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  • Writer's pictureInternational Lawyers Project

A Short Guide to Pillars 1 and 2 of the OECD’s Inclusive Framework

Updated: Nov 27, 2023

By John N. Bush, Director of International Tax and Fiscal Reform, International Lawyers Project. As the Director of International Tax and Fiscal Reform for the International Lawyers Project, I thought it would be appropriate for me to set out my thoughts on the impact of the OECD Inclusive Framework’s (IF) Pillar 1 and Pillar 2 proposals on developing countries, and to provide a brief initial analysis of a way to deal with them.


Developing countries confront an international tax system that is in tremendous flux, moving from a set of rules that have been in place for 100 years to a new set of rules, the exact contours of which are still being debated. A good part of this uncertain state of affairs can be attributed to the digital economy making it hard to apply the old rules in a fair and effective fashion. Historically, businesses were largely taxed by the jurisdictions where they were engaged in business, and this was judged by where they were physically undertaking their business. However, in the new digital world, the rubric of basing a tax system on physical presence makes less and less sense. To further complicate the current situation, a significant number of multinational enterprises (MNEs) in recent decades have undertaken aggressive tax planning techniques that have severely limited the taxes they have been paying. Through the OECD’s Inclusive Framework countries at all levels of economic development have participated in confronting both of these current problems by Issuing Pillars 1 and 2. The Pillar 2 provisions have now been anointed as the Global anti-Base Erosion Rules (GloBE rules). While the two pillars are laudable in many respects in their attempt to modernize the international tax system, their impact on developing countries imposes important unresolved questions and challenges for them.

Pillar 1: Digital Economy and Aggressive Tax Planning

Pillar 1 has two elements – Amount A and Amount B. Amount A deals with the digital economy, while Amount B confronts aggressive tax planning involving related-party payments.

Amount A - targeted to come into effect in 2023 - formulates a way to tax MNEs that undertake business in a jurisdiction either without any physical presence or with a very limited one. It levies a tax on MNEs that have revenue exceeding EUR 20 billion and a profit margin in excess of 10% as reported on their financial statements. Jurisdictions having at least Euro 1 million of revenue earned from their market will share in the tax imposed under Amount A (a lower revenue figure is set for smaller jurisdictions). An MNE meeting the revenue threshold will pay a tax on 25% of its profits that exceed the 10% threshold. The resulting tax is to be allocated to the jurisdictions satisfying the Euro 1 million revenue test in proportion to their respective revenues. Importantly, all countries participating in Pillar 1 must remove all digital service type taxes (DSTs) and agree not to impose them again in the future. The exact reach of this important prohibition has yet to be determined.

Amount B - the details of which are to be worked out by the end of 2022 - is designed to deal with the transfer-pricing problem of the charges imposed by MNEs to their foreign subsidiaries and branches for marketing and distribution activities. These charges are to be determined using a set formula thus relieving countries of having to argue over what a proper charge for these activities should be. The exact amount of the charges and on what exactly they will be charged has yet to be set.

Pillar 2: minimum taxation on an MNE’s overseas activities

Pillar 2 has three pieces to it. The first and most important piece is an income inclusion rule (IIR) that imposes a minimum tax on an MNE’s overseas activities. The tax, a so-called “top-up tax”, is to be levied at the rate of 15% by the resident jurisdiction of the parent company of the MNE with respect to any jurisdiction where the combined activities of the MNE are taxed at a rate below 15% on the income reflected on its financial statements (called “GloBE income”). It applies to MNEs having revenues in excess of Euro 750 million, but countries are free to apply the IRR to any size company. The second piece, the undertaxed payment rule (UTPR), denies MNE deductions in low taxing jurisdictions in order to increase its effective tax rate in these jurisdictions to the 15% top up tax rate taking first into account any tax levied under the IIR. The UTPR is complemented and in part superseded by a qualified minimum domestic top-up tax (QMDTT) (discussed below). The final piece is a treaty-based rule that allows source countries to impose a withholding tax at 9% on payments that are taxed below a minimum rate in the jurisdiction where they are received (the STTR). Its imposition will rely on the adoption of a multilateral instrument allowing the tax to override treaty limitations. In order of application, the STTR comes first, the IIR second, and the UTPR, a mop-up rule, last. The implementation of Pillar 2 is targeted to come into effect in 2023.

The IIR includes an adjustment to be made in calculating the tax for substance-based income exclusion. Under the exclusion, net GloBE income is reduced by an amount equal to the sum of 5% of eligible payroll costs and 5% of tangible book assets. However, this amount is not excluded from net GloBE income in calculating the effective tax rate used in computing the IIR tax making for computational complexities.

