Australia to adopt the 15% Global Minimum Tax (Pillar Two) measures

• The OECD's 15% Minimum Tax rules will apply in Australia for tax years commencing on or after 1 January 2024.
  
  
• An Income Inclusion Rule (IIR), Under Taxed Profits Rule (UTPR) and Domestic Minimum Tax (DMT) will be introduced (UTPR deferred until 1 January 2025).
  
  
• A EUR750-million threshold will apply.
  
  
• Top-up tax collected under the IIR (or UTPR) will not give rise to franking credits.
  
  
• Draft legislation has yet to be released.

Executive summary

The Australian Government has announced, as part of the Federal 2023/24 Budget announcement on 9 May 2023, that it will adopt legislation to implement the Organisation for Economic Co-operation and Development (OECD) Global Anti-Base Erosion (GloBE) Pillar Two rules (OECD Model Rules) in Australia, effective for income years commencing on or after 1 January 2024.

The new regime will incorporate a multinational Income Inclusion Rule (IIR) and an Undertaxed Profits Rule (UTPR), as well as a Domestic Minimum Tax (DMT).

The IIR and DMT will take effect for income years commencing on or after 1 January 2024 and the UTPR will take effect for income years commencing on or after 1 January 2025.

The adoption of these rules is not unexpected, as the Government flagged the issue with public consultation conducted in late 2022.

Australian legislation to implement the Pillar Two rules has not yet been released, but is expected to be released in draft form for consultation. Given that the Australian measures will principally reflect the OECD Model Rules, Commentary and recent Administrative Guidance, the legislation is unlikely to contain surprises when released. Nonetheless, further work will be required to confirm this position, as well as to assess whether the interaction of these new measures with existing Australian tax rules produce any unexpected outcomes.

Detailed discussion

The measures apply to all multinational groups (MNE Groups) that have consolidated accounting revenue of EUR750 million (approximately AUD1.2 billion) or more.

Although the Budget was not explicit on this point, based on the OECD Model Rules it is expected that:

• The Australian Pillar Two rules will apply if the turnover exceeds the threshold in at least two of the preceding four years.
  
  
• The EUR750 million threshold will be determined for any year based on the average exchange rate in December in the immediately preceding year

The measures apply equally to Australian-parented MNE Groups and to foreign-parented MNE Groups. Consistent with the OECD Model Rules, only limited exemptions to the rules will apply (e.g., for investment funds, pension funds, government entities, international organizations, not-for-profit organizations and income associated with international shipping).

The rules associated with calculating the top-up taxes required under the IIR, DMT or UTPR are complex and have been the subject of extensive consultation at both the OECD level and within Australia. This Tax Alert is not intended to examine these rules in detail, but rather to focus on some of the practical implications that the introduction of these new measures could have for MNE Groups.

Importantly, these rules are centered on, and triggered by, a threshold measure, being the jurisdictional Effective Tax Rate (ETR) for each country in which the MNE Group operates.

Broadly, the ETR for all entities of the MNE Group is determined on a jurisdictional basis by dividing the Adjusted Covered Taxes (broadly, the jurisdiction book tax expense) of the entities in the respective jurisdiction by their GloBE Income (broadly, book profit). The starting point for this calculation is the Consolidated Financial Statements prepared under the financial accounting standard adopted by the multinational parent (e.g., International Financial Reporting Standards (IFRS), US Generally Accepted Accounting Principles (US GAAP)), but with a series of complicated and nuanced adjustments applied in determining both the Adjusted Covered Taxes and GloBE Income amounts.

If the ETR is below the global minimum tax rate of 15% in a jurisdiction, the MNE Group is subject to top-up tax and this tax could be collected under an IIR, UTPR or DMT.

Application to Australian-parented MNE Groups

The application of the IIR is principally the same as the OECD Model Rules such that where an Australian entity that is the Ultimate Parent Entity (UPE) of an MNE Group and holds (directly or indirectly) an ownership interest in an entity in a jurisdiction that does not meet the 15% ETR (a low-taxed Constituent Entity), it shall pay its proportionate share of top-up tax to the Australian Taxation Office (ATO) in respect of that low-taxed Constituent Entity.

Any top-up tax paid to the ATO under the IIR will not give rise to a franking credit.

