OECD issues detailed rules to implement global minimum tax: a look at the 10 chapters
On December 20, 2021, the OECD published its model rules on the agreed Pillar 2 minimum tax, known as the Global Anti-Base Erosion (GloBE) rules, set out within the OECD Inclusive Framework. The document provides a detailed description of the rules that the jurisdictions under the Inclusive Framework are to implement in their local legislation. Additional guidance on interpreting the rules will be released in early 2022.
The GloBE rules provide the framework for a coordinated multi-country system of taxation intended to ensure large multinational enterprise (MNE) groups pay a minimum level of tax on the income arising in each of the jurisdictions where they operate. When fully implemented, the GloBE rules will impose a top-up tax on profits arising in a jurisdiction whenever the effective tax rate, determined on a country-by-country basis, is below 15 percent.
The model rules are not self-executing. It is expected that countries under the Inclusive Framework, including the US, will adopt implementing legislation in 2022, with a goal of putting the GloBE tax into effect in 2023.
The December 20 rules do not provide specific guidance for how the US Global Intangible Low-Taxed Income (GILTI) tax will be coordinated with the GloBE tax. The current GILTI tax differs from the GloBE tax as (1) GILTI is computed on an aggregate basis rather than country by country; (2) US tax, rather than financial statements, is used to determine the GILTI; (3) the GILTI is determined on a yearly basis, without adjusting for timing differences; and (4) the effective GILTI tax rate of 10.5 percent is below the agreed GloBE minimum effective tax rate of 15 percent.
The OECD model rules are broken down into ten separate chapters, which are summarized below.
Chapter 1: Scope
MNE groups are in scope if the revenue in their consolidated financial statements exceeds EUR750 million, based on two of the four fiscal years immediately preceding the tested fiscal year. Taxpayers that either have no foreign presence or that have less than EUR750 million in consolidated revenues are not in scope of the model rules. Constituent entities are group entities that are subject to the operative provisions of the GloBE rules. The term comprises all entities included in a group as well as permanent establishments (PEs). Any PE that is a constituent entity is treated as a separate constituent entity from the main entity and any other PE of the main entity.
The Pillar 2 rules do not apply to government entities, international organizations and nonprofit organizations, nor do they apply to entities that meet the definition of a pension, investment or real estate fund (therefore preserving the widely shared tax policy of not wishing to add an additional layer of taxation between the investment and the investor). These entities are excluded even if the MNE group they control remains subject to the rules.
Chapter 2: Determination of the group entity liable for the top-up tax
Chapter 2 addresses the two provisions used to determine the top-up tax for a member of an in-scope MNE group. The primary rule is the Income Inclusion Rule (IIR). Under the IIR, the ultimate parent entity (ie, the entity at the top of the ownership chain of the MNE group) is primarily liable for the top-up tax of all low-tax constituent entities, in proportion to its ownership interests in those entities that have low-taxed income.
When the ultimate parent entity has not implemented a qualified IRR rule, either the next intermediate parent entity in the ownership chain or a partially owned parent entity (ie, with more than 20 percent of the ownership interests held by non-group members) will be allowed to apply the IRR to minimize any possible leakage along the chain.
Top-up tax is attributed to parent entities in proportion to their allocable share, which is determined based on a parent entity’s inclusion ratio (ie, the share of the profits of the low-taxed entity attributable to that parent entity on the basis of accounting standards). In addition, if several parent entities are liable for the top-up tax under the IIR in respect of the same low-taxed constituent entity, the parent entity that is higher in the ownership chain shall reduce its top-up tax by the amount being paid by a lower-tier intermediate parent entity or partially owned parent entity.
If there is no charge under an IIR among any of the entities of the ownership chain of the low-taxed constituent entity, the residual top-up tax is levied through application of the Undertaxed Payments Rule (UTPR). The UTPR functions as a backstop rule, needed to ensure that the minimum tax is paid. This rule provides for an adjustment, such as a denial of a deduction, that increases the tax at the level of the constituent entity making a payment to a low-taxed constituent entity. The adjustment is an additional tax expense equal to the amount of the top-up tax remaining after the IIR is applied. The share of the top-up tax between different constituent entities making deductible payments to the low-taxed constituent entity is calculated by applying a two-factor allocation key based on (i) the net book value of tangible assets held and (ii) the number of employees employed by all the constituent entities located in such UTPR jurisdictions. This helps to ensure the rule is administrable, but it also applies the adjustment to entities that are most likely able to pay the required amount of top-up tax.
Chapter 3: Computation of GloBE income or loss
In order to determine the top-up tax allocable to each of the constituent entities, the income (Chapter 3) and the allocable taxes (Chapter 4) for each of the constituent entities must be determined per the GloBE rules. The GloBE rules provide for their own concepts to determine the income and the applicable taxes.
The financial statements, as prepared under the accounting standards of the group’s parent entity, act as the starting point to determine the income or loss of a constituent entity for the purpose of the GloBE rules. This implies that each separate constituent entity as well as every permanent establishment of a multinational group must have standalone financial statements prepared in the parent entities’ accounting standard. If that is not possible, constituent entities may use a different accounting method if certain conditions are met.
