The impact of the OECD’s Pillar 1 and Pillar 2 approach on businesses

In October last year, the OECD/G20 Inclusive Framework on Base Erosion and Profit Shifting (BEPS) agreed a two-pillar approach to address the challenges arising in relation to the taxation of the digital economy.

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Michael Beard, Philip Newbold
Published: 22 Mar 2022 Updated: 11 Aug 2022

In October last year, the OECD/G20 Inclusive Framework on Base Erosion and Profit Shifting (BEPS) agreed a two-pillar approach to address the challenges arising in relation to the taxation of the digital economy.

In recent years, the BEPS project has made significant progress in reducing the level of profit shifting undertaken by multinational enterprises (MNEs) as a result of the work on taxation of intangibles and communication between tax authorities.

What is Pillar 1?

Pillar 1 focuses upon profit allocation and nexus. It moves away from the more traditional, ‘physical presence’ approach to taxation by relocating taxing rights to the jurisdictions where business activities and profits arise.

Early examples of this new approach can be seen in the introduction of a temporary domestic digital services tax in the UK and similar unilateral measures created in other jurisdictions.

What is Pillar 2?

The focal point of Pillar 2 is to establish a global minimum tax rate of at least 15%.

The aim is to reduce the incentive for MNEs to operate in low or no tax jurisdictions, to place a floor on tax competition between jurisdictions, and to aid the sustainability of corporation tax as a major source of government revenues.

How will Pillar 1 impact my business?

First, the draft regulations for Pillar 1 only apply to the largest MNEs, with global revenues in excess of €20bn and a profit before tax margin of more than 10%.

While the Pillar 1 approach is still to be agreed by the Inclusive Framework, local applications including the UK’s digital services tax will remain. It is anticipated that these unilateral measures will be repealed as part of any future Pillar 1 agreement.

The current proposed approach for Pillar 1 is technically complex. It would see new taxing rights for market jurisdictions, based upon a formulaic approach, rather than using the arm’s length principle. This would allow taxation of residual profits in jurisdictions that are allocated at least €1m in revenue (€250,000 for jurisdictions with a GDP of less than €40bn).

A second aspect of Pillar 1 is the allocation of a routine “baseline” return for marketing and distribution activities.

Although the original proposals for Pillar 1 were targeted towards highly digitalised business models, the latest proposals are much broader, albeit it is anticipated that regulated financial services will remain exempt.

How will Pillar 2 impact my business?

The Pillar 2 regulations will only apply to MNE groups with total consolidated turnover of at least €750m.

The Pillar 2 proposals are more advanced than Pillar 1. Draft legislation was published by the Inclusive Framework in December 2021 and HMRC is currently consulting on how the Pillar 2 rules should be implemented into UK legislation.

The regulations focus on a two-step approach for granting jurisdictions additional tax rights.

First, are the two domestic rules commonly referred to as GloBE. The ‘income inclusion rule’ imposes a top-up tax on the parent entity where it has subsidiaries located in jurisdictions where the effective tax rate is below 15%. The ‘undertaxed payments rule’ acts to deny deductions or prevent adjustments on profits that are not subject to the minimum level of taxation under the income inclusion rule.

Second, a ‘subject to tax rule’ will act to override treaty benefits for intragroup payments that are not subject to a minimum tax rate of 9%. This will include interest and royalties.

It is expected that there will be some industry-based exclusions from the Pillar 2 legislation.

A substance test will also apply, so that the top-up tax will not be assessed on a low-tax subsidiary’s income, to the extent its return does not exceed 5% of payroll costs and tangible assets. The rules are therefore clearly targeted on businesses achieving excessive returns on intangible assets.

Next steps and how we can help

While the rules are complex, and only apply to the largest MNEs, the agreement of the Pillar 2 approach by the Inclusive Framework is a huge step forward and points to a future agreement of the Pillar 1 proposals in due course.

The heightened focus on global cooperation between tax authorities to tackle BEPS related issues is a clear trend, and business should be increasingly mindful of ensuring that taxation is aligned to the substance of their operations.

Having appropriate transfer pricing policies and documentation in place has never been more important, particularly in light of the increased risk of challenge from tax authorities following the loss of revenue due to the pandemic.

Whether your business needs support implementing transfer pricing for the first time, or assistance in evaluating the appropriateness of existing documentation, our team of experts would be pleased to arrange an initial call, and then help your business meet all its reporting and documentation requirements. If this is of interest, please get in touch with either:

Philip Newbold -

Michael Beard -

Ana Villaveces-


By necessity, this briefing can only provide a short overview and it is essential to seek professional advice before applying the contents of this article. This briefing does not constitute advice nor a recommendation relating to the acquisition or disposal of investments. No responsibility can be taken for any loss arising from action taken or refrained from on the basis of this publication. Details correct at time of writing.

Tax legislation is that prevailing at the time, is subject to change without notice and depends on individual circumstances. Clients should always seek appropriate tax advice before making decisions. HMRC Tax Year 2022/23.



This article was previously published on Smith & Williamson prior to the launch of Evelyn Partners.