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Setting a global minimum corporate tax rate: to begin simple but to become complex

Apostolos Thomadakis / Mar 2022

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On 1 July 2021, the OECD/G20 Inclusive Framework on Base Erosion and Profit Shifting (BEPS) agreed a two-Pillar solution to re-allocate profits of the largest and most profitable multinational enterprises (MNEs) to countries worldwide, and to implement a minimum corporate tax rate of 15% for large MNEs. In particular, Pillar One is about reattribution/reallocation of taxing rights at a global level in favour of jurisdictions where goods and services are used or consumed. On the other hand, Pillar Two (or the Global Anti-Base Erosion (GloBE) rule) is about creating a level playing field through a minimum worldwide level of taxation.

On 20 December 2021 the OECD published the Model Rules for Pillar Two. Although these are not yet finalised in all their details, they are quite robust and clear. Following the OECD agreement, on 22 December 2021 the European Commission (EC) has proposed an EU Directive to implement Pillar Two in the European Union (EU), adopting rules very closely aligned to the OECD model. 

Under the OECD rules, Pillar Two is a coordination framework, meaning that the their implementation is left to the discretion of each jurisdiction. Hence, the 137 countries that have signed the OECD deal – including all 27 Member States (MSs) – are not obliged to introduce Pillar Two rules, but if they do so, they must follow the approach taken in the OECD Model Rules. Opposite to that, the EU Directive will oblige all MSs to implement Pillar Two and adopt common rules, closely in line with the OECD ones. However, the Directive will need to be transposed into the national laws of each MS, so some differences in its implementation may still arise. Moreover, in the EU, the initiatives by the OECD and the G20 must be framed in the ‘Business in Europe: Framework for Income Taxation’ (BEFIT), which aims to harmonise business taxation in Europe by providing a single corporate tax rulebook.

Pillar Two entails the calculation of the effective tax rate (ETR) for each jurisdiction. If the ETR of a low-taxed company (or of a purely domestic European group) falls below the minimum rate of 15%, the MS of the parent company will apply to the parent company a top-up tax (known as the income inclusion rule or IIR) in order to bring the ETR in line with the minimum rate. This rule will apply for each constituent entity in a low-tax jurisdiction. When the parent company is situated outside the EU in a country which does not apply the IIR (or equivalent rules), the undertaxed payments rule (UTPR) will allocate any residual amount of the top-up tax to group to the constituent entities in the EU. Hence, the revenues will accrue to the MSs where these entities are located.

Differences between the OECD Model Rules and the EU Directive

Although the EU Directive follows the OECD rules, there are few differences that are worth mentioning. First, it is a Directive, meaning that Europe is creating a law that is binding for the 27 MS, which is different from the status of ‘common approach’ that the OECD rules have. In the way the single market operates, it will be almost impossible for MSs to apply their own rules. On top of that there is the European Court of Justice (ECJ) jurisprudence which would make it impossible to treat foreign and national companies differently, as well as to introduce isolated measures that could distort the single market and go against the EU law. 

Second, there is a difference regarding the scope of companies that fall under the Directive. Although at OECD level Pillar Two covers only the cross-border activities of MNEs with annual consolidated revenues of more than EUR 750 million per year, at EU level the Directive covers also MNE groups (with a combined annual group revenue of more than EUR 750 million) with purely domestic activities. The likelihood of having a company that meets the threshold without any activity in another MS, is rather low. 

Third, there is the third-country equivalence. Article 51 of the Directive contains provisions for the EC to assess the equivalence of a third country system based on a set of conditions, such as allowing for jurisdictional blending, instead of global blending, and recognising the IIR paid in another MS in order to avoid double taxation. Currently, out of the 137 countries that agreed to implement the OECD rules, the US will use the Global Intangible Low-Taxed Income (GILTI) rules – the US version of a minimum tax on foreign earnings of US companies.

Fourth, the Directive lays down rules on penalties/sanctions for entities that fail to provide the necessary tax information needed or make a false declaration. This also entails subsidiaries of foreign companies on EU territory, which are responsible for providing the information on behalf of the whole group. The foreseen penalty could be amount up to 5% of the constituent entity’s turnover in the relevant fiscal year.

Areas of concern

One of the most important concerns that the Pillar Two rules raise, is the heavy implementation burden for both companies and tax administrations. Under the current rules, every subsidiary of an MNE operating in a given country, is required to provide tax information on the whole group. That would be a huge challenge for a large MNE with hundreds of subsidiaries operating in many different countries. Thus, greater emphasis should be put on how the exchange of information between companies and administrations in different jurisdictions around the world can become more efficient. Of course, any agreement or disagreement on that, could potentially have an impact on other pieces of legislation.

The implementation burden is also reflected on the very strict timeline. Considering the French presidency’s willingness for quick implementation, the EC proposes that MS transpose the Directive into their national laws by 31 December 2022, with the rules coming into effect from 1 January 2023, and the collection of information for tax administrations starting on 1 January 2024. As each jurisdiction will need to implement the new rules into local law through their respective legislative process, there is very little time for lawmakers to transcribe the rules in a way that takes into account the existing local systems and tax frameworks. At the same time, taxing authorities will have to deal with administering the new laws (i.e. implementation of systems and processes for enforcement and collection).

Another area that requires attention, is the calculation of the ETR and how the carve-out can affect that calculation. This is because depending on the design, the carve-out will have different effects on the amount of top-up tax in case of a local ETR below the minimum rate. Both the OECD rules and the EU Directive include a substance carve-out which aims to reduce the impact of Pillar Two on MNE groups in a jurisdiction where they are carrying out real economic activities. A carve-out based on substance would endanger the proposal’s ability to address tax competition. It could be more attractive for countries to implement an additional domestic minimum tax (and compete through the tax system over real activities) rather than raise their tax rates. Is this what the EU Directive intend to achieve?

Conclusion

The agreement on a global minimum corporate tax that ensures that MNEs pay a fair share of tax wherever they operate, is a critical step in the right direction. However, as the rules currently stand and considering the very tight time schedule, there are several issues that require attention. With the EU Directive scheduled to apply from 1 January 2023, the time left from MNEs in scope to get ready and prepared on various levels, also because they will be subject to parallel country-by-country reporting, is limited. Evaluating and modelling the impact of the new rules to both MNEs and tax administrations, given that certain elements of them are not yet finalised, is a challenging task. Compliance and data gathering will be pivotal as well, while the calculation of the jurisdictional ETR and the applied carve-out, may give room to tax competition between MS.

 

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Apostolos Thomadakis

Apostolos Thomadakis

March 2022

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