Pillar One – OECD public consultation on Amount A draft model rules 

On 11 July 2022, the OECD published a consultation document Progress Report on Amount A of Pillar One, containing draft domestic model rules (‘draft model rules’) for the new taxing right (‘Amount A’) in favour of market countries. This follows the statement on the components of global tax reform, agreed by more than 135 members of the G20/OECD Inclusive Framework (‘Inclusive Framework’) in October 2021 and OECD consultations on seven ‘building blocks’ of Amount A draft rules published between February and May 2022.

Since 2017, the member countries of the Inclusive Framework have developed a ‘two-pillar’ approach addressing nexus and profit allocation challenges (‘Pillar One’) and global minimum tax rules (‘Pillar Two’).

The rules reallocate taxing rights in favour of market countries through the creation of a new taxing right over ‘Amount A’ profits. The model rules comprise five steps:

Step 1. Determine whether a business is large enough to be within scope

Step 2. Nexus and revenue sourcing – determine which market countries are eligible for Amount A, and identify how much revenue is derived from each country

Step 3. Determine the profit of the group

Step 4. Allocate Amount A profit to eligible market countries in proportion to revenues (capped by the marketing and distribution safe harbour)  

Step 5. Elimination of double tax – identify which countries will be responsible for eliminating double tax in relation to Amount A and in what amounts

Step 1 – Scope determination

For periods beginning on or after the commencement date, the rules will apply to groups which satisfy two tests:

• Revenues of the group in the period are greater than EUR 20 billion (revenue test), with the threshold pro-rated accordingly for periods other than twelve months; and
• The adjusted pre-tax profit margin of the group for the period is greater than 10% (the profitability test).

Where a group is not in scope in the two consecutive periods immediately before the period, the 10% profitability test will also need to be met in at least two of the four immediately preceding periods, and on average across the period and the four preceding periods.

Groups are defined by reference to accounting principles, requiring the identification of ultimate parent entities and the group entities included in consolidated financial statements. Financial statements need to be in an acceptable financial accounting standard – which includes inter alia, IFRS, and UK and US GAAP.

‘Revenues’ for Amount A purposes are those reported in the consolidated financial accounts, subject to a limited number of adjustments (e.g. removing dividends received and equity gains or losses). The ‘pre-tax profit margin’ is calculated based on the profits per consolidated financial accounts (adjusted in line with Step 3 below).

Segmentation rules apply (in exceptional circumstances) where a segment disclosed in a group’s consolidated financial statements meets the scope tests on a standalone basis (i.e. the disclosed segment has revenues greater than EUR 20 billion and profitability greater than 10%) but the group as a whole does not. In such a case the Amount A rules apply to the segment as if it were a group on a standalone basis.

Exclusions can apply to revenues and profits related to extractives and regulated financial services (see below).

Step 2 – Nexus and revenue sourcing

Nexus (taxable presence)

A market country will only be entitled to an allocation of Amount A if annual revenues arising in the country exceed EUR 1 million. A lower threshold of EUR 250,000 will apply for countries with a GDP of less than EUR 40 billion. Revenue thresholds are adjusted proportionally for periods other than twelve months. The nexus test applies solely for the purposes of applying Amount A and has no other implications.

Revenue sourcing

Revenues must be sourced according to the category of revenues earned. Revenues that fall under more than one category are sourced according to their predominant character. Businesses may source revenues from supplementary transactions in line with the rules applicable to the main transaction.

Each category of revenues has its own specific sourcing rules, including the underlying sourcing principle, potential reliable indicators (i.e. sources of information) and any allocation keys. The specified categories of revenues are: finished goods; digital content; components; services (location-specific services, advertising services, online intermediation services, passenger transport services, cargo transport services, customer reward programs and other services); intangible property (relating to: finished goods, components, services, digital content, and user data); real property; government grants; and non-customer revenues.

A reliable indicator must produce results that are consistent with the relevant sourcing rule and either meets one or more reliability tests (e.g. being relied upon for commercial purposes or to fulfil legal, regulatory, or other related obligations) or has been agreed with a review panel in an Advance Certainty Outcome.