Separately, a DMT tax calculation will apply to the Australian operations only. It appears that the DMT will only apply to Australian entities that are part of a multinational group and not to solely domestic corporations. If the ETR as calculated under the DMT is less than 15%, a top-up tax will be payable to the ATO to effectively adjust the ETR to a 15% minimum rate. This effectively enables Australia to retain taxing rights over undertaxed Australian profits and will be respected under other countries' Pillar Two rules, provided the DMT is a qualifying domestic minimum top-up tax (QDMTT).

In contrast to top-up tax paid to the ATO under the IIR, any top-up tax paid to the ATO under the DMT will give rise to a franking credit.

Where the top-up tax is collected under the IIR (in relation to any low-taxed Constituent Entity) or DMT (for the Australia operations), the UTPR rule should not apply. The UTPR represents a back-stop rule if neither an IIR nor QDMTT applies.

Application to foreign-parented MNE Groups

A DMT tax calculation will apply to the Australian operations. If the ETR as calculated under the DMT is less than 15%, a top-up tax will be payable to the ATO to effectively adjust the ETR to a 15% minimum rate. Again, this enables Australia to retain taxing rights and will be respected under other countries' Pillar Two rules, provided the DMT is a QDMTT, and any such top-up tax would give rise to a franking credit.

For Australian entities that are not the UPE of an MNE Group, the IIR may still apply in limited circumstances to require top-up tax to be paid to the ATO, such as where the UPE is resident in a jurisdiction that has not implemented the IIR (e.g., the United States ) and there is an Australian Intermediate Parent Entity (IPE) that owns (directly or indirectly) an ownership interest in a low-taxed Constituent Entity.

The UTPR could also operate in limited circumstances and result in additional tax being paid to the ATO with respect to low-taxed Constituent Entities of the MNE Group that are resident in foreign jurisdictions and not otherwise subject to a IIR or QDMTT. Where an Australian entity owns that low-tax Constituent Entity, the UTPR would not typically apply and the IIR would take precedence.

Safe harbor rules

Although not mentioned in the Budget announcement, Australia is expected to adopt the three transitional Country-by-Country Reporting (CbCR) safe harbor provisions consistent with those agreed to in the OECD Inclusive Framework in February 2023, namely the De-minimis Test, Simplified ETR Test and Routine Profits Test. The transitional CbCR safe harbors are expected to apply for the first three fiscal years beginning on or after 1 January 2024.

Compliance

Although the Budget announcement was silent on compliance obligations, MNE Groups can expect, based on the OECD Pillar Two rules, to be required to submit the first filings under the new measures within 18 months after the end of the first relevant income year, and within 15 months after the end of each income year thereafter.

Considerations for affected taxpayers

Impact assessment

Many MNE Groups have already conducted preliminary assessments of the likely impact of these measures, based on the OECD Model Rules. Given that the commencement date of 1 January 2024 is confirmed, further work should be undertaken to update the assessment and provide a more definitive assessment of the likely impact of these rules from both an ETR and cash tax perspective.

For MNE Groups that have held off undertaking an assessment, it will be important to commence this now in line with best practice to address both the technical impact of the rules as well as the organization's data and systems readiness to comply with and report on the rules.

Financial accounting disclosures

Consideration will need to be given to new accounting public disclosure rules governing the disclosure of Pillar Two information in financial accounts. These disclosures may be required for reporting periods before the rules take effect. The timing of these disclosure obligations is likely to significantly precede the actual filing of the relevant tax returns with tax authorities.

Further guidance will be released on these accounting disclosure rules relevant for entities that apply IFRS as the International Accounting Standards Board finalizes its recommendations for accounting for Pillar Two.

Reliance on safe harbors

As noted above, the measures contain transitional CbCR safe harbors. However, it is critical to assess the availability and accuracy of the information upon which the transitional safe harbors rely and, in particular, to ensure underlying CbCR reports are prepared using Qualified Financial Statements (broadly, the accounts used to prepare Consolidated Financial Accounts of the UPE, with some exceptions). In addition, it is important to understand the impact of applying a safe harbor in other aspects of the Pillar Two rules, such as the separate transitional rules under the OECD Model Rules.

The transitional safe harbor rules contain a "once out, always out" rule. That is, once a transitional safe harbor is not applied for one fiscal year for a jurisdiction, a transitional safe harbor cannot be applied for subsequent years.

