Silencing the tax challenges arising digitalisation: The Two-pillar solution

Pillar Two introduces the Global Anti Abuse Erosion (GloBE) rule, which seek to address the remaining Base erosion and profit shifting (BEPS) challenges and are designed to ensure that larger internationally operating businesses pay a minimum level of tax regardless of where they are headquartered or what jurisdiction they operate from.

The writer is a Certified Tax Advisor & a Member of the Institute of Certified Public Accountants of Uganda (ICPAU)

The architectural design of the rules

Pillar Two consists of:

• Two interlocking domestic rules (together the Global anti-Base Erosion Rules (GloBE)

• A treaty-based rule

The Income inclusion rule (IIR)

In some instances, it is based on traditional Controlled Foreign Corporation (CFC) rules, although the IIR is much broader and triggers additional tax at the level of the parent.

Where the income of the constituency entity when aggregated at the constituency level is taxed at below the minimum tax rate of 15%. This is deeply known as the parent country measures and Income Inclusion Rule (IIR), which imposes top-up tax on a parent entity in respect of the low taxed income of a constituent entity.

Under taxed profits rule (UTPR)

It is a back stop that only applies where the group income is not already subject to Income inclusion rule (IIR). It operates by denying deduction or an equivalent adjustments. It denies deductions or requires an equivalent adjustment to the extent the low tax income of a constituent entity is not subject to tax under an IIR.

The Subject to Tax Rule (STTR)

It complements the other rules. It denies treaty benefits intragroup payments made to jurisdictions where those payments are subject to low tax rate of nominal taxation. The STTR is the one that allows source jurisdictions to impose limited source taxation on certain related party payments subject to tax below a minimum rate. The STTR will be creditable as a covered tax under the GloBE rules. The STTR is a treaty-based rule

How does a qualified top up tax fit in?

The below are the steps to follow

• Determine Global Anti Abuse Erosion (GLoBE) income on a jurisdiction basis.

• Determine covered tax on a jurisdiction basis.

• Calculate jurisdictional Effective Tax Rate (ETR), covered tax /GLoBE Incomes.

• Calculate TOP Up Tax percentage in terms of minimum Effective Tax Rate (ETR) & jurisdictional.

Effective Tax Rate (ETR)

• Determine excess profits with Global Anti Abuse Erosion (GLoBE) Income less substance carve.

• Calculate jurisdictional top up tax percentage times profits.

• Jurisdictional top up tax of CE if the absorbed by a qualified domestic top up tax charged to a parent (IIR) or apportioned to a subsidiary company Under taxed profits rule (UTPR).

Rule status

The Global Anti Abuse Erosion (GloBE) rules will have the status of a common approach. This means that Inclusive framework (IF) members: are not required to adopt the GloBE rules, but, if they choose to do so, they will implement and administer the rules in a way that is consistent with the outcomes provided for under Pillar Two, including in light of model rules and guidance agreed to. Accept the application of the GloBE rules applied by other if members including agreement as to rule order and the application of any agreed safe harbours.

Rule design

The IIR allocates top-up tax based on a top-down approach subject to a split-ownership rule for shareholdings below 80%.

The Global Anti Abuse Erosion (GloBE) rules will apply to MNEs that meet the 750 million euros threshold as determined under BEPS Action 13. Government entities, international organisations, non-profit organizations, pension funds or investment funds that are Ultimate Parent Entities (UPE) of an MNE Group or any holding vehicles used by such entities, organizations or funds are not subject to the GloBE rules.

Effective Tax Rate (ETR) calculation

The GloBE rules will operate to impose a top-up tax using an effective tax rate test that is calculated on a jurisdictional basis and that uses a common definition of covered taxes and a tax base determined by reference to financial accounting income with agreed adjustments consistent with the tax policy objectives of Pillar Two and mechanisms to address timing differences.

Minimum rate

The minimum tax rate used for purposes of the Income inclusion rule (IIR) and Under taxed profits rule (UTPR) will be at least 15%.

