1. Overview
In October 2021, over 135 jurisdictions embraced a two-pillar solution to reform international taxation, focusing on the Global Anti-Base Erosion (GloBE) Model Rules. The GloBE Model Rules consist of the global minimum tax and the Subject to Tax Rule (STTR).
The global minimum tax, based on the GloBE Model Rules, allows jurisdictions to impose a top-up tax on low-taxed income up to 15%. The STTR permits source jurisdictions to tax back certain cross-border intra-group covered income with nominal corporate tax rates below 9%.
This approach aims to ensure fair taxation by multinational enterprises globally, with the global minimum tax being a central element.
2. The GloBE Rules
GloBE strategically targets MNE groups with annual revenues surpassing EUR 750 million, finding equilibrium between maximizing the global minimum tax impact and minimizing compliance intricacies. Aligned with Country-by-Country Reporting (CbCR) parameters, it simplifies assessments for tax policymakers.
At the core are Effective Tax Rate (ETR) calculations performed jurisdictionally, leveraging the financial accounts of local entities. Integration with consolidated financial systems streamlines this, ensuring efficiency across jurisdictions.
Top-Up Tax and Substance-Based Income Exclusion:
A financial checkpoint emerges with the top-up tax, triggered if the calculated ETR falls below 15%. This ensures compliance in low-tax jurisdictions, focusing solely on low-tax income with a strategic "substance-based income exclusion."
Substance-Based Income Exclusion Rationale:
Guided by indicators like payroll and tangible assets, the substance-based income exclusion surgically removes fixed returns tied to substantive activities. This pivot directs the global minimum tax towards "excess income," targeting intangibles and mitigating Base Erosion and Profit Shifting (BEPS) risks.
In summary, GloBE rules orchestrate a symphony of tax precision, navigating through application frameworks, ETR calculations, adjustments, and top-up tax impositions.
2.1. Structure of GloBE rules
The GloBE rules deploy three provisions for top-up tax collection:
Qualified Domestic Minimum Top-Up Tax (QDMTT);
Income Inclusion Rule (IIR); and
Undertaxed Payment Rule (UTPR).
These provisions adhere to a predefined rule order embedded in the GloBE design.
2.2. Rule Order and Implementation:
QDMTT Application: Primary right rests with the low-tax jurisdiction, imposing an additional tax on MNE Group's excess profits to meet the 15% ETR.
IIR for Secondary Taxing Rights: Without a QDMTT, the Ultimate Parent Entity (UPE) enforces top-up tax; If the UPE is located in a jurisdiction that has not implemented a Qualified IIR, the obligation shifts down the ownership chain to the next highest entity in the ownership chaine in a Qualified IIR jurisdiction.
UTPR as IIR Back-Up: Residual taxing rights go to jurisdictions with UTPR if IIR cannot be applied. Allocation is based on a substance-based key.
QDMTT safeguards the local tax base without altering the MNE Group's after-tax cost. Additional tax imposition ensures uniform tax liability across scenarios, maintaining consistency and fairness in GloBE rule application.
3.1. Applicability of GloBE Rules
An MNE Group should go through following basic steps to compute its top-up tax liability with respect to GloBE Rules:
Step 1: Determine whether the MNE Group is within scope
To determine the applicability of the rules to internationally operating MNE Groups, following needs to be evaluated:
Determine Group International Activity: The initial step scrutinizes the membership of Constituent Entities within an MNE Group, evaluating whether they belong to an internationally operating group under the control of an Ultimate Parent Entity (UPE).
Revenue Threshold Test: Moving forward, the revenue threshold is set at EUR 750 million or more of revenue in two of the four fiscal years immediately preceding the fiscal year being tested.
Identify Excluded Entities: In the final step, specific entities, such as governmental organizations and investment funds, are excluded from the scope to maintain reporting consistency.
Step 2: Allocating income of constituent entities on a Jurisdictional Basis
Once the applicability is established, the focus shifts to the precise allocation of income for each Constituent Entity within an MNE Group, and includes:
Identify Constituent Entities: Delineation of entities within the MNE Group occurs, considering factors like the formation of Permanent Establishments (PE) or specific arrangements necessitating distinct account sets.
Determine Entity Location: Assigning a location to each Constituent Entity is integral, aligning with domestic law considerations such as residence or incorporation. Special recognition is given to "Stateless Entities" exempt from taxes.
Calculate FANIL: Financial Accounting Net Income or Loss (FANIL) is computed for each Constituent Entity, drawing from financial accounts used for MNE Group's Consolidated Financial Statements. Special considerations are made for PEs and flow-through entities.
Step 3 – Calculate the GloBE Income
In the third step of implementing GloBE rules, the focus is on computing the GloBE income or loss for each Constituent Entity. This involves adjustments to the FANIL to align the tax base for global minimum tax with local tax practices.
Types of Adjustments to the FANIL:
Aligning with Taxable Income: Rectifying disparities between financial accounting and taxable income, preserving policy choices to avoid double taxation.
Correct Allocation between Jurisdictions: Ensuring arm's length pricing for cross-border transactions, countering intra-group transactions evading top-up tax.
