The OECD’s two-pillar solution to address the tax challenges arising from the digitalisation of the economy is continuously evolving.
The solution is made up of:
- Pillar One – under which taxing rights over 25% of the residual profit (defined as profit in excess of 10% of revenue) of the largest and most profitable MNEs would be re-allocated to the jurisdictions where the customers and users of those MNEs are located.
- Pillar Two – provides for a global minimum tax of 15% for MNEs with a global annual turnover of over €750 million.
The OECD is currently progressing through different phases of public consultations on Pillar One. These public consultations are expected to continue until mid-2022. The OECD’s timetable for implementation of Pillar One is scheduled for 2023, however, uncertainty as to the final content and timeframe remains.
As referred to above, Pillar Two aims at introducing a common approach for a global minimum effective tax rate of 15% applicable to multinational enterprises (MNEs) with a global annual turnover in excess of €750m. The OECD is expected to publish three sets of guidance under Pillar Two.
The first set of guidance, the Model Global Anti-Base Erosion (“GloBE”) rules, were published on 20 December 2021 and cover the income inclusion rule (IIR) and the undertaxed payments rule (UTPR).
The main takeaways from the Model Rules are: -
- The rules apply to constituent entities that are members of an MNE group with annual global revenue of €750m or more in the consolidated financial statements in at least two of the immediately preceding four fiscal years;
- Certain excluded entities including pension and investment funds are not subject to the GloBE rules;
- A “constituent entity” includes an entity that is excluded from consolidated financial statements solely on the grounds of size or materiality or that it is held for sale;
- The Model Rules focus on the application of the IIR and UTPR. The calculation of GloBE income will be primarily based on the financial accounting net income or loss determined for a constituent entity in preparing consolidated financial statements of the ultimate parent entity.
- The total top-up tax amount will be calculated for each low-taxed constituent entity of an MNE group. Further guidance on this is expected;
- Specific treatment applies to permanent establishments and flow-through entities;
- An exclusion will be available for income that is at least 5% of the carrying value of tangible assets and payroll, known as substance-based income. A transition period will initially exclude 8% of the carrying value of tangible assets and 10% of payroll, declining gradually over a ten-year period to 5%;
- A de minimus exclusion applies for jurisdictions where the MNE has revenues of less than €10m and profits of less than €1m;
- Exclusion from the UTPR will be allowed in the initial phase of an MNEs international activity, that is, for the fiscal year, the following conditions are met: -
- the MNE group has constituent entities in no more than six jurisdictions;
- the sum of the netbook values of tangible assets in all constituent entities located in five of those jurisdictions does not exceed €50m; and
- the MNE group has been within the scope of the GloBE rules for no more than five fiscal years.
The Model Rules are complex and further guidance is expected on key concepts in due course. Excluded from the Model Rules were details on the Subject to Tax Rule (STTR). The STTR provides for withholding tax on payments included on a defined list (e.g., interest, royalties), from developing countries. Details on this rule are expected to be released in early to mid-2022.
Other challenges lie ahead of Pillar Two implementation, particularly regarding its co-existence with the US GILTI rules. The US GILTI rules are linked to the Build Back Better Act, which did not pass the US Senate in 2021. To date, discussions regarding tax reform, particularly the GILTI rules, are still underway. The main concern is that the GILTI rules are not currently determined on a jurisdiction-by-jurisdiction basis and would apply a (nominal) effective rate of tax of 10.5%. As a result, it is not clear whether other countries will agree to US GILTI co-existence.
In light of the complexities involved, timing in relation to the introduction of the new rules is currently uncertain. The earliest timeframe being considered is for the rules to be effective in 2023 for the Income Inclusion Rule (IIR) and 2024 for the Undertaxed Payments Rule (UTPR).
If you have any questions in relation to the above, or if you would like to discuss this topic further, please contact a member of the Mazars corporate tax team.
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