On 1 July 2021, a statement providing a framework for reform of the international tax rules was published by the OECD/G20. The statement has been approved by 132 countries. A comprehensive agreement is to be finalised by October 2021 with changes coming into effect in 2023.
The statement was short in detail (it was only 5 pages long), however, we set out below what is understood to be the current intention for how this reform (described as a two-pillar approach) is to be implemented.
Pillar 1 – profit allocation
As business models have developed there has been increasing concern that existing tax rules on where to tax profits have become outdated. This pillar seeks to adjust the profit allocation rules so that some profit associated with selling goods or services to consumers located in a jurisdiction may become taxable in that jurisdiction.
This change will apply to groups with a global turnover of over Euro 20 billion with a net margin of over 10 per cent. It is expected that this pillar will only impact around 100 businesses globally. After 2030, following a review, groups with a turnover of over Euro 10 billion may also be included.
In addition, this pillar applies only to certain types of businesses, with extractives being specifically excluded. While the statement does not define what constitutes an extractive business, earlier publications had made it clear that this exclusion would cover oil and gas exploration and production, and importantly also exempt midstream and downstream activities.
Therefore, while not 100 per cent clear from the statement, it would appear that oil and gas businesses will not be affected by pillar 1.
Pillar 2 – global minimum tax rate
Changes to the international tax rules had already been made through other BEPS initiatives; however, it was perceived that there remains a need for a broader change to address the possibility that companies could still shift profits to low tax jurisdictions. This pillar seeks to ensure that large internationally operating businesses pay a minimum level of tax regardless of where they are headquartered, the jurisdictions they operate in, or where their profits are booked.
Where implemented it will apply to groups with a turnover of over Euro 750 million per annum (the same threshold as for country by country reporting in BEPS Action 13). The statement states that countries are free to implement some of these rules that will also apply to smaller groups. The principal rule in this pillar allows the jurisdiction of the parent company to charge an amount of tax where any of its 80% owned subsidiaries do not suffer an effective tax rate (ETR) of “at least 15 per cent”.
The ETR is to be calculated on a jurisdictional basis using a common definition of what constitutes tax and with taxable profits determined by reference to financial accounting income. The statement notes that there will be “agreed adjustments consistent with the tax policy objectives” and “mechanisms to address timing differences”. It is not clear how such timing differences will be addressed, and as for many oil and gas companies they will pay little or no tax early in the project life cycle, this will be important.
There are other rules, carve-outs, and exceptions, included in this pillar that are to be introduced to support the main aim of preventing profits arising in overly tax advantaged jurisdictions.
Comments
While pillar 1 seems not to apply to the upstream oil and gas industry many such companies will need to consider the pillar 2 changes. Although we would expect UK operations to meet the minimum ETR test, groups with operations outside the UK will need to look closely at the detailed rules once they are available.
The timeline for implementation is tight with an expectation that details will be agreed at the G20 Finance Ministers and Central Bank Governors meeting in October 2021. The concepts are novel and complex. This will leave companies little time to understand how the rules may impact their existing tax burden, investment plans and prepare for what for many will be a significant increase in compliance burden.
What is particularly important is to understand how individual countries will react to these changes. For countries that currently have a low corporate tax rate (often where they have a higher indirect tax take), they may feel the balance between direct tax and indirect tax take will need to shift in favour of higher direct taxes.
For countries that have had no broad-based corporate income tax regime (e.g. many Gulf countries), this may mean that a swift introduction of corporate income tax is inevitable.
How E&P companies are to calculate their ETR on a jurisdictional basis, taking into account such matters as losses brought forward, tax refunds for decommissioning expenditures, accelerated capital allowances, other temporary differences (such as disregarded derivatives), the treatment of production-sharing arrangements, etc. will need to be addressed in the detailed implementation rules, and we will be reviewing the position once further detail is available.
CW Energy LLP
July 2021