Is the new two-pillar solution to address tax challenges suitable for African countries?

This new solution is expected to reallocate more than $100bn of profit annually to market jurisdictions.  However, this raises the question, to what extent emerging economies, and more specifically, African countries, will be entitled to levy taxes on profits generated by multinational enterprises from their markets?  This source and others are sorely needed by these countries in order to rebuild their economies following the Covid-19 crisis and prepare for climate change, amongst other demands.

This article examines the challenges raised by global corporate tax reform, from an African perspective.

In the process of reaching the October 2021 agreement on international tax reform, African countries, along with many emerging economies, raised concerns as to whether they would, in reality, get a fair share of any reallocated revenue and a reduction in losses from tax avoidance.

With regards to the Pillar One solution, the main concern would be to assess whether African economies, which represent 19% of the Inclusive Framework members, are effectively covered by the proposed solution.

The in-scope companies of the Pillar One solution are limited to those with a global turnover above €20bn and profitability of 10%.  According to the Econpol[1] this represents only 78 of the world’s 500 largest companies.  As many of the digital operators in African jurisdictions will be below this level, it seems unlikely that this solution will result in any meaningful reallocation to African economies.

A reduction of the in-scope turnover to €10bn will enlarge the scope of estimated MNE groups with primary activity in Automated Digital Services (ADS) or Consumer Faced Business (CFD) to 350 companies, and an alignment with the Pillar Two solution will bring 2,300 companies into the scope. 

The same position has been shared by ATAF[2] on its statement regarding a revised Two Pillar solution on taxing the digital economy.  It also considers that the design of the Pillar One solution will lead to a low level of profit reallocation, in particular, to smaller markets jurisdictions.  The ATAF proposal, in addition to the simplification of the rules of the Inclusive Framework solution, was the adoption of a single global threshold rule to cover all MNEs irrespective of their business activities (i.e. excluding the proposed exceptions for sectors such as financial services, construction, and transportation).

In the same vein, ATAF considers that the part of MNE’s global profit that will be allocated to market jurisdictions needs to be increased.  It proposed an additional profit allocation rule corresponding to an “Amount D”, which corresponds to a portion of the MNE’s total profits instead of its residual profit. The rationale behind this proposal is to ensure a more equitable allocation right to the African markets through a portion of the MNEs routine profits in addition to the residual profit allocated under the Amount A.

These representations have influenced the OECD to include in its October announcements the fact that the €20bn threshold will reduce to €10bn after seven years. 

There are a number of complications still to be resolved with the OECD’s latest proposal, but there is a commitment to resolve these in the remainder of 2021 and 2022 so that Pillars One and Two are ready to implement by 2023.    

With regards to the dispute resolution mechanisms, ATAF expressed concerns with the mandatory and binding dispute resolution mechanism proposed for issues arising Amount A.  As an alternative, it proposed the implementation of an elective binding dispute resolution mechanism to be made available to African countries with limited capacity and either no or a low level of mutual agreement procedure (MAP).  It is pleasing to see that there is a facility for an elective binding dispute resolution mechanism to apply for African and other developing countries.

With regards to the Pillar 2 solution, African countries through the ATAF and the African Union advocated for a higher rate than the 15% to protect the African tax bases. In addition, it was suggested to make source-based rules such as the Undertaxed Payment rules (UTPR) and the Subject to tax Rule (STTR) as primary rules under pillar two instead of the Income Inclusion Rule (IIR). This proposal has not been maintained but African countries can implement the STTR into their bilateral tax treaties with other members of the inclusive framework that apply nominal corporate income tax rates below the STTR minimum rate to interest, royalties, and other defined sets of payments.

While it will be some time before the Pillar One proposals work for African countries, there are helpful refinements in the latest proposals that take account of the position of African countries.

Most businesses operating in Africa will need to take account of the coming implementation of the OECD Pillar One and Two proposals, which will need to be considered alongside the existing transfer pricing and other national tax legislation.

[1] https://www.econpol.eu/press_releases/2021-07-05

[2] African Tax Administration Forum