two establishes a 15% global minimum tax for MNEs with annual revenues above €750 million.
o The primary rule ensuring this is the Income Inclusion Rule (IIR), which taxes the income of a low-taxed
subsidiary at the parent company level.

2. Application of UTPR:
o If the IIR cannot be applied (e.g., the parent company is in a jurisdiction that does not implement the
IIR), the UTPR steps in.
o The UTPR reallocates the undertaxed profits of the low-tax jurisdiction to other jurisdictions where
the MNE operates. These jurisdictions then impose an additional tax on the MNE to bring its effective
tax rate up to 15%.

3. Mechanism:
o The UTPR functions by denying tax deductions or making adjustments to taxable income in jurisdictions
where the MNE operates, to collect the shortfall in the global minimum tax.

Key Features

 Secondary Rule: UTPR is secondary to the IIR; it applies only when the IIR does not fully address the undertaxed
income.
 Scope: Targets large multinational groups above the revenue threshold.
 Implementation: Jurisdictions adopting Pillar Two rules must include the UTPR in their domestic legislation.

Benefits

 Ensures that profits are taxed at a minimum level globally, reducing opportunities for tax avoidance.
 Encourages jurisdictions to adopt the global minimum tax and reduces the incentive to offer extremely low tax
rates.

Challenges

 Implementation complexity, as it requires detailed coordination among countries.

 Potential disputes over allocation and enforcement of taxes across jurisdiction.
 How many members agrees to Pillar two rules?
 140+ members of the OECD/G20 Inclusive Framework on BEPS have agreed in principle to the
Pillar Two rules.
 These members represent a wide range of economies, including developed, developing, and emerging
markets.

However, the implementation of Pillar Two rules varies across jurisdictions, as countries must incorporate the
rules into their domestic laws.

Key Participants in the Pillar Two Agreement:

1. OECD and G20 Countries: Most members of the OECD and G20 have agreed to implement the rules.
2. Developing Economies: Many non-OECD developing countries, including those with growing
economies, have joined the framework.
3. Non-G20 Economies: Numerous small and medium-sized economies also participate.

Notable Members of the Agreement:

 Developed Economies: United States, United Kingdom, Germany, France, Canada, Japan, Australia,
etc.
 Emerging Markets: India, China, Brazil, South Africa, Indonesia, and others.
 Developing Nations: Many African, Asian, and Latin American countries.

Implementation Status:

While a majority have agreed to the framework, the actual implementation through domestic laws varies. For
example:

 The European Union (EU) has mandated its members to align with Pillar Two rules, and many have
begun implementing them.
 Countries like the United States and some others are still navigating political and legislative hurdles to
fully adopt the rules.

Highlights by Leader
 Prime Minister Narendra Modi highlighted the importance of equitable and transparent global tax policies
during India's leadership in G20 negotiations,

"International tax systems must support equity and innovation while ensuring corporations are accountable to the
jurisdictions they operate in."

 Former UN Secretary-General Kofi Annan highlighted the necessity of fair tax systems:

"A global economy needs global tax cooperation to ensure justice, fairness, and to eliminate tax havens
that deepen inequality."