17 March 20227 minute read

OECD releases commentary on the Pillar Two GloBE Rules – observations on selected topics

The OECD has published its long-awaited technical commentary, together with illustrative examples, explaining the application and practical implementation of the Global Anti-Base Erosion (GloBE) Model Rules under Pillar Two released in December 2021.

In the same release on March 14, 2022, the OECD initiated a public consultation seeking input from interested parties on the Implementation Framework, which shall facilitate the coordinated implementation and administration of the GloBE rules. Stakeholders’ input, to be provided by April 11, 2022, will be critical for the OECD in identifying efficient rule coordination and preserve consistent outcome for multinational companies that avoid the risk of double taxation.      

Just one day after this release, the EU finance ministers publicly discussed the EU proposal for a Directive on ensuring a global minimum level of taxation for multinational groups in the EU (the Pillar Two Directive).

The new compromise text introduces the following key changes to the initial EU proposal:

  • The deadline for transposition of the rules is extended to December 31, 2023, meaning that the IIR would enter into effect for fiscal years starting on or after December 31, 2023 instead of January 1, 2023, as initially proposed, and the UTPR for fiscal years starting on or after December 31, 2024.
  • Member states in which there are fewer than 10 parented groups in scope of Pillar Two can choose not to adopt the IIR and UTPR until 2025.

The EU finance ministers aim to formally adopt the Pillar Two Directive during their next meeting on April 5, 2022. 

Generally, the commentary provides in-depth technical guidance about the Model Rules, including the scope of the rules, the rule order, the computation of the GloBE income or loss and adjusted covered taxes, the calculation of the GloBE effective tax rate and top-up tax, compliance instructions and transition rules. The commentary also covers how the rules will work in the context of corporate restructuring and for holding structures as well as how they will interact with tax neutrality and distribution regimes.

Here are six topics found in the commentary which have particular relevance for multinational companies and other stakeholders:

1. Income Inclusion Rule and GILTI compliance

In the absence of legislative progress in the US with respect to the US GILTI rules, the commentary remains silent on guidance around the compatibility of GILTI with the GloBE rules. The commentary does, however, provide details on the definition of a qualifying Income Inclusion Rule. A Qualified Income Inclusion Rule refers to a set of rules that is implemented in the domestic law in accordance with the GLoBE Rules. Further, the commentary indicates that additional guidance will be provided outlining a process to assist jurisdictions to determine if they had introduced a Qualified Income Inclusion Rule.

2. The Income Inclusion Rule and CFC rules

It is intended that the GloBE Rules will apply after the application of the Subject to Tax Rule and domestic tax regimes, including regimes for the taxation of CFCs. Taxes paid on income arising in a jurisdiction, including under CFC regimes, are taken into account for purposes of computing the GloBE effective tax rate in that particular jurisdiction. In other words, taxes that a country applies to offshore income of a domestic company's CFC are generally allocated to that foreign entity, essentially increasing the effective tax rate of the CFC.

While the Income Inclusion Rule is similar to CFC rules, it still could be significant even where groups are already subject to CFC rules.

As mentioned above, the commentary does not clarify whether the US GILTI would be considered a CFC tax regime under the Pillar Two rules in case the proposed changes to GILTI, which would align the regime with the Income Inclusion Rule, are not passed by the US Congress.

3. Qualified Domestic Minimum Top-Up Tax

The Qualified Domestic Minimum Top-Up Tax provides a low taxed jurisdiction with the primary taxing right over the top-up tax.  As a result, the Qualified Domestic Minimum Top-Up Tax precedes the Income Inclusion Rule.  It is expected that many jurisdictions will safeguard their right to levy their local top-up tax by introducing a qualifying domestic top-up tax. As an example, Switzerland proposed introducing such a tax in its recently released guidance to the implementation of Pillar Two in Switzerland.

4. Pre-regime losses – tax attributes upon transition

The Model Rules addressed the treatment of pre-regime loss carry-forwards indirectly through a transition rule that would take existing deferred taxes into account as the approach to dealing with timing differences.

The commentary confirms this approach and does not seem to introduce any limitation to the carry-forwards. In this respect the commentary reinforces a principle originally stated in the Blueprint, that “failure to take appropriate account of operating losses that the MNE Group has incurred in the period(s) prior to becoming subject to the GloBE Rules could result in a distorted picture of the MNE Group’s tax position in that jurisdiction and may subject the MNE Group to taxation in excess of its economic profit.”

5. Currency conversion

The commentary explains why euros are used to set the GLOBE thresholds and recommends that jurisdictions use euros when implementing the new rules in their domestic law. However, if a jurisdiction faces legal or practical impediments to using a foreign currency when setting its own monetary thresholds, it may provide for a threshold in its domestic currency. In such a case, the respective jurisdiction should re-base the local currency threshold each year based on a consistent methodology to minimize the difference between the local threshold and those set by other countries.

The same principle shall apply for an MNE group that prepares its consolidated financial statements in a currency that is different from the one set by the domestic legislation. The MNE group must convert the relevant amounts into local currency using an agreed methodology that provides a level playing field for MNEs and maximizes consistency in outcomes across jurisdictions.

6. Refundable and non-refundable tax credits

An issue for many companies that will be subject to the GloBE Rules is the treatment of tax credits in the computation of the 15 percent minimum tax rate per jurisdiction. After the publication of the Model Rules back in December 2021, a number of business organizations submitted comments on the provision in the Model Rules that allows for an adjustment to take only refundable tax credits into account in computing the effective tax rate. The comments noted that because the UTP no longer required that there be a transaction between two related parties before the UTP could apply, many US and other country ultimate parent entities that incur large R&D expenses could fall below the effective minimum tax rate in their home jurisdiction, since R&D credits are non-refundable in the US and many other countries. The commentary does not respond to these comments and only treats refundable credits as being qualified for purposes of computing the minimum effective tax rate.

A toolkit for the international tax community

With this release of the OECD commentary, the international tax community essentially has at its disposal the toolkit and guidance to assess the material tax impacts of the Pillar Two rules.   

Learn more about the implications of the commentary by contacting any of the authors or your usual DLA Piper relationship attorney.

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