Australia, New Zealand and more than 130 other jurisdictions will soon adopt coordinated tax rules to update the international system for today’s globalised and digital economy. It’s a move that could present a major compliance challenge for corporations.

The Global Anti-Base Erosion Rules being coordinated by the Organisation for Economic Co-operation and Development (OECD) have two main pillars. Pillar 1 is designed to ensure that the tech giants pay tax to the nations where they earn their revenue, even if they don’t have a physical presence there. Pillar 2 aims to ensure that companies pay a minimum of 15% corporate tax in the country where they earned their income.

Closing the loopholes

The new rules are part of a broader package to address the problem of base erosion and profit shifting (BEPS), where tax planning strategies used by multinational entities (MNEs) exploit gaps and mismatches in tax rules to avoid paying tax. While some of these strategies are illegal, most are not.

“This undermines the fairness and integrity of tax systems because businesses that operate across borders can use BEPS to gain a competitive advantage over enterprises that operate at a domestic level. Moreover, when taxpayers see multinational corporations legally avoiding income tax, it undermines voluntary compliance by all taxpayers,” the OECD says.

It estimates that BEPS practices cost countries US$100–US$240 billion in lost revenue annually.

Two pillars

The OECD’s BEPS package contains 15 actions, including the two pillars. Pillar 2 is likely to come into effect next year, but it’s unclear when Pillar 1 will be introduced because it has become very complex and there is a lack of political will to implement it.

“Pillar 1 is really struggling,” says Tony Merlo CA, head of tax policy at EY in Australia.

Initially it was targeted only at the tech sector, then expanded to include very large multinationals with a minimum margin and then a carve-out for specific industries, including the extractive industries and financial services. Tech companies can sell virtual goods such as downloads, apps, films and music into jurisdictions where they don’t have any physical presence and Pillar 1 will ensure they pay tax in the jurisdiction where their products are consumed.

The implementation of Pillar 2 is more advanced. The UK and the European Union have committed to implementing it for income earned after 31 December this year – 2024, in effect – and the US Treasury is also working through the details.

In Australia, the federal government indicated in the May Budget that it will implement Pillar 2 income inclusion rules and the 15% domestic top-up tax for income years starting on or after 1 January 2024, and the undertaxed profits rule for income years starting on or after 1 January 2025. Meanwhile, New Zealand started its consultation process in mid-2022. Shortly after the May 2023 Budget, Inland Revenue clarified in its draft Taxation Bill that the proposed multinational tax legislation regarding payments of top-up tax would not apply earlier than 1 January 2024 for New Zealand MNE foreign operations under the income inclusion rule, and 1 January 2025 for overseas MNEs subject to the undertaxed profits rule.

A minimum corporate tax rate

In essence, Pillar 2 seeks to ensure a minimum corporate tax rate of 15% is paid in every jurisdiction in which a company operates. Additionally, if the local country doesn’t impose the 15% corporate tax, another country which has signed up to Pillar 2 will be able to levy the tax – either the company’s home base or another jurisdiction – under a prescribed allocation mechanism.

The practical effect of the law will be to end the race to the bottom for corporate tax rates because if one jurisdiction doesn’t impose the tax, another will. Jurisdictions with a corporate tax rate of under 15% will likely increase the rate to at least 15% on the basis that if someone is going to tax those profits, they may as well tax them themselves.

Merlo notes that the 15% effective tax rate is calculated using global tax rules, rather than an individual nation’s tax rules. This means countries won’t be able to unilaterally define how the 15% is calculated, ensuring all countries will operate on a level playing field.

It can also lead to some unintuitive results, he says. For instance, a company might make a tax loss as the result of a tax incentive, but under Pillar 2 rules may still result in additional tax being paid. For instance, if a company earns $100 in a jurisdiction and then receives a research and development tax incentive of $100, it would have zero taxable income under that country’s tax rules. But under the accounting rules applied in Pillar 2 it would have earned $100, and the 15% tax would be levied on that $100.

New Zealand concerns

The absence of a capital gains tax and the imputation credits regime in New Zealand are causing concern about other unintended consequences of Pillar 2.

Overall, Pillar 2 will come into play in New Zealand in a very limited way, says Craig Elliffe FCA, deputy chair of Chartered Accountants Australia and New Zealand Tax Advisory Group (TAG). However, the absence of capital gains tax means it’s possible for New Zealand-based subsidiaries of MNEs to make a significant capital gain, which isn’t subject to tax. Consequently, the effective rate of tax for their profits could well be below the minimum required under Pillar 2.

This could lead to a top-up tax under the OECD regulations, says Elliffe, who is a co-author of a CA ANZ submission on the tax to the New Zealand Inland Revenue Department. In such a case, the minimum domestic tax of 15% would apply.

The OECD rules allow companies to spread capital gains over different periods. A carve-out for substantive businesses operating in the jurisdiction means the rules should not be applied very frequently, but CA ANZ does consider it an issue.

CA ANZ is also concerned that the inability to grant dividend imputation credits for tax paid under Pillar 2 will cause double taxation.

Inland Revenue considers the 15% top-up tax to be a penalty and that the imputations are a benefit for the tax paid. However, CA ANZ argues the tax isn’t a penalty but is merely an additional tax that will be payable. The result of Pillar 2 tax should be imputation credits.