The guidance provides for a number of adjustments to the income or loss in the financial statements in relation to permanent differences between tax and financial statement reporting, such as (i) adjustment of tax expenses, (ii) exclusion of tax exempts dividends and (iii) exclusion of tax-exempt capital gains.
Furthermore, the guidance allows for stock-based compensation expenses to qualify as as a deductible item for GloBE purposes. It additionally requires non-arm’s-length transactions between group entities to be adjusted to arm’s-length conditions. Among other things, the guidelines state that qualified refundable tax credits will be considered income for GloBE purposes, and gain in relation to the sale of a tangible asset may be allocated to the year of the disposition or spread out pro rata over the period of ownership.
Permanent establishments must prepare separate financial statements. In case a permanent establishment suffers a GloBE loss, the loss will be attributed to the main entity and recaptured with future profits of the permanent establishment. For flow-through entities, the income or loss will, in principle, be allocated to its owners based on interest percentages. If the flow-through entity is the top parent entity of the group, the income will be allocated to the flow-through entity itself, requiring standalone financials to be prepared for the flow-through entity.
Chapter 4: Computation of adjusted covered taxes
In order to determine the amount of taxes allocable to a constituent entity, Chapter 4 provides a multistep approach. The current-year tax expense outlined in an entity’s financial statements with respect to covered taxes acts as a starting point. Covered taxes include a wide range of taxes, including corporate taxes, taxes on distributed profits and taxes on retained earnings and corporate equity. The current-year tax expense is reduced for taxes that relate to income that is excluded from financial statements for GloBE purposes (see Income section above). Interestingly, the current-year tax expense is also reduced for the current-year tax expense related to uncertain tax positions for financial statement purposes.
Covered taxes may need to be re-allocated to other constituent entities, such as permanent establishments, flow-through entities and hybrid entities. Further, CFC taxes levied at the level of a constituent entity are re-allocated to the CFC constituent entity. The same goes for taxes on distributed profits (ie, dividend withholding taxes), which are re-allocated to the parent company of the distributing entity.
Finally, the guidelines provide for guidance with respect to the mechanism used to address temporary differences. The starting point is the deferred tax expense accrued in the entity’s financial statements but capped at the minimum rate. Certain exclusions and adjustments to the financial statement deferred tax expense are provided for in the model rules.
Chapter 5: Computation of effective tax rate and top-up tax
Chapter 5 provides formulaic and fairly complex rules related to the computation of the ETR per jurisdiction and the determination of any top-up tax for the year. If a top-up tax is determined to apply with respect to a low-taxed jurisdiction under these rules, such tax will be allocated to each of the constituent entities within the low-taxed jurisdiction in proportion to their contribution to GloBE income.
Steps for determining ETR and computing the top-up tax
- The ETR is determined on a jurisdiction-by-jurisdiction basis by dividing the aggregate amount of covered taxes imposed in a jurisdiction by the aggregate amount of GloBE income within the same jurisdiction. Basically, the GloBE income and covered taxes of all constituent entities within the jurisdiction are aggregated.
- Subsequently, the top-up percentage is the difference between the ETR and the minimum rate (ie, 15 percent).
- The top-up percentage is then applied to the GloBE income within the jurisdiction after reducing it by the substance-based income exclusion (the provision is akin to, although broader than, QBAI within the GILTI determination). Generally, the substance carve-out excludes from the GloBE tax base a certain amount of income calculated by reference to a fixed return on assets and payroll expenses in each jurisdiction. The amount of the exclusion is equal to the sum of (i) 8 percent of the carrying value of tangible assets located in the jurisdiction and (ii) 10 percent of the payroll costs for employees that perform activities in the jurisdiction, with both exclusions declining to 5 percent over time.
- The resulting amount is further reduced by the amount of any qualified domestic top-up tax – a tax imposed under the domestic law of a jurisdiction and whose characteristics are equivalent to the GloBE rules. Notably, the clearest example of a potential qualified domestic minimum top-up tax may be the US GILTI – at least, the version of the GILTI that is currently being considered by Congress. In addition, a de minimis exclusion applies for operations in a jurisdiction that are below EUR1 million in income and EUR10 million in revenue.
- Finally, the top-up tax is allocated to the constituent entities in the low-taxed jurisdiction based on its proportion of GloBE income within the jurisdiction.
Taxpayers that have engaged in corporate restructurings and holding structures during the fiscal year are encouraged to consider the rules in Chapter 6. This chapter contains rules relating to acquisitions, disposals, joint ventures and multi-parented MNE groups.
Mergers and demergers
For the purposes of the rules in Chapter 6, any arrangement will qualify as a merger where an entity that is not a member of a group or all (or substantially all) of the group entities of two or more separate groups are brought under common control so that they constitute group entities of a combined group. Where the group entities of a single group are separated into two or more groups that are no longer consolidated by the same ultimate parent entity, it will qualify as a demerger for the purposes of the rules of Chapter 6.
