Pillar 2 and the Myth of the “Easy Button”

Readers may recall the clever ad campaign for Staples Inc., which marketed the company as an “easy button”: one push, and your problems are solved. One of the great frustrations for in-house tax professionals is the (implicit) assumption among tax policy makers (and tax authorities) that the information necessary to comply with new tax-reporting obligations is readily available to large multinational enterprises (MNEs) in the requisite form; we need only press the “easy button” to produce it. This is not the case, however. Taxpayers take their compliance obligations seriously and must build complicated systems to identify, collect, and process the relevant information in order to comply with those reporting obligations. Often, that information can be readily identified and processed only where such systems already exist. It can take years and tremendous expense to build out new systems in large MNEs. And yet tax policy makers continue to enact increasingly complex proposals without (1) providing taxpayers with adequate time to build and modify reporting systems to comply with those enactments or (2) adequately minimizing the incremental compliance burden such proposals impose.

The OECD’s pillar 2 initiative is a prime example of this practice. This initiative, intended to ensure that MNEs are subject to a minimum 15 percent effective tax rate in all jurisdictions in which they operate, is proposed to come into effect in 2023. Yet Canada’s federal government has only now (as of April 2022) commenced consultation on implementing this proposal for Canadian MNEs, with a view to enacting these rules at some (as yet unknown) date in 2023. In fairness to the Canadian government, the OECD released the model rules only in December 2021 and the commentary thereon in March 2022, and consultations on the implementation framework, including safe harbours and simplifications, are ongoing. This puts Canadian MNEs in the difficult position of having to try to develop systems to comply with pillar 2 without clear guidance on what they actually have to comply with.

Consider the requirement under pillar 2 for corporate groups to compute global anti-base erosion (GloBE) income/loss by “constituent entity,” aggregated on a jurisdiction-by-jurisdiction basis. To meet this requirement, taxpayers must start with their financial accounting net income, and then make a variety of adjustments to recompute income at both the constituent entity and the jurisdiction levels. The details of those adjustments are beyond the scope of this article, but suffice it to say that they are significant and complex. Thus, to comply with pillar 2, MNEs will have to create reporting systems to identify, collect, and process information about the transactions, circumstances, and events that might give rise to such adjustments.

This, in turn, requires that the adjustments be well defined: you can’t develop a system to identify transactions giving rise to an adjustment without a clear understanding of what that adjustment is and what facts and circumstances have given rise to it. Many such details under the pillar 2 model rules—and what they mean in practice—are still being worked out, and thus taxpayers cannot yet develop systems to comply with them.

Pillar 2 overlaps with country-by-country reporting (CbCR)—another OECD/G 20 initiative—and other existing Canadian reporting obligations for foreign affiliates (FAs); each is intended to provide tax authorities with information on the income, expenses, and tax payable by multinational corporate groups. Frustratingly, however, each reporting regime imposes different reporting requirements, requires different reporting of income, and is subject to different timelines. MNEs devoted significant resources to putting systems in place to gather CbCR data—systems that were implemented just a few years ago. Now, yet another OECD/G 20 BEPS initiative will further increase the compliance burden on MNEs without allowing them adequate time to leverage the CbCR data.

Instead of layering a third level of FA reporting over existing obligations, the government should seek to build on existing requirements and to eliminate duplicative reporting where possible. For example, if pillar 2 were implemented in a way that allowed MNEs to make use of the systems put in place for CbCR (for example, by allowing taxpayers to use CbCR income for the purposes of computing GloBE income), the incremental compliance burden arising from pillar 2 for MNEs could be significantly reduced. Similarly, given the existence of pillar 2 and CbCR, the government might consider simplifying the current reporting obligations for FAs. It is sound tax policy to seek information about the foreign activities of Canadian MNEs, but so is doing so in the most efficient and cost-effective manner possible.

The Canadian government had previously estimated that it would generate $4.5 billion of tax revenue through pillar 1 and pillar 2; in the 2022 federal budget, however, no estimates were provided. If jurisdictions with tax rates below 15 percent decide to increase their rates as a result of pillar 2, the revenue provided to the Canadian government could be negligible (or, indeed, negative). Compliance costs to MNEs, however, will not be. Whether or not pillar 2 represents well-designed substantive tax policy, it clearly imposes significant tax-reporting and compliance obligations on Canadian MNEs. In the rush to implement pillar 2 in 2023, it is unclear whether policy makers have fully considered the compliance burden that these rules will impose on taxpayers (and, it should be noted, on tax authorities). In implementing pillar 2, governments must recognize the compliance burdens MNEs are facing and work to simplify the implementation and determination of GloBE income. More broadly, in light of pillar 2, consideration should also be given to reducing complexity both in the tax system and in reporting obligations.

Sue Wooles and Carl Irvine
BMO Financial Group, Toronto

International Tax Highlights

Volume 1, Number 1, May 2022

©2022, Canadian Tax Foundation and IFA Canada

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