A tale of two Pillars | International Tax Review Page 1 of 10

Transfer Pricing

A tale of two Pillars

Julien Pellefigue of Deloitte Société d’Avocats explains the importance of pillars one
and two and the impact on transfer pricing.

Sponsored by

By Julien Pellefigue
May 12 2022

https://www.internationaltaxreview.com/article/b1xzwp74fw2xxv/a-tale-of-two-pillars 27/05/2022
A tale of two Pillars | International Tax Review Page 2 of 10

Sponsored by

By Julien Pellefigue
May 12 2022

After a lot of suspense, it looks like the big OECD driven tax revolution will finally become a reality in the

https://www.internationaltaxreview.com/article/b1xzwp74fw2xxv/a-tale-of-two-pillars 27/05/2022
A tale of two Pillars | International Tax Review Page 3 of 10

This organisation of industry gradually changed as the world entered the second globalisation wave.
With the drop in transportation costs, the improvement in information technology and the fade out of
regulatory barriers (tariffs and capital account liberalisation), firms started to realise they could reduce
their cost structure significantly by splitting their production process into individual steps and locating
each step in the most appropriate country (low wage countries for labour intensive steps, etc.)

This fragmentation of the production process completely changed the shape of the global economy to the
point that, now, the production of pretty much any consumer good involves dozens of steps located in
dozens of countries interconnected within global value chains, and intermediary products being
transported over thousands of kilometres.

Another consequence of the second globalisation wave is the massive development of multinational
entreprises (MNEs), which became coordinators of almost all value chains. MNEs were very small in the
70s but they have grown much faster than the economy. Today they account for a third of worldwide
GDP and they control 50% of international trade. Two other numbers are relevant for the purposes of
this paper:

Collectively, MNEs generate a consolidated annual taxable profit of around $9 trillion, which represents
a tax revenue of around $2 trillion, while most Corporate Income Tax (CIT) revenue of OECD countries
actually comes from MNEs;
In a normal year, MNEs make foreign direct investment (FDI) of around $1.5 trillion. For developing
economies, this can represent up to 40% of their total gross capital formation.

From national tax monopoly to international tax competition

For a long time, states enjoyed a fiscal monopoly. Whatever innovative new tax they enacted, taxpayers –
including firms – had no (legal) choice other than paying. With globalisation, the balance of power has
been turned upside down and MNE have become so large that they can have states compete to attract
them to their jurisdictions.

Yet, in a world where direct state interventions are generally prohibited, the most obvious tool to attract
the MNEs is the tax lever, specifically reducing the corporate tax rate they would have to pay.

Using a pastry metaphor for international tax competition, MNEs represent two big pies: one taxable
profit pie and one investment pie. States are competing, under the current rules of the tax game, to have
the bigger share.

https://www.internationaltaxreview.com/article/b1xzwp74fw2xxv/a-tale-of-two-pillars 27/05/2022
A tale of two Pillars | International Tax Review Page 4 of 10

The intensity of tax competition has increased over the past 30 years, so much so that one could even
talk about a tax war. Ireland is a good example of a winner of that war. Decreasing its statutory CIT rate
from 50% to 12.5% enormously increased the flows of inward FDI, from $100 million in the 1990s to
$1.2 billion at the end of the 2010s. Maybe more surprisingly, that move also multiplied its CIT revenue
by almost three, from 1.8% to 5% of its GDP.

This rather counterintuitive result can be explained by a base effect offsetting the rate effect: the decrease
in the tax rate led MNEs to allocate significantly more profit to their Irish subsidiaries, which more than
compensated for the lower rate. All in all, the Irish GDP per capita compared to the UK GDP per capita
rose from 60% in the 90s to almost 200% now. The same story could be more or less told for other
investment hubs, like Luxembourg (the only large country in Europe where GDP per capita is higher
than Ireland).

Things get political, finally

The tax war also had severe consequences for the losers, particularly in Europe, the US and some
developing states. Rich countries lost inward FDIs and a taxable base, but in addition, they had to reduce
their CIT rate to limit the erosion effect. As public spending continued to rise in the same period, states
had to find new sources of revenues and they generally chose to increase the tax on consumption, which
was a less mobile base.