A specified allocation key may or must be used to approximate the source countries, typically where reasonable steps have been taken to conclude that a reliable indicator is not available. A ‘knock-out rule’ first eliminates countries for which there is reliable information that revenue did not arise due to legal, regulatory or commercial reasons. Under one such key - the ‘global allocation key’ - revenues are deemed to arise in countries in proportion to the size of the country’s consumer economy. Other allocation keys can apply to specific categories of revenue. All the revenues of a business must be sourced, and a back-stop rule ensures an allocation key would apply such that no revenue is left unsourced.

The group must have an internal control framework to evidence the approach taken to revenue sourcing, including the characterisation of revenues, indicators and allocation keys used, design of the relevant systems used, quality assurance of the outcomes, and a periodic review to account for any business changes.

During an initial transition phase, groups are not required to apply the specific sourcing rules and instead may apply the relevant allocation keys to all or any part of their revenues. This transition phase covers the first three periods beginning on or after the entry into force of the multilateral convention to implement Amount A.

Step 3 – Determine the relevant measure of profit for the group

The ‘allocation tax base’ of the group determines the amount of profit (or loss) that will be used for Amount A purposes – i.e. in the calculation of the business’s residual profits to be reallocated to market countries.

The starting point for computing the allocation tax base is the financial accounting profit/loss of the consolidated financial statements. A limited number of book-to-tax adjustments will be required to determine adjusted profit before tax. Adjustments include: tax expense; excluded dividends; excluded equity gains/losses; policy disallowed expenses (such as penalties); prior period errors and changes in accounting principles; financial accounting profit/loss of excluded entities; asset fair value or impairment adjustments; acquired equity basis adjustments; and asset gain/loss spreading adjustments. Further work is ongoing on whether and how profit attributable to non-controlling interests should be included/excluded.

Loss carry-forwards

Net losses carried forward (subject to time limitations), calculated after the same book-to-tax adjustments above, are deducted when calculating adjusted profit before tax.

Losses generated after the implementation of Amount A (‘post-implementation losses’) may be carried forward and utilised for ten years. Losses generated in the three years before the implementation of Amount A (‘pre-implementation losses’) may also be carried forward for ten years.

Special rules apply to historical loss amounts associated with the transfer of entities into the business as part of an eligible business combination, or with the eligible division of a larger predecessor business, subject to business continuity conditions.

Step 4 – Allocation of Amount A

Allocation of profit to countries

The total amount of profit that can be reallocated under Amount A is 25% of a business’s residual profit above a 10% profit margin. This amount is then allocated to the individual countries in which the business has an Amount A nexus, in proportion to the ratio of the revenues arising in each country over the total revenues of the group.  

The share of Amount A allocated to a specific country can be reduced by the marketing and distribution profits safe harbour (see below).

Return on depreciation and payroll

‘Returns on depreciation and payroll’ are used as a proxy for profitability and to identify which countries are required to eliminate double tax. The return on depreciation and payroll is calculated for each country as:

                       Elimination profit                       
 Depreciation amount plus payroll amount

The elimination profit/loss (sometimes called the elimination tax base) is calculated for each country. The starting point is the net income or loss for a group entity (before any consolidation adjustments eliminating intra-group transactions) as used in preparing the consolidated financial statements of the group. A limited number of book-to-tax adjustments are required e.g. to reflect arm’s length prices and to allocate amounts to permanent establishments. Many adjustments are aligned with the equivalent rules developed for the tax base computation under the Pillar Two rules for global minimum taxation. The elimination tax base for a country is the sum of the elimination profit (or loss) for each group entity in a country (after deductions for losses carried forward).

The depreciation amount for a country is the reduction in the carrying value of tangible assets located in the country including property, plant and equipment, and natural resources.

The payroll amount includes salaries, health insurance, pension contributions, stock-based compensation, employment taxes, and employer social security contributions of eligible employees (including independent contractors) performing activities in the country.

Marketing and distribution profits safe harbour

The marketing and distribution profits safe harbour aims to address ‘double counting’ issues where a market country already taxes the same item of residual profit. The safe harbour reduces the amount of profit otherwise allocated to a country by capping the Amount A allocation to the country. In line with other elements of the Amount A calculation, the safe harbour is calculated for each country and is based on a return on depreciation and payroll.

The safe harbour applies in a country where the ‘elimination profits’ result in a return on depreciation and payroll greater than the higher of:

• the group’s ‘elimination threshold return on depreciation and payroll’ (equal to 10% of the group’s revenues, divided by the group’s total depreciation and payroll); or
• a 40% return on depreciation and payroll.

