First impressions of OECD’s Model Rules on Pillar Two Global Minimum Tax

Background

In January 2019, the OECD began the current project with the release of a policy note describing two pillars of work: Pillar One addressing the broader challenges of the digitalization of the economy and the allocation of taxing rights to market jurisdictions, and Pillar Two addressing remaining concerns about potential BEPS and tax rate competition among countries. Since then, the OECD has released a series of documents on the development of the two pillars, culminating with the release in October 2020 of detailed Blueprints on both Pillar One and Pillar Two. The Model Rules are intended to provide guidance to countries for use in incorporating Pillar Two global minimum tax rules into their domestic tax legislation.

Structure of the Model Rules

The Model Rules cover scope, charging provisions, computation of GloBE income or loss, computation of adjusted covered taxes, computation of effective tax rate (ETR) and top-up tax, corporate restructurings and holding structures, tax neutrality and distribution regimes, administration, transition rules and definitions.

Scope

Generally, a multinational enterprise (MNE) Group and its constituent entities are in scope of the GloBE rules if the annual revenue in the consolidated financial statements of the Ultimate Parent Entity (UPE) is €750 million or more in two out of the four fiscal years immediately preceding the tested fiscal year.

Effective tax rate calculation and Top-up tax

The Model Rules provide rules for calculating the ETR and the  Top-up tax. The starting point to calculate the GloBE income or loss is the financial accounting net income or loss as determined under the accounting standard used in preparing the consolidated financial statements of the UPE, before any consolidation adjustments for intragroup transactions. The Model Rules provide for limited adjustments to financially accounting income or loss, such as for excluded dividends and equity gains or losses. The Model Rules also provide that transactions between group entities in different jurisdictions that have not been recorded at arm’s length for accounting purposes, will need to be adjusted when calculating GloBE income or loss.

For the computation of adjusted covered taxes, the starting point is the current tax expense accrued in the financial accounts, with some limited adjustments. An important development in the Model Rules is the inclusion of detailed rules for including certain deferred taxes in adjusted covered taxes to address temporary book-tax timing differences.

Once these two amounts have been determined, the ETR of the MNE Group for a jurisdiction is calculated by dividing the sum of the adjusted covered taxes of each constituent entity located in the jurisdiction by the net GloBE income of the jurisdiction (i.e., the positive amount equal to the GloBE income of all constituent entities in that jurisdiction reduced by the GloBE losses of all constituent entities in that jurisdiction). The net GloBE income is reduced by the substance-based income exclusion for the jurisdiction (which is based on payroll costs and carrying value of eligible tangible assets) to get to the excess profit for the jurisdiction.

The top-up tax percentage is broadly the difference between the 15% minimum rate and the ETR. The jurisdictional top-up tax for a jurisdiction is the top-up tax percentage multiplied by the excess profit for the jurisdiction (with adjustments for additional current top-up tax and qualifying domestic top-up tax for the jurisdiction). Finally, the top-up tax of a constituent entity reflects the jurisdictional top-up tax multiplied by the ratio of the Globe income of the constituent entity for the jurisdiction to aggregate GloBE income of all constituent entities for the jurisdiction.

Mechanics of the top-up tax

The Model Rules describe the process for determining the amount of top-up tax to be charged to a parent entity or to the constituent entities located in a UTPR jurisdiction by attributing the top-up tax of each low-taxed constituent entity to the parent entity under the IIR, and then by allocating the residual top-up tax, if any, to UTPR jurisdictions.

Administration

The Model Rules also include some administrative provisions. They provide an obligation to file a standardized information return (the GloBE information return) that will provide tax authorities with the information required to assess the tax liability under the Model Rules. The Model Rules also provide for the development of optional safe harbors to reduce the compliance and administrative burden and agreed administrative guidance.

Other items of note

The Model Rules also include specific rules for the treatment of corporate restructurings and holding structures and tax neutrality and distribution regimes. They also include specific transition rules.

Implications

Implementation of the Model Rules will bring  significant changes to the overall international tax rules under which businesses operate. It will also introduce a new filing obligation that will require gathering additional data and adaption of companies’ internal processes and systems. It is important for companies to evaluate the potential impact of the proposed global tax changes, and monitor activity in relevant countries related to the implementation of new rules through changes in domestic tax rules and bilateral and multilateral agreements,  given the very ambitious implementation timeline. It is important for businesses to evaluate the potential impact of the global tax changes both on their tax positions and on their processes and systems.