MNEs subject to 15% minimum tax rate from 2023: main OECD provisions and EU implementation proposals now available
Tue 18 Jan 2022
The OECD two-pillar approach
In October 2021, the OECD’s 137 Inclusive Framework members agreed to adopt a two-pillar approach to address the tax challenges of the digital economy.
Pillar I provides for new profit allocation and nexus rules for MNEs with a turnover greater than EUR 20 billion and profit before tax margins of 10% of revenue. It creates a new taxing right for market jurisdictions such that 25% of the profits in excess of 10% of revenue will be allocated to market jurisdictions using a revenue-based allocation key. The details on sourcing rules and revenue-based allocation keys are still under construction.
The Pillar II provisions, released in December 2021, set out the global anti-base erosion (GloBE) rules. They include an Income Inclusion Rule (IIR) and an Undertaxed Payment Rule (UTPR).
The IIR ensures a top-up tax on a parent entity in respect of the low-taxed income of constituent entities within the MNE group. The UTPR requires an adjustment (such as the denial of a deduction) in an MNE constituent entity, where the income is not subject to the IRR. The IIR is expected to apply from 2023.
The UTPR can be reduced by any qualified IIR (imposed by domestic rules that are in line with the GloBE rules). Generally, if the effective tax rate (ETR) in the IIR jurisdiction exceeds 15%, it is unlikely there will be a UTPR adjustment. The UTPR is expected to apply from 2024.
Pillar II also includes a Subject to Tax Rule (STTR) imposing limited source taxation on certain related-party payments that are subject to tax below a minimum rate.
In early 2022, the OECD will release the Commentary relating to the model rules and address co-existence with the US Global Intangible Low-Taxed Income (GILTI) rules. This will be followed by the development of an implementation framework focused on administrative, compliance, and coordination issues relating to Pillar II. The Inclusive Framework is also developing the model provision for a Subject to Tax Rule, together with a multilateral instrument for its implementation, to be released in the early part of 2022. A public consultation event on the implementation framework will be held in February, and another on the Subject to Tax Rule in March.
The approach in the EU
On 22 December 2021, the European Commission published the proposal for the “Directive on ensuring a global minimum level of taxation for multinational groups in the Union”, which adopts the OECD Pillar II proposal and ensures that large groups operating in the European Union pay a minimum tax rate in every jurisdiction in which they operate.
The Directive implements only the GloBE OECD Pillar II model rules and acknowledges that the STTR should be addressed in bilateral tax treaties. The proposal provides for a minimum ETR of 15% for groups, both domestic and international, with combined financial revenues of more than EUR 750 million a year, and with either a parent company or a subsidiary situated in an EU Member State.
Calculation of the ETR and top-up tax
The ETR will be calculated by the ultimate parent entity of the group, taking into account the adjusted covered taxes of the group and dividing them by the adjusted income earned by the group following a jurisdictional approach. If the ETR for the entities in a particular jurisdiction is below 15%, the group must pay a top-up tax to bring its rate up to 15%.
The top-up tax is calculated per jurisdiction. It is the difference between the minimum ETR of 15% and the ETR of the jurisdiction. In addition, the top-up tax is then multiplied by the ‘excess profits’ for the GloBE purposes for a respective jurisdiction and year. Excess profits are determined after calculating a substance-based deduction (to take account of payroll costs and tangible assets in the jurisdiction).
The definitions of adjusted covered taxes and adjusted income are the same as in the OECD Pillar II model rules as well as the minimum ETR of 15%.
The scope includes also purely domestic groups
The scope of the proposed Directive is broader than the minimum required under the OECD Pillar II rules. The provisions are not limited to MNE groups but also include purely domestic groups.
The OECD proposal gives an option to apply a domestic top-up tax to low-taxed domestic subsidiaries. As a consequence, the Directive will allow the top-up tax due by the subsidiaries of the MNE group to be charged locally in the respective Member State, and not at the level of the parent entity.
Substance carve-out and transitional period
The Directive includes a substance carve-out so that companies will be able to exclude from the top-up tax an amount of income that is at least 5% of the payroll costs and 5% of the value of tangible assets. However, a ten-year transition period allows the substance carve-out rates to start at 10% of the payroll costs and 8% of the carrying value of tangible assets. For tangible assets, the rate declines annually by 0.2% for the first 5 years and by 0.4% for the remaining period. In the case of payroll, the rate declines annually by 0.2% for the first 5 years and 0.8% for the remaining period.
In line with the OECD pillar-two agreement, government entities, international or non-profit organisations, pension funds, or investment funds that are parent entities of MNE groups, are not within the scope of the Directive.
The proposed Directive is very similar to the OECD Pillar II model rules with the novelty that large domestic companies will also be covered, and the jurisdiction of the low-taxed subsidiary will be permitted to charge a domestic top-up-tax in place of the parent jurisdiction top-up tax.
As this is a fiscal proposal, the adoption of the proposal for a Directive requires unanimous agreement by all 27 EU Member States. This proposal has the support of the majority of the EU Member States. Cyprus, which is not a member of the Inclusive Framework, is expected to support the proposed EU Directive. In addition, the approval of the European Parliament and European Economic and Social Committee opinion is required during a legislative process. The EU set a goal of reaching an agreement on the implementation of the Directive by Spring 2022, with the new rules entering into force by the beginning of 2023.
These new rules will require businesses to consider how to collate the relevant information and calculate top-up taxes. While there may be some element of uniformity within the EU, there may also be differences in implementation between jurisdictions that need to be considered.
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