29 November 2022
Plans are at an advanced stage for a new global minimum tax rate of 15% for large multinational enterprises. The OECD, supported by the G7, G20 and the Inclusive Framework of almost 140 countries, has released detailed model rules for ‘pillar two’ of their efforts to reform the international tax system.
A meeting of the Inclusive Framework at the start of October 2022 reaffirmed its intention to introduce pillar two, focusing on those aspects of the rules coming into force from 2024.
Lawmakers have started the process of adopting domestic pillar two rules, and the UK government published its proposed legislation for public consultation this summer. Although Hungary is currently withholding support for a directive requiring all EU member states to have legislation in place before the end of 2023, France, Germany, Italy, the Netherlands, and Spain are pressing ahead with their own independent implementation plans.
The proposed new rules are complex and could increase the global effective tax rate for certain businesses. However, the intent to introduce them remains clear and businesses should, therefore, be planning action now.
A brief recap
Pillar two will apply to multinational enterprises with consolidated annual global revenues exceeding €750m in at least two of the last four years (subject to certain exclusions). This is broadly the same threshold as applies for country-by-country reporting requirements, but with important differences in how it is tested.
The rules provide a methodology for determining the relevant profits of group entities in a jurisdiction, together with related covered taxes. These figures are then aggregated, and the effective tax rate in each territory is then compared to the global minimum rate of 15%. Any shortfall will give rise to ‘top-up tax’ payable either by the ultimate parent entity of the group or, in some circumstances, other entities in the group structure.
Most top-up tax is expected to be collected through a mechanism known as the income inclusion rule, but in some circumstances a separate mechanism, known as the undertaxed profits rule, will apply. Some territories, for example the UK, plan to introduce a domestic minimum tax which will ensure the amount of any top-up tax due in respect of that jurisdiction is collected locally. A further rule, known as the subject to tax rule (STTR), will follow to allow source jurisdictions to tax payments between related parties that are considered to be undertaxed in the recipient jurisdiction.
The computation of amounts due will be filed by the group’s ultimate parent entity in a specific GloBE (global anti-base erosion) return, due 15 months after the year end (or 18 months for the first period).
Implementation and timing
The OECD published model rules for pillar two in December 2021. These set out its workings, although provisions regarding the STTR and implementation guidance are yet to be published. Enough detail is available for businesses to form an initial assessment of the likely impact, although enough remains outstanding for it to be difficult to put in place definitive plans to address its requirements.
Some of the current sources of potential uncertainty are as follows.
- It is unclear whether there will be international consistency in the application of the rules. For a global rule to be effective, ideally all participating countries should adopt similar legislation and implement those rules in the same way. The requirement for national governments to address pillar two is leading to inconsistencies; for example, the UK has published legislation closely aligned to the OECD’s model rules while the US has taken a different approach to the question of global minimum taxation as part of its Inflation Reduction Act. As noted above, Hungary remains a voice of opposition to the implementation of pillar two in the EU, which is otherwise favoured by member states.
- An important part of the pillar two calculations will be the treatment of tax incentives such as research and development tax reliefs, particularly whether they fall above or below the profit before tax line when determining the effective tax rate for comparison with the 15% minimum rate. Businesses will need to be aware of each territory’s approach, as this could affect the application of local top up tax and, as a consequence, wider investment decisions.
- There is nothing to oblige national governments to wait for 2024 to apply the rules. While widespread early adoption is not expected, businesses should be aware of the position in relevant territories as some could chose earlier implementation.
Preparation – what can businesses be doing now?
Designing detailed procedures for reporting under pillar two may remain challenging at this stage and many businesses may not wish to commit resources to the creation of specific processes until more implementation guidance is available. However enough detail is available to understand the likely complexities, risks and impacts of pillar two.
We recommend that businesses:
- review the model rules and draft legislation to understand complexities or risks in the context of their corporate structure and business model;
- model the likely outcomes, even at a high level at this stage, to quantify potential tax costs;
- consider the information requirements, and the steps required to have confidence that the right data will be available and reliable by the time the rules go live;
- engage with stakeholders (including auditors, who may wish to consider the impact of pillar two on the financial statements) regarding the rules, their likely impacts and reporting requirements; and
- consider appropriate governance processes to support pillar two reporting.
The OECD, the Inclusive Framework and legislators must ensure that the right tools are in place to provide a clear set of rules that are consistently applied. Importantly, this will include resolving uncertainties around the interaction of pillar two with US domestic legislation.
Businesses should ensure that they have a plan to address pillar two and manage stakeholder expectations. They should also watch out for territories adopting the rules early, and knock-on effects such as the potential loss of tax incentive benefits to top-up tax.