What Is BEPS 2.0? Pillar One and Pillar Two Explained

BEPS 2.0 is an international tax reform initiative led by the Organisation for Economic Co-operation and Development (OECD). This comprehensive project aims to modernize global tax rules to address challenges from the increasing digitalization of the economy. The primary goal is to ensure large multinational enterprises (MNEs) pay a fair share of tax where they operate and generate profits, preventing profit shifting to low-tax areas. This initiative, structured around Pillar One and Pillar Two, seeks to create a more transparent and equitable international tax environment. The framework endeavors to prevent tax avoidance by aligning taxing rights with economic activity and value creation across borders.

Explaining Pillar One

Pillar One reallocates taxing rights over the profits of the largest and most profitable multinational enterprises to market jurisdictions. This ensures a portion of MNEs’ profits is taxed where consumers are located, even without a physical presence. This approach departs from traditional international tax rules requiring physical presence, addressing digital businesses that generate revenue without a traditional taxable nexus.

This pillar introduces “Amount A,” a new taxing right applying to an MNE’s residual profit, which is profit exceeding a routine return. Amount A reallocates 25% of an MNE’s residual profit, defined as profit before tax in excess of a 10% return on revenue, to market jurisdictions. This reallocation mechanism aims to capture profits generated from broad market participation. The calculation of Amount A involves methodologies to determine the MNE’s global residual profit and its allocation to eligible market jurisdictions based on revenue sourced from those markets.

Pillar One also includes “Amount B,” which simplifies the arm’s length principle for baseline marketing and distribution activities. The arm’s length principle requires related-party transactions to be priced as if between independent parties. Amount B offers a simplified, optional approach for determining arm’s length remuneration for these routine activities. This aims to reduce tax disputes and compliance burdens. While Amount A creates a new taxing right, Amount B improves the certainty and efficiency of existing transfer pricing rules for specific activities.

Explaining Pillar Two

Pillar Two introduces a global minimum corporate tax rate of at least 15%. Its objective is to prevent a “race to the bottom” in corporate taxation by ensuring multinational enterprises pay this rate on profits in every operating jurisdiction. This counteracts strategies where MNEs shift profits to low-tax jurisdictions, eroding other countries’ tax bases. The rules impose a “top-up tax” if an MNE’s effective tax rate falls below 15%.

The core of Pillar Two consists of the Global Anti-Base Erosion (GloBE) Rules, which include two main interlocking provisions: the Income Inclusion Rule (IIR) and the Undertaxed Payments Rule (UTPR). The IIR operates by requiring a parent entity to pay a top-up tax on the low-taxed income of its constituent entities. This applies when the effective tax rate in a foreign jurisdiction is below the 15% minimum. For instance, if a subsidiary in a foreign country pays an effective tax rate of 10%, the parent company would be required to pay an additional 5% top-up tax on that subsidiary’s income.

The UTPR acts as a backstop to the IIR, applying when the IIR has not been fully implemented, such as if the ultimate parent entity’s jurisdiction has not adopted it. In these cases, the UTPR denies deductions or requires an equivalent adjustment in implementing jurisdictions, imposing a portion of the top-up tax. This ensures low-taxed income is subject to the minimum tax, even if the parent jurisdiction doesn’t apply the IIR. Both rules work together to achieve the global minimum tax across an MNE group.

Pillar Two also includes the Subject to Tax Rule (STTR) and the Qualified Domestic Minimum Top-up Tax (QDMTT). The STTR is a treaty-based rule allowing source jurisdictions to levy additional tax on intra-group payments taxed below a minimum rate in the recipient jurisdiction. This targets mobile income that could be shifted to low-tax areas. The QDMTT is a domestic minimum tax countries can adopt, allowing them to collect top-up tax on low-taxed domestic entities before the IIR or UTPR apply, ensuring the primary taxing right remains domestic.

Who Is Affected and Implementation Progress

BEPS 2.0 primarily targets large, highly profitable multinational groups. Pillar One applies to MNEs with global annual revenues exceeding €20 billion and a profit-before-tax margin over 10%. Certain industries, like extractive and regulated financial services, are typically excluded from Amount A.

Pillar Two, with its global minimum tax, has a broader reach. It applies to MNE groups with consolidated group revenues exceeding €750 million in at least two of the four preceding fiscal years. This lower threshold means significantly more multinational enterprises are subject to these rules compared to Pillar One. The goal is to ensure most large MNEs contribute a minimum level of tax globally, regardless of profitability.

BEPS 2.0 implementation is an ongoing process involving domestic legislation and international agreements. Over 140 countries have joined the OECD/G20 Inclusive Framework on BEPS, showing broad political support. Many jurisdictions have enacted Pillar Two GloBE rules, with the Income Inclusion Rule (IIR) generally effective from January 1, 2024, and the Undertaxed Payments Rule (UTPR) often from January 1, 2025.

Countries are progressively incorporating these model rules into their national laws, requiring MNEs to prepare for new compliance obligations. This includes the need to calculate effective tax rates for each jurisdiction and, if necessary, pay top-up taxes. The continuous development of administrative guidance by the OECD further supports the consistent application of these complex rules globally. While the United States has not yet adopted the OECD project into its domestic tax system, U.S. multinational businesses operating abroad are still impacted by the adoption of these rules in other jurisdictions where they have operations.