Recent changes to Pillar 2 will enable countries, including developing countries, to adopt a QMDTT. Essentially, it will let the source country collect the tax that the resident country of a group’s parent company would otherwise collect under the IIR. This rule could prove attractive to both developed and developing countries, although it presents challenging questions related to implementation. The UK and the EC (as part of a draft directive for the EU) have already published proposals to impose their own form of a QMDTT.

The QMDTT is designed, in part, to deal with the situation where a country has a corporate tax rate equal to 15%, but companies doing business there may still incur a top-up tax because of the manner in which the GloBE effective tax rate is calculated. This results from the fact that income excluded from the GloBE tax base through GloBE’s substance-based carveout rule reduces covered taxes but is disregarded in calculating the IIR effective tax rate. As a result, a country that has a material substance-based carve out will need a corporate tax rate higher than 15% to fully exclude the top-up tax that would be charged under the IIR [1]. The QMDTT resolves this problem since by definition it must operate to generate a 15% minimum tax under the facts of the country imposing it.

Developing countries will need to consider carefully how they deal with Pillar 2. While they may have few MNEs incorporated under their law that will be subject to the IRR, they will still need to understand that it may be applied by the parent resident jurisdiction to companies operating in them. To avoid losing revenue to these resident jurisdictions, they can raise their tax rate sufficiently to satisfy the minimum tax rate or more simply, adopt a QMDTT.

Thoughts on Pillar 1

In October 2021, 136 countries agreed to be bound by the Pillar 1 and Pillar 2 proposals. Pillar 1 is intended to be mandatory, while Pillar 2 is left to the discretion of countries to join. Even though Pillar 1 is meant to be mandatory, some countries, most notably the U.S., may have difficulty in getting the needed legislation enacted and the necessary treaty commitments made. Developing countries should probably adopt a wait-and-see approach to the adoption of Pillar 1, adopting it if committed to doing so once the major economies adopt it.

Amount A Although the OECD says that developing countries’ revenue gains are expected to be proportionately greater than the revenue gains for more advanced economies under Pillar 1, not much of the revenue in actual dollar amount produced under Amount A is likely to go to developing countries. Unfortunately, the proposal also puts a ban on DSTs and related taxes that extends to companies not even being taxed under Amount A.

The OECD has indicated that the ban is not meant to prohibit all broad-based taxes on gross revenue, but the dividing line between what is a permissible tax and what is not has been left to be worked out in the future. The likelihood is that taxes falling within the definition of indirect taxes will fall outside of the purview of Amount A. However, these taxes will then be subject to the trade tax rules. The first hurdle under these rules is the moratorium on customs duties on “electronic transmissions” currently in place. This prohibition defies a precise definition as to its reach. The national treatment and most favored nation trade tax rules will also come into play, and the U.S. may launch investigations under Section 301 of the Trade Act of 1974 claiming trade tax violations.

Amount BAmount B presents a better picture for developing countries. If adopted, it could reduce the tax audit burden of these countries. However, there is a significant issue about the scope of charges that will be subject to Amount B. The term “marketing and distribution activities” is vague. There is to be a positive list of functions covered and a negative list of functions not covered, but much of the detail is yet to be determined. Also, the taxable amount is to be based on a return on sales with geographic differences, industry segments, and functional intensity considered. The simplicity of the proposal may get buried under the details of how it operates when these details are finally spelled out.

Thoughts on Pillar 2

Adoption of Pillar 2 appears to have been pushed to the forefront, largely at the instigation of the U.S. The OECD sees much of the benefit to developing countries under Pillar 2 to be indirect – a reduction in tax competition. This will be particularly true if many developing countries adopt a QMDTT. The alternative view is that it effectively reduces the tax sovereignty of developing countries to decide what their tax systems should be. The benefit to developing countries under Pillar 2 would have been greater if the UTPR by itself was given priority over the IIR. The STTR rule is given priority over the IIR, but it will only be effective once the majority of countries adopt the multilateral instrument needed for its implementation, which could take a number of years.

Developing countries will need to carefully assess the impact of Pillar 2 on their tax systems and then decide the best approach to deal with it. For starters, developing countries should not give up tax revenue attributable to businesses operating in their jurisdiction to the resident country of the parent of the MNE operating a business there. This will require an analysis of the effective tax rate of foreign businesses operating in the country and to what extent a low effective tax rate is attributable to any tax incentive they have given. Will a tax incentive meet the substance requirement of Pillar 2? If not, a review of the tax incentive may be warranted. This may require renegotiation of agreements built into investment contracts or the provisions in bilateral investment agreements. Importantly, developing countries can adopt the QMDTT and avoid the application of the IIR, with its shifting of revenues to MNEs’ residence countries, altogether.