“The work of the OECD concerning the two pillars is probably the most
important piece of international policy that has been put together in the recent
past.”

As a result, the worldwide average CIT rate dropped from 40% in 1981 to 23% in 2020, while VAT rates
increased from 18% to 20% over the same period. As capital tax is mostly borne by the richest
households whereas VAT is paid by everyone, the tax mix in OECD countries generally became more
regressive as a result of the international tax war.

The turning point of the story took place in the aftermath of the 2008 financial crisis. A famous 2012
article (which won the Pulitzer Prize) in the New York Times took the topic of international tax out of the
muffled atmosphere of academia and international organisations and brought it into the wider public

https://www.internationaltaxreview.com/article/b1xzwp74fw2xxv/a-tale-of-two-pillars 27/05/2022
A tale of two Pillars | International Tax Review Page 5 of 10

The notion that large multinationals were evading tax resonated very strongly with the middle class in a
number of rich countries. And this is easily understandable as the members of that class have been the
big losers of globalisation – their net revenue stagnated in real terms between the 1980s and now, while
they have suffered from the politics of fiscal austerity that were put in place, and from the more
regressive nature of the tax mix they were facing.

Politicians finally realised that they could use public resentment against MNEs and globalisation as a
trumpeted cause in their campaigns, and the topic of tax reform left the administrative realm to become
political. It is probably this political drive that explains the success of the two pillars proposal, whereas
all previous attempts at reform, which lacked such support, failed – like the original CCCTB directive in
Europe.

Enter the two pillars (of wisdom?)

The story is ultimately rather simple: rich countries realised that they were losing too much revenue,
investments and public goodwill from tax competition. Tax competition was made possible by the
current international tax regime, so they decided to change that tax regime.

Two things particularly needed revision: (i) the ability of states to attract MNEs with low tax rates should
be curbed, and (ii) the rules should be updated to better allocate the profit generated by the ‘digital
economy’ (that’s to say, allocate more profit to rich countries that have a large consumption base).

The two pillars can be seen as ways to implement that programme. Pillar two aims to limit the intensity
of tax competition by imposing a de facto minimum CIT rate of 15% worldwide. Pillar one aims to
allocate more taxable profit to ‘market economies’ by modifying the transfer pricing (TP) rules.

While pillar one was originally designed to tackle the specificities of the digital economy, as the US
strongly objected to a tax specifically targeting ‘digital’ companies, its scope was extended, from digital
MNEs to the largest and most profitable MNEs from many sectors.

As of today, two questions remain: (i) will the two pillars globally be turned into positive law? And (ii)
will they ultimately achieve the objective that was ascribed to them? A number of academic studies have
been produced recently on that topic, which helped us propose the following analysis:

Despite the recent opposition of some European countries, it is now almost certain that pillar two will be
turned into a directive in Europe and incorporated into the positive law of a large number of countries by
2024. As to its efficiency, that depends on whether one looks at taxable base or investments.

https://www.internationaltaxreview.com/article/b1xzwp74fw2xxv/a-tale-of-two-pillars 27/05/2022
A tale of two Pillars | International Tax Review Page 6 of 10

It does not mean that it will reduce all incentives to structure operations so as to allocate more taxable
base to states with a 15% CIT rate (15% is still significantly less than the average tax rate in OECD
countries) but it will stop the race to the bottom and it will presumably reduce the total amount of profit
allocated in low tax jurisdiction. The most serious estimates however show a limited macroeconomic
effect of the measure (eg 3% of CIT increase in France, according to a study by Parenti and Toubal).

For the competition to attract investments on the other hand, it is likely that the effects of pillar two will
be completely marginal. In the current state of the world, it would be somewhat naïve to imagine that
countries will stop trying their best to attract the investments of MNEs because of pillar two. They will
simply stop using CIT rates and switch to other instruments.

This has already started as certain states that have increased their CIT rate to 15% publicly mentioned
that they didn’t need the money and were willing to give it back to firms as subsidies. Other strategies
exist: CIT is a small portion of the total taxes paid by firms, decreasing the production taxes or SSC
would also be a very attractive measure that could be used by states to attract investments.