The amount of profit allocated to the country is reduced by an as yet undetermined percentage of the excess. Consideration is being given to a de minimis threshold test, the metrics to identify residual profits in a market country, and the portion of those residual profits that will reduce Amount A allocations. The interaction of this adjustment with the elimination of double tax mechanism is also still under development.

Step 5 – Elimination of double tax with respect to Amount A

The obligation to eliminate double tax in respect of any Amount A liability is allocated among countries that earn residual profits (‘relieving jurisdictions’), using a formulaic quantitative approach. Groups are required to identify the smallest group of countries which represent 95% or more of the group’s total ‘elimination profit’ (see above), plus any other countries where the elimination tax base is EUR 50 million or more. Countries are divided into tiers based on profitability in each country relative to the overall profitability of the group, measured by reference to the return on depreciation and payroll. Double tax is relieved in the following order, until the full Amount A profit reallocation has been eliminated:

• Tier 1 countries with a return on depreciation and payroll in the country which exceeds 15 times that of the group, starting with the country with the highest return. The first country provides relief from double tax on the amount of profit needed to reduce its return on depreciation and payroll to the same level as the country with the second highest return. The two countries then both relieve double tax on an amount of profit to reduce their returns to the same level as the country with the third highest return (and so forth), until the resulting return on depreciation and payroll of all Tier 1 countries has been reduced to 15 times that of the group.
• Tier 2 countries with a return on depreciation and payroll which exceeds 1.5 times that of the group, in proportion to the country’s proportion of the group’s residual profits within that tier.
• Tier 3A countries with a return on depreciation and payroll in excess of both 40% and the group’s ‘elimination threshold return on depreciation and payroll’ (10% of the group’s revenues, divided by the group’s total depreciation and payroll).
• Tier 3B countries with a return on depreciation and payroll in excess of the group’s ‘elimination threshold return on depreciation and payroll’ (10% of the group’s revenues, divided by the group’s total depreciation and payroll).

Countries which do not meet the criteria for any of the tiers will not be required to relieve double tax arising from Amount A.

Further work is being undertaken on rules to determine which specific entities in a relieving jurisdiction will be entitled to relief from double tax.

Extractives and regulated financial services exclusions

Revenues and profits of qualifying extractives groups engaged in exploration, development or extraction activities may be excluded from the scope of Amount A where relevant conditions are met. Calculations to identify extractive and non-extractive revenues and profit margins can be performed using a disclosed segment or entity-based approach.  

An initial extractives transition phase applies for the first six periods beginning on or after the entry into force of the multilateral convention to implement Amount A, during which time simplified approaches may be used.

Similarly, modifications to the Amount A rules apply to exclude from the Amount A scope and calculation revenues and profits of a group or disclosed segment which conducts regulated financial services. These modifications apply where one or more group entities meet the definition of a regulated financial institution, including banking, insurance and asset management businesses. Group captive insurance entities and group treasury entities are specifically excluded from the definition of regulated financial institutions.

Administration and tax certainty

The approach for administration and tax certainty is not included within the draft model rules, and will be released separately. Public consultation documents were released in May 2022 on:

• A tax certainty framework for Amount A, incorporating elements designed to guarantee certainty for in-scope groups over all aspects of Amount A and including design of a Scope Certainty Review, an Advance Certainty Review, and a Comprehensive Certainty Review; and
• Tax certainty for issues related to Amount A, which aims to ensure that in-scope groups have access to dispute prevention and resolution mechanisms to address double tax due to issues related to Amount A, such as transfer pricing and business profits disputes, in a mandatory and binding manner. An elective binding dispute resolution mechanism will be available for certain developing countries.

Next steps

Comments on the draft model rules are invited by 19 August 2022. The Inclusive Framework will review stakeholder input and seek to ‘stabilise’ the Amount A rules in October 2022. The rules on administration and tax certainty for Amount A are expected to be released in advance of October.

The model rules, once finalised, will serve as the basis for a multilateral convention to implement Amount A, expected to be available for signature by countries in the first half of 2023, with the aim for Amount A rules to enter into force in 2024 once a critical mass of countries have ratified the multilateral convention.