For nearly a century, international tax law relied on a simple, tangible concept of physical presence. If a business built a factory, opened an office, or hired staff in a country, that country had the right to tax the profits. It was a system built for the Industrial Age of steel and shipping containers.
Then came the internet. The advent of the Internet enabled the evolution of tech giants that could generate billions in revenue from users in France, Brazil, or India without having a single physical brick in those countries. Worse, they could legally shift their valuable intellectual property, and the profits that flowed from it, to tiny jurisdictions with zero percent tax rates.
This phenomenon, known as Base Erosion and Profit Shifting (BEPS), allowed multinational enterprises (MNEs) to effectively make profits disappear from high-tax countries and reappear in tax havens. The result was a ‘race to the bottom’, as nations slashed tax rates to compete for headquarters, draining public coffers globally.
The OECD/G20 introduced an Inclusive Framework through a historic agreement among over 140 countries to replace the old rules with a ‘Two-Pillar Solution’. It is the biggest shake-up of global taxation since the 1920s.
Pillar One Solves the ‘Where to Tax’ Problem
The digital economy created a disconnect between where value is created (by users and consumers) and where profits are taxed (often where the IP sits).
Pillar One aims to reallocate taxing rights from a company’s home country to the ‘market jurisdictions’ where their goods are consumed, or digital services are used, regardless of physical presence.
Pillar One is incredibly exclusive. It doesn’t apply to most businesses. It targets the roughly 100 largest and most profitable companies in the world. To be in scope, a corporation must have:
- Global revenue exceeding €20 billion; and
- A pre-tax profit margin above 10%.
The rules deem the first 10% of profit as a normal return (Routine Profit). Pillar One is only interested in the ‘super-profits’ above that threshold (‘Residual Profit’).
The mechanism, known as Amount A, works as under:
1. Calculate the company’s Residual Profit (profit above the 10% margin).
2. Take 25% of that Residual Profit.
3. Reallocate this “slice” to market countries based on where sales were made to end consumers.
4. Those market countries can then tax their allocated slice at their local corporate rate.
To prevent double taxation, the company’s home country must provide tax relief for the amounts paid to market countries.
Current Status: Pillar One is politically fraught. It requires a multilateral convention to override existing tax treaties. While the technical work is mostly done, ratification, especially in the US Senate, remains a major hurdle.
Pillar Two: Solves ‘How Much to Tax’ Problem
While Pillar One changes where tax is paid, Pillar Two changes the minimum amount that must be paid.
To put a floor on global tax competition and neutralize the advantages of tax havens. It ensures that large MNEs pay a minimum effective tax rate of 15% wherever they operate.
Pillar Two applies to a much broader group than Pillar One: any multinational group with consolidated revenues over €750 million.
The Top-Up Tax Mechanism (GloBE Rules)
Pillar Two is designed as a flawless funnel. If a company tries to pay low taxes in one country, another country gets to scoop up the difference.
Let’s say a German multinational opens a subsidiary in a zero-tax jurisdiction and books €100m in profit there.
- The global minimum requires a 15% tax (€15m).
- The subsidiary pays 0% local tax.
- Under the ‘Income Inclusion Rule’ (IIR), Germany (the headquarters location) has the right to charge a ‘Top-Up Tax’ of 15% on those profits.8
The German company still pays the €15m tax, they just pay it to Germany instead of the tax haven. The incentive to shift profits to the haven disappears overnight.
Current Status: Unlike Pillar One, Pillar Two is already live. The EU, UK, Japan, Korea, and many others began implementing these rules on January 1, 2024.
The global implementation of these rules varies significantly based on a country’s economic structure and existing tax system.
Adoption in The United Arab Emirates (UAE)
Historically known as a tax-free hub, the UAE has undergone a rapid transformation to align with global standards and diversify its economy beyond oil.
- In June 2023, the UAE introduced its first federal Corporate Tax at a rate of 9% for standard businesses.
- The UAE recognizes that the 9% rate is below the 15% global minimum. For large MNEs (revenue >€750m) operating in the Emirates, if the UAE only charges 9%, another country will collect the remaining 6% as a Top-Up Tax.
- To keep that tax revenue within the country, the UAE Ministry of Finance has indicated it will issue specific regulations for these large MNEs to ensure their effective tax rate hits the required 15% threshold, aligning fully with the OECD Pillar Two standards. They are choosing to collect the tax themselves rather than letting foreign governments collect it.
Status in Pakistan
Pakistan is a developing economy facing significant fiscal challenges. Its approach to the OECD deal is driven by a need for immediate revenue and protecting its sovereign taxing rights.
- Pakistan already has high corporate tax rates (29% plus Super Tax) and has aggressively pursued digital giants through unilateral measures, such as Withholding Taxes on online advertising and marketplaces.
- While Pakistan initially signed the Inclusive Framework, it has expressed significant reservations about Pillar One. The government is concerned that the complex formulas might require them to give up their existing withholding taxes in exchange for a very small slice of the “Amount A” reallocation. Furthermore, mandatory binding arbitration clauses in Pillar One are seen by some policymakers as infringing on national sovereignty.
- Pillar Two is less of an immediate threat to Pakistan’s tax base, as its rates are already high. However, implementing the complex compliance rules for multinationals operating in Pakistan is a significant administrative burden for the Federal Board of Revenue (FBR). Pakistan generally supports the idea of stopping profit shifting but is wary of rules that seem tailored for developed economies.
The Two-Pillar solution is not perfect. It is much complex, politically fragile (especially Pillar One), and creates immense compliance costs for businesses.
However, Pillar Two has effectively set a global floor for corporate taxation. The era where massive corporations could operate globally while paying virtually zero tax is drawing to a close (barring certain exceptions).
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