OECD Pillar 1 and Pillar 2: The Tax Rules Explained

The architecture of international taxation is undergoing a significant shift, driven by a two-pillar solution developed by the Organisation for Economic Co-operation and Development (OECD) and the G20 Inclusive Framework. This initiative addresses the tax challenges from the increasing digitalization of the world’s economy, as traditional tax rules based on physical presence struggled to keep pace with modern business models. The overarching goals of this global effort are twofold.

The first objective is a more equitable distribution of profits and taxing rights among countries, ensuring that taxes are paid where economic activity and value creation occur. This confronts situations where companies have many customers in one country but book the profits in a lower-tax jurisdiction. The second objective is to curtail the shifting of profits by establishing a global minimum tax rate. This measure reduces the incentives for multinational enterprises to move profits to low-tax jurisdictions, mitigating a “race to the bottom” in corporate tax rates.

Understanding Pillar One Reallocation of Taxing Rights

Pillar One introduces a new method for allocating the right to tax the profits of the largest and most profitable multinational enterprises (MNEs). Its primary goal is to reallocate a portion of these companies’ profits to the market jurisdictions where their customers and users are located, regardless of whether the company has a physical presence there. This represents a significant departure from long-standing international tax principles that relied on a physical nexus to establish taxing rights.

The scope of Pillar One is narrowly defined by high revenue and profitability thresholds. It applies to MNEs with a global turnover exceeding €20 billion and a profitability margin greater than 10%, calculated as profit before tax divided by revenue. These criteria ensure that only the world’s largest companies are subject to this new reallocation mechanism. Certain industries, such as extractives and regulated financial services, are excluded from these provisions.

A component of Pillar One is the creation of a new taxing right known as Amount A. This allows market jurisdictions to tax a share of an MNE’s residual profits, which is defined as the profit that exceeds a 10% return on revenue. Under the framework, 25% of this excess profit is then allocated to market jurisdictions based on a revenue-based sourcing key.

For example, if a covered MNE has €50 billion in revenue and €8 billion in pre-tax profit, its profitability is 16%. The residual profit is the 6% above the 10% threshold, which amounts to €3 billion. Amount A would then reallocate 25% of that €3 billion, or €750 million, to the countries where the company’s sales occurred.

Pillar One also introduces Amount B, which simplifies the application of the arm’s length principle for baseline marketing and distribution activities. The goal is to provide a fixed, standardized return for these routine functions to increase tax certainty and prevent prolonged transfer pricing disputes. As of early 2025, Amount B has been incorporated into the OECD’s Transfer Pricing Guidelines, and jurisdictions have the option to apply this simplified approach for fiscal years beginning on or after January 1, 2025.

Understanding Pillar Two Global Minimum Tax

Pillar Two establishes a global minimum tax regime intended to ensure that large MNEs pay a minimum level of tax on the income they generate in each jurisdiction where they operate. The principal objective is to make certain that this income is subject to an effective tax rate of at least 15%. This pillar works to neutralize the benefits of shifting profits to jurisdictions with very low or zero corporate income tax, fundamentally altering the incentives that have shaped international corporate tax planning for decades.

The scope for Pillar Two is broader than that of Pillar One, applying to MNEs with annual consolidated revenues of €750 million or more. This lower threshold means that thousands of multinational companies will be impacted by these rules. The implementation of Pillar Two is achieved through a set of interlocking regulations known as the Global Anti-Base Erosion (GloBE) rules. These rules provide a standardized mechanism for calculating a company’s effective tax rate in each country and for imposing a top-up tax when that rate falls below the 15% minimum.

The GloBE rules consist of three main components. The primary rule is the Income Inclusion Rule (IIR), with the Undertaxed Payments Rule (UTPR) serving as a backstop. The framework also allows countries to implement a Qualified Domestic Minimum Top-up Tax (QDMTT). A QDMTT gives a country the first right to collect the 15% minimum tax from its own domestic entities, with any tax paid under a QDMTT being credited against any potential tax liability under the IIR or UTPR.

The Income Inclusion Rule (IIR) operates as a top-down rule, meaning the ultimate parent entity of the MNE group is responsible for paying the top-up tax to its home country’s tax authority. For instance, if a subsidiary of a French-based MNE operates in a country where it pays an effective tax rate of only 5%, the IIR would allow France to collect the additional 10% tax. This brings the total tax on that foreign income up to the 15% minimum.

The backstop rule, known as the Undertaxed Payments Rule (UTPR), applies when the IIR cannot, for instance, if the jurisdiction of the ultimate parent entity has not implemented the IIR. In such cases, the UTPR allows other countries in which the MNE group operates to collect the top-up tax. This is achieved by denying tax deductions for payments made to the low-taxed entity or through an equivalent adjustment.

Global Adoption and Implementation Status

The global rollout of the two pillars is proceeding on separate tracks, reflecting their different legal foundations. Pillar One requires a change to the nexus and profit allocation rules embedded in thousands of bilateral tax treaties. Its implementation is contingent upon the development and widespread adoption of a Multilateral Convention (MLC). This convention would allow participating jurisdictions to amend their existing tax treaties simultaneously, and the process to finalize and ratify the MLC is ongoing.

In contrast, the implementation of Pillar Two is being carried out through amendments to the domestic laws of individual countries. The OECD has provided a detailed set of GloBE Model Rules to serve as a template for countries to use when drafting their own legislation, promoting a consistent and coordinated approach. A significant number of jurisdictions, including many major economies, have enacted laws to implement the IIR and UTPR, with the rules taking effect in many countries for fiscal years starting in 2024 and 2025. However, the United States has not enacted legislation to make its tax law compliant with Pillar Two. The current U.S. administration has indicated it has withdrawn from the political commitments made by the prior administration regarding the OECD pillars, creating uncertainty about its future adoption.

Key Implications for Multinational Enterprises

For businesses falling within the scope of these new rules, the most immediate impact is a substantial increase in compliance and data-gathering responsibilities. To comply with Pillar Two, MNEs must collect and process vast amounts of financial data on a jurisdictional basis. This is necessary to accurately calculate the effective tax rate (ETR) for each country of operation and determine any potential top-up tax liability. Similarly, Pillar One requires sophisticated data analysis to correctly source revenues to specific markets for the profit reallocation calculations.

The rules are expected to have a direct effect on the tax liabilities and financial reporting of many MNEs. For companies that have historically benefited from low-tax jurisdictions, the 15% global minimum tax will likely lead to higher cash tax payments. Under U.S. Generally Accepted Accounting Principles (GAAP), the Financial Accounting Standards Board (FASB) has issued guidance clarifying that the Pillar Two global minimum tax should be treated as an alternative minimum tax. This means the tax is recognized as a cost in the period it is incurred, rather than requiring companies to adjust their deferred tax assets and liabilities.

These new global tax standards necessitate significant updates to internal systems and processes. The complexity of the ETR and top-up tax calculations under Pillar Two often exceeds the capabilities of existing accounting and tax software. Many companies will find it necessary to invest in new technology solutions or substantially modify their current systems to manage the data collection, perform the required calculations, and ensure accurate and efficient compliance. This often involves a re-engineering of how tax and finance data is collected and managed across the enterprise.