Carve-outs

The Global Anti Abuse Erosion (GloBE) rules will provide for a formulaic substance carve-out that will exclude an amount of income that is at least 5% (in the transition period of 5 years, at least 7.5%) of the carrying value of tangible assets and payroll.

The Global Anti Abuse Erosion (GloBE) rules will also provide for a de minimis exclusion.

Other exclusions

The GloBE rules also provide for an exclusion for international shipping income using the definition of such income under the OECD Model Tax Convention.

Simplifications

To ensure that the administration of the Global Anti Abuse Erosion (GloBE) rules are as targeted as possible and to avoid compliance and administrative costs that are inconsistent to the policy objectives, the implementation framework will include safe anchorages and/or other mechanisms.

Global Intangible Low Taxed Income (GILTI) co-existence

It is agreed that Pillar Two will apply a minimum rate on a jurisdictional basis. In that context, consideration will be given to the conditions under which the US GILTI regime will co-exist with the GloBE rules, to ensure a level playing field.

Subject to tax rule (STTR)

Inclusive Framework members recognize that the STTR is an integral part of achieving a consensus on Pillar Two for developing countries. Inclusive Framework members that apply nominal corporate income tax rates below the STTR minimum rate to interest, royalties and a defined set of other payments would implement the STTR into their bilateral treaties with developing Inclusive Framework members when requested to do so.

Implementation

Inclusive Framework members will agree and release an implementation plan. It was contemplated that Pillar Two should be brought into law in 2022, to be effective in 2023.

Next steps

Here the agreement reached above indicates the ambition of the Inclusive Framework members for a robust global minimum tax with a limited impact on MNEs carrying out real economic activities with substance. It acknowledges that there is a direct link between the global minimum effective tax rate and the carve-outs and includes a commitment to continue discussions in order to take a final decision on these design elements within the agreed framework.

The strategic focus of Pillar Two Solutions

Below are measures and outcomes of the Two pillar solutions

Threshold rule for Pillar Two solution

This is intended for the much larger group of MNEs Based on Euro currency, the company with over EUR 750 million of its annual revenue would be subjected to a global minimum tax and are subject to an effective tax rate lower than the minimum rate, and those profits would still be taxed at a minimum rate of 15%.

What are the Target MNES to apply these Two pillar solutions?

Pillar Two’s goal is to ensure that a much broader range of MNEs, those with a turnover of at least EUR 750M, which will be hundreds of companies) pay a minimum level of tax, while preserving the ability of all companies to innovate and be competitive.

How will the Two pillar solution end profit-shifting by MNEs, via tax havens?

• Pillar Two will now ensure that those companies pay a minimum effective tax rate of 15% on their profits booked there (subject to carve outs for real, substantial activities).

• The work of the G20 and the OECD-hosted Global Forum on Transparency and Exchange of Information for Tax Purposes has ended bank secrecy (including leading to the automatic exchange of bank information).

• The OECD Base Erosion and Profit Shifting (BEPS) Project requires companies to have a minimum level of substance to put an end to shell companies along with important transparency rules so that tax administrations can apply their tax rules effectively.

• Pillar Two will now ensure that those companies pay a minimum effective tax rate of 15% on their profits booked there (subject to carve outs for real, substantial activities).

• The cumulative impact of these initiatives means that “tax havens” as people think of them would no longer exist.

• Those jurisdictions that offer international financial services may continue to find a market for their services, but on the basis that they add real economic value for their customers and support for commercial transactions that are not tax-driven.

The corporate tax rates of more than 20% vs the minimum tax set at 15%

Much as a large portion of corporate profit is subject to an effective tax rate lower than 15% despite the fact that the MNEs’ home jurisdiction has a stated corporate tax rate that is much higher rate, so the compromise reached represents a major achievement.

Conclusion

In order to address the BEPS issues, there have been many proposals, recommendations, or even countries’ unilateral actions and among others the Two-Pillar Package, BEPS Projects, consisting of 15 actions to counteract the BEPS issues ,the Inclusive Framework Therefore, the Two-Pillar solution is a major and radical change in the international taxation regime. The Two-Pillar solution reached by OECD has incorporated several provisions beneficial to the interests of developing countries and set a minimum tax rate at 15%.

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