Significant compliance effort

Affected taxpayers will need to seriously consider the significant compliance effort needed to comply with the new rules. This includes understanding and identifying the many tax, financial and other data requirements for the calculations, as these go beyond what is needed for traditional tax compliance and reporting. MNE Groups need to develop a plan for timely access to necessary information to enable budgeting, forecasting, interim and annual tax accounting, tax compliance and tax controversy.

MNE Groups should also assess whether existing systems can manage the Pillar Two calculations and compliance obligations, or whether a redesign of tax processes and systems will be required to support compliance.

MNE Groups should also address their resource needs to manage the calculations and compliance obligations. We anticipate that the ATO will likely examine the tax corporate governance aspects regarding compliance with the new measures to ensure that corporate taxpayers have adequate processes in place.

Interaction with other Australian tax rules

The Budget announcement acknowledged that the Government will further consider interactions with Australia's existing income tax laws and amendments made as part of the Multinational Tax Integrity Package announced in the October 2022/23 Budget.

The reference to the need to consider the interaction with the Multinational Tax Integrity Package is welcome. In particular, it would seem the definition of "Low Corporate Tax Jurisdiction" and the associated 15% threshold applied to the measures addressing payments by Australian taxpayers involving the exploitation of intangibles should take into account (and respect) where a foreign jurisdiction already imposes a 15% minimum tax rate.

Other considerations include:

• The impact on franking accounts and associated planning, in particular the divergent franking account treatment of top-up tax collected under the DMT vs. IIR (and UTPR), discussed above
  
  
• Normal penalty and anti-avoidance provisions under existing tax laws will likely apply to the new rules, though this has yet to be confirmed; as a result, substantial Significant Global Entity (SGE) related penalties will likely be applied to compliance failures and careful attention will be required in structuring or restructuring MNE Groups to ensure any anti-avoidance rules are taken into account
  
  
• The interaction of top-up tax payments with the normal PAYG corporate tax payments system
  
  
• Care is required to provide consistency between the top-up tax accounting and payment disclosures under the new rules and the Public CbCR Transparency Rules due to take effect in Australia from 1 July 2023

Communication with management/boards

Tax teams should now brief management, and in some cases the board, on the likely impact of these measures, including any potential top-up taxes that may be payable, the financial accounting disclosure requirements, and the extensive compliance effort that will be required to meet the administrative and filing requirements.

Engagement with statutory auditors

It is likely that statutory auditors will want to understand the potential application of these new measures and may request both qualitative and quantitative information as to the likely impact on MNE Groups. Accordingly, early engagement with auditors to understand their expectations with respect to both the disclosure requirements and, as appropriate, governance processes in place to meet the potentially onerous compliance obligations, is recommended.

ATO engagement

The ATO has indicated that it is prepared to meet with interested companies to discuss the likely compliance impact of Pillar Two, as well as for the ATO to gather any insights on how to simplify compliance for taxpayers. EY has previously consulted with the ATO in relation to this more broadly.

Whilst we encourage engagement with the ATO, it is likely that the ATO may be somewhat limited in its ability to simplify Pillar Two compliance for taxpayers, given that the detailed data disclosure requirements of the annual filings are required under the OECD Model Rules. Nonetheless, we believe that the ATO is genuine in its endeavors to engage with taxpayers and tax professionals to see if it can in some way assist as MNE Groups transition into the new Pillar Two rules.
 

For additional information with respect to this Alert, please contact the following:

Ernst & Young (Australia), Sydney
 

• Alf Capito, Tax Policy Services
  
  
• Nadine Redford, International Tax and Transaction Services
  
  
• Peter Sanders, Tax Technology and Transformation
   

Ernst & Young (Australia), Perth
 

• Andrew Nelson, International Tax and Transaction Services
   

Ernst & Young (Australia), Melbourne
 

• Tony Merlo, Tax Policy Services
  
  
• Liz Cullinan, International Tax and Transaction Services
  
  
• Caroline Wright, Tax Technology and Transformation
  
  
• Sam Humphris, Global Compliance and Reporting
   

Ernst & Young (New Zealand), Auckland
 

• Matt Andrew, International Tax and Transaction Services
   

Ernst & Young LLP (United States), Australia Tax Desk, New York
 

• Naomi Ross

Published by NTD’s Tax Technical Knowledge Services group; Carolyn Wright, legal editor

For a full listing of contacts and email addresses, please click on the Tax News Update: Global Edition (GTNU) version of this Alert.