The following rules will determine whether the consolidated revenue threshold as per article 1.1. shall apply to group mergers and demergers:
If two or more groups merge to form a single group in any of the four fiscal years prior to the tested fiscal year: the consolidated revenue threshold of the MNE group for any fiscal year prior to the merger is deemed to be met for that year if the sum of the revenue included in each of their consolidated financial statements for that year is equal to or the greater than EUR 750 million. The same threshold and principle shall apply if an entity that is not member of a group (ie, target) merges with an entity or group (ie, acquirer) in the tested fiscal year.
Where a single in-scope MNE group demerges into two or more groups (each a demerged group), the consolidated revenue threshold is deemed to be met by the demerged group with respect to the (i) first tested fiscal year ending after the demerger, if the demerged group has annual revenues of EUR750 million or more in that year; (ii) to the second and fourth tested fiscal years ending after the demerger, if the demerged group has annual revenues of EUR750 million or more in at least two of the fiscal years following of the demerger.
For the purposes of the GloBE rules, the acquisition or disposal of a controlling interest in a constituent entity will be treated as an acquisition or disposal of assets and liabilities if (1) the jurisdiction in which the target constituent entity is located treats the acquisition or disposal of that controlling interest in the same or similar manner as an acquisition or disposition of assets and liabilities and (2) imposes a covered tax on the seller based on the difference between the tax basis and the consideration paid in exchange for the controlling interest or the fair value of the assets and liabilities.
Transfer of assets and liabilities
In case of transfer of assets and liabilities, a disposing constituent entity must include the gain or loss resulting from the disposal in the computation of its GloBE income or loss. An acquiring constituent entity will determine its GloBE income or loss by using the carrying value of the acquired assets and liabilities determined under the accounting standard used in preparing consolidated financial statements of the ultimate parent entity. This rule shall not apply if the disposition or acquisition of assets and liabilities is part of a GloBE reorganization (as defined in Chapter 10), nor will it apply if the transfer of assets and liabilities is part of a GloBE reorganization in which a disposing constituent entity recognizes non-qualifying gain or loss.
With respect to transfer of assets between constituent entities after November 30, 2021 and before the commencement of a transition year, when an MNE group enters within the scope of the GloBE rules, the transition rules of Chapter 9 clarify that the basis in the acquired assets shall be determined based on the disposing entity’s carrying value of the transferred assets.
For purposes of computing the top-up tax of a joint venture and its JV subsidiaries, the GloBE rules shall apply as if the JV subsidiaries were constituent entities of a separate MNE group and as if the joint venture were the ultimate parent entity of that group. A parent entity that holds (directly or indirectly) ownership interests in the joint venture or a JV subsidiary shall apply the IIR with respect to its allocable share of the top-up tax of a member of the JV group. The top-up tax of the JV group shall be reduced by each parent entity’s allocable share of the top-up tax of each member of the JV group that is brought into charge under a qualifying IIR, and any remaining amount shall be added to the total UTPR top-up tax amount taken into account under Article 2.5.1.
This chapter contains a number of special rules that apply to a relatively narrow range of taxpayers subject to special tax regimes. Articles 7.1 and 7.2 provide special rules in relation to ultimate parent entities that are subject to tax neutrality regimes (such as a tax transparency regime or a deductible dividend regime). Further special rules will apply in case of certain tax regimes that subject an entity to tax on its earnings when those earnings are distributed or deemed distributed. Finally, the chapter contains special rules in relation to controlled investment entities that seek to preserve the tax neutrality of these entities without giving rise to any leakage under the GloBE rules.
Chapter 8 provides an internationally coordinated approach to administering the rules. This includes a standardized information return to facilitate the coordination of compliance and reduce burdens on taxpayers, as well as mechanisms to avoid duplicative reporting and the scope to release coordinated guidance on the application of the rules in practice.
The chapter additionally provides for the possibility of safe harbors that would reduce administrative burdens, where particular operations of an MNE are likely to be taxable at or above the minimum rate of 15 percent on a jurisdictional basis. The final design of any safe harbors as well as other aspects of administration, compliance and coordination will be developed further in consultation with the business and stakeholders and reflected in the Implementation Framework, to be released in 2022.
The transition provisions in Chapter 9 take existing tax attributes into account, including all pre-existing tax losses, to simplify the application of the rules and reduce compliance burdens when an MNE first comes into scope of the Pillar 2 model rules. As a principal rule, when determining the effective tax rate for a jurisdiction in a transition year (and for each subsequent year), the MNE group shall take into account – at the lower of the minimum rate or the applicable domestic tax rate – all deferred tax assets and deferred tax liabilities reflected or disclosed in the financial accounts of all constituent entities in a jurisdiction for the transition year.
Chapter 9 additionally provides a limitation of the application of the UTPR when an MNE is in its initial phase of expanding abroad. The transition rules also provide a phased introduction of the rules through a gradual reduction of the substance-based income carve-out over the first ten years of Pillar 2.
The final chapter provides definitions for the terms used in the previous chapters.
IN CASE YOU MISSED
Our Global Tax Reform hub houses related articles covering developments in global tax legislation.