On 8 October 2021 agreement was reached between 136 OECD member countries on a framework for implementation of the BEPS 2.0 project. Ireland was a signatory to a plan which proposes to increase the global minimum effective tax rates of certain large multinational groups to 15%. Before signing, Ireland stated that its negotiating aims had been achieved. The minimum rate was capped at 15%, as opposed to “at least” 15%, and the 12.5% rate remains available to all Irish tax resident companies not crossing the €750m global consolidated revenue threshold. In this article, we review what has been agreed, consider the possible impact on aircraft lessors and airlines, and look to next steps as BEPS 2.0 moves towards implementation.

Brian Brennan and Claire Waters of our Aviation Finance team assess the impacts of this change below.

What is BEPS 2.0?

The first round of changes to international tax law was introduced by the OECD via the tax treaty amending Multilateral Instrument in 2015. The anti-base erosion and profit shifting (“BEPS”) project sought to tackle perceived tax avoidance on a global scale, targeting challenges such as treaty shopping and offshoring to low tax jurisdictions. Notwithstanding the very significant changes introduced, continued rapid digitisation of the world economy and the growth of the tech sector led to calls for further radical change to the structure of international taxation, ultimately leading to the two new “pillars” of rules proposed under BEPS 2.0.

Initial progress towards agreement was slow, but it accelerated significantly in late 2020 and through 2021 following the announcement of support from the Biden administration. The accession of Ireland to the agreement in early October was a strong statement of support for the process, and remaining EU holdouts Estonia and Hungary quickly followed suit. At the time of writing, Nigeria, Kenya, Pakistan and Sri Lanka are the only Inclusive Framework jurisdictions remaining to sign up.

While much remains to be finalised, the basic shape of the rules across Pillar One and Pillar Two is beginning to become clear.

Pillar One: Dark horse

Pillar One’s primary aim is to ensure that tax is paid in the jurisdiction(s) in which sales are realised, as opposed to the jurisdiction in which substance is located. Following much negotiation and some pressure from the United States, Pillar One will now apply only to those groups with consolidated global revenues of €20bn and above (reducing to €10bn in seven years), and only where a profit margin of 10% of revenues is realised. Where Pillar One applies, it will result in a proportion of profit being reallocated to market jurisdictions (i.e. where ticket-purchasing passengers, or lessee airlines, are located).

It is clear that Pillar One is designed to target the very largest of companies, however noting the proposed revenues threshold reduction to €10bn, it is possible that the Pillar One rules could in due course impact the very largest airlines and leasing groups, or those groups which are consolidated into much larger banks or funds. While there are certain carveouts provided for regulated financial services and extractive industries, there are none (as yet) for aviation.

The operation of the Pillar One rules remains to be finalised. A timetable has been set for the second half of 2022 to complete work on the calculation of amounts to be reallocated to customer jurisdictions for taxing. At this point, there is consensus that Pillar One is the less important of the two pillars to the aviation industry, but it remains one to watch as the final rules take shape.

Pillar Two: Headline maker

Pillar Two is the set of rules which has made headlines around the world recently, and which will establish a minimum 15% effective rate of corporate tax. As with Pillar One, significant aspects of the calculations which will ensure this 15% effective rate remain to be ironed out. One helpful recent clarification (and which led to Ireland signing up) was the removal of the uncertainty implicit in references to a rate of “at least” 15%.

Like Pillar One, there is a threshold to be crossed in order to be in scope of Pillar Two. The minimum effective rate of 15% will apply (subject to any other domestic rules) only to those groups with consolidated revenues of €750m or more. No allowance is made for inflation, meaning that this bar will become easier to cross in future years. For the present, as a general rule of thumb, if you have EU Country by Country reporting obligations, you are also likely to be in scope of Pillar Two. As with Pillar One, lessors and airlines which are consolidated into larger financial institutions are at risk of finding themselves unexpectedly in scope. There is potential for a helpful carveout based on the carrying value tangible assets on balance sheet, however the specifics of how this will work remain to be established.

Where a given jurisdiction does not operate the agreed global minimum rate, there are certain rules which will enforce groups’ compliance. At a very high level, these include:

  • The Income Inclusion Rule (IIR): this CFC-style rule will tax income held offshore in jurisdictions imposing a rate of less than 15%;
  • The Under-Taxed Payments Rule (UTPR): there will be a denial of tax deductions on payments to jurisdictions imposing a rate of less than 15%;
  • The Subject to Tax Rule (STTR): this tax treaty instrument will deny withholding tax relief on related party payments to jurisdictions which do not impose a nominal 9% rate of tax.

The practical impact

When assessing the likely practical impact of Pillar Two on a business, the first key consideration is the €750m consolidated revenues threshold. Aircraft lessors with fund, bank or broader corporate ownership may need to take account of the wider financial position of their ultimate owners, and in some cases may find themselves unexpectedly in scope. In Ireland, it is expected that the vast majority of companies will remain subject to the 12.5% rate (subject to final agreement at EU level), with only 1,600 companies likely to be taxed at 15%.

Of these companies, 10-20 are anticipated to be aircraft lessors. For those lessors in scope, there should be no immediate cash tax impact due to the deferral of taxation by way of the offset of accrued tax losses. However, it remains to be seen whether a remeasurement of deferred tax balances will be required to recognise the impact of a change in rate, and if so, how this will impact both balance sheets and the statement of profit or loss. The calculation of the ETR itself under Pillar Two, and the allowance to be made for deferred tax and accrued losses, remains to be finalised.

Overall, the impact of the rate change to Irish headquartered, in-scope lessors is expected to be a net 2.5% increase in ETR. A Hong Kong headquartered in-scope lessor can expect an additional 9% to 11% tax, and an in-scope lessor headquartered in Singapore will pay an additional 7% tax.

Next steps

The Inclusive Framework members have set 2023 as the hoped-for implementation date for the Pillar One and Pillar Two rules. This timeline is ambitious notwithstanding the rapid acceleration of progress throughout 2021, particularly given the breadth of technical detail remaining to be worked out. Even after the complexities of a rulebook designed to revolutionise tax treatments in 140 jurisdictions have been ironed out, politics may slow the process. Many OECD signatory states will need to pass legislation to implement the rules, EU Member States will be required to agree (unanimously) the text of a Directive, and the Biden administration will need to steer a bill through both the House of Representatives and Senate, neither of which has a comfortable Democratic majority. The road ahead is long, however BEPS 2.0 has surprised us before, and given the consensus that has now been reached, it is certain that significant change in some form is approaching.

The nature of the proposed rules is such that planning opportunities are likely to be limited. Pillar Two is designed to impose top up taxes and deny deductions on multinationals where payments are being made to, or profits held in, jurisdictions where they have an effective corporate tax rate of less than 15%. However, much remains to be negotiated. As the shape of the final text emerges, there may be windows for managing some of the increased tax leakage for in-scope groups.

In summary

BEPS Pillars One and Two pose very significant challenges to business. It is likely that the coming years will witness a fundamental change to the framework of international taxation. The majority of groups will remain out of scope of both pillars of rules, however the lead in time available should be used wisely by those in the aviation industry to plan and prepare for what is coming. In particular, in scope groups should consider modelling the potential tax effect of the proposed changes to better understand the impact on the bottom line. 

This article originally appeared in Airline Economics magazine and is reproduced here with their kind permission.

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