Elliffe, a professor specialising in taxation at the University of Auckland Law School, says imputation credits are not so much a benefit as a relief from double taxation, which should be considered a normal outcome.

Eye on data and compliance

Australia and New Zealand have high corporate tax rates, broad tax bases and don’t offer huge tax incentives, so it’s unlikely that many companies operating in those two countries will end up having to pay the 15% top-up tax.

Additionally, they are unlikely to collect the 15% top-up tax where other countries fail to do so, because most countries will ensure they collect the tax if they are entitled to it.

However, a significant number of multinationals trade in Australia and New Zealand, as both nations are inbound investment jurisdictions. These subsidiaries will have to prove that they have paid at least 15% tax on their earnings in these countries.

Brett Curtis, a tax partner at Grant Thornton, says Australia and most other nations are likely to implement Pillar 2 along the same lines as the OECD model rules, but there is still concern in the tax community that we haven’t seen the legislation.

“There’s an understanding and expectation from the tax business community that it’s coming but there’s the uncertainty around gearing up and getting ready for its implementation and the work necessary to comply,” he says.

Merlo says the rules are continuing to evolve and the OECD is periodically issuing updates. Its publication, Tax Challenges Arising from the Digitalisation of the Economy – Commentary to the Global Anti-Base Erosion Model Rules (Pillar Two), First Edition, already runs to 228 pages.

Many companies which won’t be subject to the tax will still have to meet its reporting requirements. “The compliance burden is massive,” he says.

In fact, there is already a draft accounting standard which requires certain disclosures to be made this financial year, a year ahead of the rules coming in.

Ducks in a row

Merlo advises corporates to prepare for the tax by doing two things. The first is a data impact assessment: what data you need, whether you can get it, how you can pull it together and how consistently you can do it.

“You’ve got to look at your systems, processes and controls to ensure you bring the data together in a consistent, repeatable and defensible manner around the world.”

“You’ve got to look at your systems, processes and controls to ensure you bring the data together in a consistent, repeatable and defensible manner around the world.”

Secondly, companies should assess whether they will have top-up taxes in any jurisdictions because their auditors will want to know if there are any additional disclosures to be made in the financial statements.

Michael Barbour CA, group head of tax at Westpac, deputy chair of CA ANZ Australia’s tax committee and chair of the tax working group of the International Banking Federation, says corporates are at various levels of readiness for the new tax. Miners will be more advanced because they are already required to demonstrate where their taxes are generated. “Other companies will probably have to make some system changes to get the information seamlessly, and others will probably require more effort,” he says.

“The information needs to be prepared and presented in a coherent and consistent way, and the key to success for everyone is to make sure that it’s done as simply as possible and to take into account the fact that it is going to take time to get those systems updated. Any sort of system change normally takes at least 12 months to work its way through the organisation.”

“Any sort of system change normally takes at least 12 months to work its way through the organisation.”

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Country-by-country reporting

Country-by-country reporting is an accounting practice that requires companies to publish how much profit and cost they incur in each of the countries they operate in, instead of publishing all the profits and costs they incur around the world as a grouped sum.

The measure aims to maintain trust in the tax system, by providing transparency on how much tax is paid by multinational corporations with a global consolidated income of A$1 billion / NZ$1.3 billion or more.

New Zealand announced country-by-country reporting for large companies with consolidated annual group revenue of more than NZ$1.3 billion back in 2021.

However, as Inland Revenue notes, it only impacts around 20 companies headquartered in the country.

Large companies in Australia have been required to report their country-by-country income and tax to the Australian Taxation Office since 2016, but were not expected to share the information more broadly.

While the Albanese government made an election promise to introduce public country-by-country reporting in Australia from 1 July 2023, the legislation was wound back substantially in June.

Further consultation with business stakeholders is on the cards, but the initial indications are the revised requirements will align more closely with the European Union’s less stringent rules.

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Developing countries suffer most

Developing countries’ higher reliance on corporate income tax means they suffer disproportionately from base erosion and profit shifting (BEPS), the Organisation for Economic Co operation and Development (OECD) says.

“BEPS is of major significance for developing countries due to their heavy reliance on corporate income tax, particularly from multinational enterprises. Engaging developing countries in the international tax agenda is important to ensure that they receive support to address their specific needs and can effectively participate in the process of standard setting on international tax,” it states.

The International Centre for Tax & Development (ICTD) estimates multinationals shifted US$1 trillion of profits to tax havens in 2016, which implies approximately US$200–US$300 billion in tax revenue losses worldwide.

“Our analysis shows that only a small number of countries gain any tax revenue. Profit shifting is thus a phenomenon where the majority of countries lose, and especially so lower income countries,” the ICTD wrote in its Working Paper 119, published in March 2021.

Lower-income countries lose the equivalent of between 28% and 82% of their government health expenditure, or between 8.68% and 31.9% of their government education expenditure, the ICTD says.

Multinational entities (MNEs) headquartered in the US and Bermuda are the most aggressive at shifting profits towards tax havens, while MNEs headquartered in India, China, Mexico and South Africa are the least aggressive.