Global Minimum Tax: Making Sense Of OECD’s Pillar Two Model Rules
The Organisation for Economic Co-operation and Development has published Model Rules under Pillar Two—Global Anti-Base Erosion or ‘GloBE’ Rules—to help domestic governments implement a 15% global minimum tax on multinational enterprises from 2023.
It is the first step towards the implementation of the historic political agreement reached in October 2021. This marks the transition from consensus to implementation phase. The rules are designed to ensure large multinational enterprises pay a minimum level of tax on the income arising in each jurisdiction where they operate, and provide a template that jurisdictions can translate into domestic law which would assist in the implementation of Pillar Two.
It is not mandatory for countries to adopt GloBE rules. However, if they choose to do so, it is expected that they should implement the rules in accordance with the model rules so that Pillar Two is implemented in a consistent and coordinated manner.
The rules define multinational enterprises within the scope of the minimum tax; set out a mechanism for calculating a multinational enterprise’s effective tax rate on a jurisdictional basis as well as determine the amount of top-up tax payable; and impose the top-up tax on a member of the multinational enterprise group in accordance with an agreed rule order.
Generally, a multinational enterprise and its constituent entities are in scope of the GloBE rules if the annual revenue in the consolidated financial statements of the ultimate parent entity is €750 million or more in two out of the four fiscal years immediately preceding the tested fiscal. Although not specified in the model rules, the October statement provides that jurisdictions are free to apply the Income Inclusion Rule to groups headquartered in their jurisdictions without regard to the threshold.
Income Inclusion Rule
The IIR will be implemented from 2023.
The interlocking nature of these rules ensures that top-up tax must be applied according to a set of ordering rules that begins with IIR.
▸As per the primary rule, the top-up tax will apply to the group’s ultimate parent entity.
▸The backstop or secondary rules will apply if a country where a multinational enterprise is based does not apply the primary rule.
▸Countries that adopt the GloBE rules may also introduce domestic top-up taxes on their own resident taxpayers. This will reduce the amount of top-up tax that may be payable in another jurisdiction, preserving their primary right to tax their own residents.
For purpose of simple illustration, consider a multinational enterprise group that consists of four constituent entities located in jurisdictions A, B, and C.
HoldCo is a tax resident of Country A and is the ultimate parent entity of the multinational group subject to the GloBE Rules.
HoldCo owns directly the shares of B Co (tax resident in Country B).
B Co owns the shares of C Co 1 and C Co 2 (tax residents in Country C) that are subject to a tax rate of 9%.
(This effective tax rate is computed considering all the constituent entities of the multinational group located in country C, using the jurisdictional blending approach.)
As per the GloBE Rules, a top-up tax liability will arise when the effective tax rate of a jurisdiction in which the multinational group operates is below the agreed minimum rate.
In this case, the effective tax rate of constituent entities located in country C is 9%, which is lower than the global minimum rate of 15%, thus, a top-up tax of 6% will be required to be paid by the ultimate parent entity, i.e. the HoldCo in country A, using the IIR. If the IIR is not applied by the HoldCo, the top-up tax will be charged by the group entity which has adopted IIR based on a top-down approach till the immediate parent of the constituent entities in jurisdiction C.
Undertaxed Payments Rule
The Undertaxed Payments Rule applies as a secondary (backstop) rule in cases where the effective tax rate in a country is below the minimum rate of 15% but the IIR has not been fully applied. The UTPR can also apply to low-taxed GloBE income in the ultimate parent entity country, even if that parent country has adopted the IIR.
UTPR will be implemented from 2024. Groups that are newly expanding internationally are exempt from paying top-up tax under the UTPR for up to five years. Such groups must have entities in no more than six countries and the net book value of their ‘international’ tangible assets must not exceed €50 million.
In the above example, if the IIR is not applied even by the immediate parent of the constituent entities in jurisdiction C, then the top-up tax of 6% will be levied by applying UTPR and would be allocated amongst all constituent entities in the multinational group who have adopted UTPR based on the relative share of assets and employees of such entities.
The tax base is the accounting net income (or loss) of each constituent entity as used in the preparation of the ultimate parent entity’s consolidated financial statements (before any consolidation adjustments eliminating intragroup transactions) subject to a variety of adjustments described in the model rules.
The model rules adopt deferred tax accounting as the primary mechanism for addressing timing differences that arise when income or loss is recognised in different years for accounting and tax purposes. As a result, timing differences generally will not result in top-up tax. However, this is subject to a recapture mechanism in respect of certain deferred tax liabilities that do not unwind within five years.
Therefore, even businesses that operate only in ‘high tax’ jurisdictions will need to carefully follow how the model rules are translated into local legislation in the jurisdictions in which they operate to determine if top-up tax is likely to arise in those jurisdictions.
The GloBE rules also address the treatment of acquisitions and disposals of group members, and include specific rules to deal with particular holding structures and tax neutrality regimes. The rules relating to mergers and acquisitions describe how to apply the consolidated revenue threshold to group mergers and demergers, how to treat situations involving constituent entities joining or leaving a multinational enterprise group, how to account for the transfer of assets and liabilities in a re-organisation, and how to apply the model rules to joint ventures and dual-listed multinational enterprise groups.
The rules relating to tax neutrality regimes address the treatment of situations where the ultimate parent entity is subject to a tax neutrality regime, such as:
A tax transparency regime, i.e. where the ultimate parent entity is a tax transparent entity with respect to its income, expenditure, profit or loss to the extent that it is fiscally transparent in the jurisdiction in which its owner is located, or
A deductible dividend regime that yields a single level of taxation on the owners of an entity through a deduction from the income of the entity for distribution of profits to the owners. It also provides special rules in relation to certain distribution tax regimes and for controlled investment entities.
The OECD expects to release a commentary on the model rules in early 2022 and will address the issue of the rules’ coexistence with the U.S. global intangible low-taxed income rules at that time. The OECD then plans to issue an implementation framework dedicated to administrative, compliance, and coordination issues regarding Pillar Two.
The OECD is also working on model rules for the ‘Subject to Tax’ rule as well as on a multilateral instrument for its implementation. Another public consultation event on the ‘Subject to Tax’ model rules and the multilateral instrument will be held in March 2022. In the meanwhile, we will see many Inclusive Framework countries making changes in their domestic law to adopt the GloBE rules.
Shefali Goradia is Partner at Deloitte India.
The views expressed here are those of the author and do not necessarily represent the views of BloombergQuint or its editorial team.