Policy-Based Adjustments: Prohibiting illegal payments and preventing the public from sharing economic burdens through decreased tax revenues.
Step 4 – Determine Adjusted Covered Taxes
After determining GloBE Income, the next critical step is calculating the taxes associated with that income. This step involves:
Covered taxes: It is based on FANIL and excludes non-income taxes. It also adjusts for deferred tax liabilities to comply with the minimum rate.
Adjustments to Covered Taxes: Irrelevant taxes are excluded, and deferred tax accounts are adjusted, ensuring precision and rule integrity. This streamlined approach enhances operational efficiency and aligns with the strategic goals of GloBE.
Cross-Border Allocation: Adjustments are made to allocate certain cross-border taxes to the proper Constituent Entity to ensure fair distribution of tax responsibilities among entities operating in different jurisdictions.
Post-Filing Adjustments: Address changes in tax liability, whether from audits, transfer pricing shifts, or unpaid taxes, ensuring adaptability to evolving fiscal scenarios.
Step 5 – Compute the Effective Tax Rate (ETR) and Calculate the Top-Up Tax
In this critical step, the ETR for each jurisdiction is meticulously computed, considering GloBE Income and Covered Taxes from Constituent Entities within that jurisdiction.
Computation of the ETR: In GloBE rules implementation, GloBE Income and Covered Taxes in each jurisdiction are aggregated. Use a simplified ETR methodology, possibly akin to CbCR transitional safe harbour. It excludes jurisdictions below de minimis thresholds (EUR 10 million revenue and EUR 1 million income) from ETR calculation for efficiency and focus on significant fiscal impacts.
Computation of the Top-Up Tax: Calculate the top-up tax by finding the percentage difference between the 15% minimum rate and the jurisdiction's ETR. Apply this to GloBE Income, considering a substance-based income exclusion, based on tangible assets and payroll. Then, the top-up tax is proportionately distributed among Constituent Entities.
Step 6 – Charge the Top-Up Tax under QDMTT, IIR, or UTPR
In implementing top-up taxes under GloBE rules, jurisdictions follow a strategic order:
1. Qualified Domestic Minimum Top-up Tax (QDMTT);
2. Income Inclusion Rule (IIR); and
3. Undertaxed Payment Rule (UTPR).
QDMTT applies in jurisdictions with a consistent domestic minimum tax, offsetting top-up tax. IIR steps in when QDMTT is lacking, ensuring payment at the parent entity level. UTPR acts as a backstop, obliging resident entities to pay tax if IIR is unavailable. This systematic approach ensures harmonized outcomes, emphasizing administrative cooperation and standardized reporting.
4. Implementation Considerations
In December 2021, following the Inclusive Framework's endorsement of a two-pillar solution for digital economy tax challenges, the GloBE Model Rules were released. These rules, accompanied by a Commentary and Administrative Guidance, serve as a template for domestic legislation. Many jurisdictions have implemented or are in the process of translating GloBE rules into domestic law.
The Governments of such jurisdictions follow the below two stages:
4.1. Decide: Impact assessment and Reform options:
In the domestic sphere, jurisdictions must identify in-scope MNE Groups with revenue exceeding EUR 750 million, assess their profits, and evaluate if excess profits surpass EUR 10 million or EUR 1 million. This scrutiny extends to potential low-taxed domestic profits, considering ETR and tax base nuances. Reform options include targeted changes to align domestic tax systems with GloBE Rules, addressing tax incentives favoring MNE Groups.
On the international front, jurisdictions evaluate their status as headquarter jurisdictions for MNE Groups and assess the impact of GloBE rules on foreign operations. Reform options include adopting an IIR for headquarter jurisdictions or considering the UTPR as a backstop tax.
This comprehensive approach ensures a coordinated application of the global minimum tax, promoting fairness and reducing tax competition globally.
4.2. Implement: Legislating for consistent and co-ordinated outcomes
In the pursuit of implementing the GloBE Rules, jurisdictions have diverse strategies. Some, like Japan and the UK, adopt a 'full form legislation' approach, directly transcribing Model Rules. Others, such as Liechtenstein and New Zealand, prefer a 'reference approach,' incorporating rules by cross-referencing the Model Rules. A 'skeleton legislation and detailed regulations' strategy involves primary laws focusing on core provisions and delegating specifics to secondary legislation. Ensuring consistency, jurisdictions may align with the Commentary or directly incorporate it into domestic law. The Qualified Rule Status may be assessed through peer review process, and guarantees a uniform approach. Administrative tools like standardized GloBE Information Return and information exchange mechanisms ensure to streamline compliance.
Conclusion
In the realm of international taxation, a significant shift is underway through the Two-Pillar Solution and GloBE Model Rules. With over 135 jurisdictions joining this transformative narrative, the focus is on fairness and collaboration. Key actors like QDMTT, IIR, and UTPR play their roles, ensuring a balanced tax storyline. Nations, each with their unique approach, contribute to a collective effort for global tax harmony. The journey unfolds with careful consideration, avoiding the pitfalls of the past tax competition. The international tax landscape is evolving, embracing transparency and cooperation—a noteworthy change marking the conclusion of an era and the dawn of a more balanced fiscal narrative.