Developing countries will also need to think through their strategy on the imposition of withholding taxes. Do they have a robust set of withholding taxes? To what degree are the taxes constrained by tax treaties? Can the treaty provisions dealing with withholding taxes be renegotiated without the benefit of the STTR multilateral instrument? To what degree do the withholding rates exceed the 9% rate proposed under the STTR? These are some of the questions that need to be addressed.

Issues to be Resolved

OverallAll countries will need to assess the impact of both pillars on their existing tax laws. How much revenue may be lost under certain provisions? How much revenue may be gained under others? To what degree can these outcomes be changed by modifying old laws, enacting new ones, or by administrative fiat? This type of careful analysis can help chart the way forward.

Pillar 1 - A large number of developing countries have already agreed to move forward with Pillar 1, assuming it proceeds. Those that have not will want to assess whether becoming a party to its provisions is to their benefit.

For countries participating in Pillar 1, an appraisal will need to be made of whether they wish to supplement the revenue raised from remote business enterprises under Amount A. If the revenue generated under Amount A is small, consideration will need to be given to some form of gross revenue tax that will avoid the DST-tax prohibition of Pillar 1. This will need to be done with an eye to the trade laws that may limit a country’s ability to craft these taxes.

As for Amount B, countries will need to see what items are covered by Amount B. For items so covered, a country’s laws will need to be revised to give priority to the provisions of Amount B. For items not covered, a review of a country’s transfer pricing policies may be warranted, considering the thrust of the provisions incorporated into Amount B.

Pillar 2 - The first issue under Pillar 2 is whether a country should incorporate the IIR under the provisions of Pillar 2. Most developing countries will get little benefit by doing so since the Pillar 2 minimum tax only applies to the offshore operations of MNEs headquartered in a country. Few such enterprises may be headquartered in many developing countries.

The second step for many developing countries will be to review the effective tax rate of the businesses operating in-country. Is the country’s tax rate above the 15% tax rate imposed by the minimum tax? If not, should it undertake a review of its corporate tax law? Even if it is, will corporations that do business in-country still suffer a top-up tax because of the way it is calculated under the Pillar 2 rules? In either case, it may want to enact a QMDTT so that tax revenue is not lost to a residence country. Countries will also want to review any tax incentives they have given under investment contracts or investment agreements. Will the incentives survive scrutiny under the substance-based carveout rules contained in Pillar 2, which focus on assets used in the country and employees located there? If not, can the incentives be modified given that the MNE will be subject to tax on the income earned in the country under a minimum tax imposed by a parent company’s resident jurisdiction?

The third step will be to review a country’s application of withholding taxes. To what degree do the withholding taxes cover all base eroding payments? If the withholding taxes are constrained by a tax treaty, can the treaty be renegotiated early on, particularly considering that this will happen under the STTR multilateral instrument? If a country’s withholding tax rate is above the 9% rate planned for the STTR, a country will benefit by applying its withholding taxes without the need to resort to the STTR. The overall goal of a country’s withholding taxes should be to increase the rate of tax on base eroding payments so that the minimum tax imposed on a parent company has no application.


Irrespective of how a country feels about the merits of Pillar 1 and Pillar 2, they will need to evaluate the impact of the pillars on their tax revenue and tax laws and decide how best to address this impact. The suggestions offered in this blog are not intended to be a comprehensive guide to the necessary review but simply an indication of the direction such a review should take.

In this regard, the ILP is ready to work with other like-minded organizations or independently to assist developing countries in undertaking a preliminary evaluation of the likely impact of Pillar 2 on their tax revenue considering the possible application of the STTR and UTPR. Following this evaluation, we can help with any needed legislative response and any training to implement the changes made to local laws. Although Pillar 1 is likely to come into effect later than Pillar 2, we are also prepared to provide similar assistance with it.

The GloBE effective tax rate is obtained by dividing Adjusted Covered Taxes by GloBE Income, and, if this rate is below 15%, the rate is subtracted from 15% to give the Top-up Tax percentage. The figure for Covered Taxes is reduced by the tax associated with the substance-based carveout. In a jurisdiction that has a 15% corporate tax rate and a substance-based income exclusion, the GloBE effective tax rate will be below 15% resulting in a Top-up Tax percentage because of the subtraction of the tax associated with the income exclusion from Adjusted Covered Taxes.


[1]. The GloBE effective tax rate is obtained by dividing Adjusted Covered Taxes by GloBE Income, and, if this rate is below 15%, the rate is subtracted from 15% to give the Top-up Tax percentage. The figure for Covered Taxes is reduced by the tax associated with the substance-based carveout. In a jurisdiction that has a 15% corporate tax rate and a substance-based income exclusion, the GloBE effective tax rate will be below 15% resulting in a Top-up Tax percentage because of the subtraction of the tax associated with the income exclusion from Adjusted Covered Taxes.


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