The impact of BEPS 2.0 on financing the NextGenerationEU debt issue and on EU tax reforms

November 2021  |  SPECIAL REPORT: CORPORATE TAX

Financier Worldwide Magazine

November 2021 Issue

An international corporate tax reform called the base erosion and profit shifting (BEPS) project 2.0 is currently underway at the G20 level in order to address the challenges of the digital economy. The project comprises ‘Pillar 1’ and ‘Pillar 2’.

The existing international tax rules no longer provide a fair system for taxing businesses where value is created. Increased globalisation and digitalisation of the economy means that many businesses can operate successfully in a jurisdiction without any (taxable) physical presence there, and intangibles can be held in low tax jurisdictions to minimise the tax burden further. The two pillars of this reform aim to address these concerns by ensuring that profits are taxed where generated, and at a minimum rate of tax.

Pillar 1 provides for market jurisdictions to be able to tax 20-30 percent of the profits over 10 percent of the very largest multinationals – those with a global turnover over €20bn – regardless of any physical presence in that jurisdiction and their business sector (extractive industries and regulated financial services are, however, excluded from these rules). In this regard, a political agreement has been reached and accepted by the US, provided that the various national digital services taxes (DST) that have arisen in many countries of late are eliminated.

Pillar 2 consists of an agreement to impose a minimum effective tax rate on corporate profits for groups with at least €750m in consolidated turnover, subject to a substance-based carve out for lower tax jurisdictions where the multinational has staff and tangible assets. Under a political agreement, this minimum tax has been set at no less than 15 percent. However, countries such as Ireland, Hungary and Estonia have not yet joined the agreement, concerned by the effects that Pillar 2 may have on their tax sovereignty and competitiveness.

First EU debt issuance. In parallel with the abovementioned international corporate tax reform and as a consequence of the pandemic, Europe has agreed a recovery plan, the so-called ‘NextGenerationEU’ (NGEU), which aims to mitigate the economic and social impact of the coronavirus (COVID-19) pandemic and make European Union (EU) economies and societies more sustainable, resilient and better prepared for the challenges and opportunities of green and digital transitions.

In this context, EU member states have agreed, for the first time in history, a mutualised debt issuance by the EU to finance the reconstruction of European economies through grants and loans in favour of certain specific national projects. Specifically, the EU has agreed to issue bonds for €750bn. However, no agreement has yet been reached at EU level on the financial and tax instruments that will raise income to service the debt issuance over the next 30 years.

Confluence of BEPS 2.0 and the financing of European debt issuance

It is in this context that the work of the Organisation for Economic Co-operation and Development (OECD) and G20 on BEPS 2.0 and the issuance of EU debt converge, as the former will have a major impact on financing debt issuance and on potential coordination of the corporate income tax (CIT) base in the EU.

Potential new sources of revenue. It is envisaged that revenues derived from new own resources to be introduced after 2021 will be used to repay borrowing under the NGEU.

As for tax instruments that could be used to finance EU debt issuance, a set of taxes has been considered at European level, including the so-called ‘EU Digital Levy’, a carbon border adjustment mechanism (CBAM), a European financial transaction tax, a new contribution based on non-recycled plastic packaging waste – effective since January 2021 – and even a surcharge on multinationals that have particularly benefitted from the single market.

Of all these potential new sources of revenue, the EU digital levy and the CBAM are the two most advanced, and the most important in terms of their international implications, and capacity to raise collections.

It should also be noted that, against this backdrop, discussions on the common consolidated CIT base are now back on the table, giving rise to the ‘Business in Europe: Framework for Income Taxation’ (BEFIT) proposal.

The EU digital levy and the CBAM. The proposed EU digital levy of 0.3 percent of the online sales of goods and services sold by companies operating in the EU with an annual turnover of €50m will ensure a fair contribution from the digital sector to financing the EU recovery. According to EU Commission sources, it is envisaged that this tax is designed to be independent of the forthcoming global agreement on international corporate tax reform and would hence coexist with the implementation of Pillar 1.

A first version of the EU digital levy regulation was scheduled to be published in July 2021, but due to pressure from the US, has been deferred until October 2021.

In the context of Pillar 1, this tax has an uncertain future unless the US is convinced that the levy is not just a sweetened version of the domestic DST, which countries have committed to eliminating in exchange for the US approving Pillar 1, nor a precedent for those same jurisdictions to follow after dismantling their domestic DST.

If the EU digital levy is not ultimately approved, it will force a rethink of the set of taxes to be approved to service new EU debt issuance. This is especially true considering that CBAM, the other tax with significant revenue raising effect (a mechanism that entails a tax on any product imported from a third country with the purpose of adjusting the carbon price of the imported goods as if they were produced in the EU to avoid a relocation out of the EU of carbon-intensive product manufacturing industries) is also being questioned, mainly by countries such as China, the US, Russia and Australia (all major exporting countries).

The European tax on financial transactions. Regarding the European financial transaction tax, many EU countries are against it due to the negative impact it may have on capital markets liquidity, although a number of them have established domestic taxes of this type such as France, Italy and Spain, among others.

Related questions arising. Consequently, we are facing a situation in which everything is up in the air, although the first EU debt issuances have already been launched with great success, in terms of demand and low financial cost.

Once the tax instruments that could finance the issuance of European debt have been defined, another big question is who is going to be the tax creditor of these taxes: member states as traditional owners of tax sovereignty or the EU as direct debtor of NGEU issuance?

Indeed, with very few exceptions, the EU has never held tax sovereignty (in other words, been a sovereign entity with taxation capacity), although in this case it would be plainly justified to reduce creditworthiness risks. Otherwise, if each member state were the tax creditor, an additional layer in the debt service process would exist.

Another question is what the impact of Pillar 2 on EU tax policy will be. The EU would like to amend the Anti-Tax Avoidance Directive to introduce on a harmonised basis the changes that are agreed (probably as a best practice only) at Pillar 2 level globally (i.e., a minimum effective tax rate on corporate profits). But politically speaking, this will be very difficult due to the current opposition of some member states such as Ireland, Hungary and Estonia, which oppose the implementation of Pillar 2, since unanimous agreement is required to approve tax legislation, but also given the highly sensitive issue of setting minimum CIT rates at EU level.

On the other hand, the BEFIT proposal recently published by the EU Commission, to approve a common consolidated CIT base (which would then be allocated to the different group member entities and jurisdictions and taxed at national CIT rates), may gain momentum after the implementation of, in particular, Pillar 1. This is not the least because, for the first time, intangibles would be considered among the tax base allocation rules, something which benefits jurisdictions such as Ireland, The Netherlands and Luxembourg, which have been traditionally sceptical of this proposal.

Conclusion

We are facing an uncertain but critical time for the configuration of international tax rules for the 21st century. The forthcoming approval of BEPS 2.0 by the G20 will trigger significant reform of rules which have governed the international tax environment for the last 60 years at national level. And the EU, as a growing player in this field, will have a lot to say – not least due to the launch of the NGEU fund.

 

Eduardo Gracia is practice group head of tax at Ashurst. He can be contacted on +34 (91) 364 9854 or by email: eduardo.gracia@ashurst.com.

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BY

Eduardo Gracia

Ashurst

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