Pillar one is a completely different animal. We don’t have yet the final version of the proposal, but the
complexity of the rules is such that it is still uncertain whether it will be fully enacted. Even if it is, it
concerns so few firms (with the current size threshold) that its impact on the allocation of the tax base
should be very limited, save for the US according to a study by Devereux.

“If we want everything to remain as it is, everything must

change”
Despite all the talk about a revolution, it seems that, even if the two pillars will put a stop to the CIT race
to the bottom, they will only marginally change the international allocation of the tax base. And these
results will be obtained at an extremely high cost for firms, as the complexity of the new rules is
extraordinary, even from tax practitioners’ standards.

Based on this conclusion, one could be tempted to downplay the importance of the reform. That would
however be very wrong, because the new tax framework is likely to have an incredibly important impact
outside of the tax world. As mentioned at the beginning of this article, the current global industrial
organisation is based on fragmented processes where the production of any good involves many
international transactions of intermediary product moving from one step of the value chain to the next.

Such an organisation requires a total absence of tax friction on international transactions: in particular
no customs duty and no double taxation of the profit. There are so many steps in a given value chain, that
if each step were to be taxed, the total taxes would quickly exceed the overall profit and it would make

https://www.internationaltaxreview.com/article/b1xzwp74fw2xxv/a-tale-of-two-pillars 27/05/2022
A tale of two Pillars | International Tax Review Page 7 of 10

After the failure of the BEPS project (a failure for TP, it was a success in many other areas), there was a
serious risk that the global consensus on international taxation, based on the arm’s-length principle,
would collapse.

States would have then started to make unilateral decisions on international taxation (DSTs are a good
example of that), and the multiple taxations that would have arisen would have quite simply broken the
international production system, with potentially unfathomable economic consequences.

So, it could be argued that what was really at stake with the tax reform was the creation of a new
international consensus on taxation, that would avoid multiple taxation, so that the international
production infrastructure could be maintained. In other words, a tax revolution had to be made so that
the globalised production infrastructure remains the same, hence the title of this chapter (an excerpt
from The Leopard by Lampedusa).

Whatever one thinks of the current globalised economy, and its impact on the environment, the work of
the OECD concerning the two pillars is probably the most important piece of international policy that
has been put together in the recent past.

Click here to read all the chapters from ITR's TP Special Focus

Julien Pellefigue

Partner
Deloitte Société d’Avocats
T: +33 1 55 61 79 72
E: jpellefigue@avocats.deloitte.fr

Julien Pellefigue is an economist with around 20 years’ consulting experience

focusing on the application of quantitative methods to tax and legal matters.

With Deloitte, Julien is mostly involved in the economic side of transfer pricing,
particularly dealing with litigation support, profit splits, cost sharing agreements
and intangible valuation. He also has an activity of public policy analysis, having
recently performed studies on the withholding of personal income tax in France,
on the impact of the French digital service tax, on the efficiency of the anti-COVID
measures etc.

Aside from his consulting activity, Julien is an associate professor at the

University Paris II CRED (Centre for law and Economics). He has published many
academic articles on international tax and has been part of the expert panel

https://www.internationaltaxreview.com/article/b1xzwp74fw2xxv/a-tale-of-two-pillars 27/05/2022
A tale of two Pillars | International Tax Review Page 8 of 10

The material on this site is for financial institutions, professional investors and their professional advisers. It is for information
only. Please read our Terms and Conditions and Privacy Policy before using the site. All material subject to strictly enforced
copyright laws.

© 2021 Euromoney Institutional Investor PLC. For help please see our FAQ.

https://www.internationaltaxreview.com/article/b1xzwp74fw2xxv/a-tale-of-two-pillars 27/05/2022
A tale of two Pillars | International Tax Review Page 9 of 10

https://www.internationaltaxreview.com/article/b1xzwp74fw2xxv/a-tale-of-two-pillars 27/05/2022
A tale of two Pillars | International Tax Review Page 10 of 10

https://www.internationaltaxreview.com/article/b1xzwp74fw2xxv/a-tale-of-two-pillars 27/05/2022