Global Minimum Tax Rules Published

The OECD yesterday published model rules for domestic implementation of the new global minimum 15% tax rate for large multinationals.

Much of the framework for this has been known for some time. The interest lies in the detail of how a business's effective tax rate (against which the minimum tax is assessed) is to be calculated; in particular, what adjustments to the accounting treatment will be mandated, and how deferred tax will be dealt with.

The OECD's Base Erosion and Profit Shifting (BEPS) project has resulted in massive changes worldwide to domestic tax systems, ensuring minimum standards in areas such as interest deductions, hybrid mismatches and minimising tax treaty abuse. However, gaps remain in which multinationals can operate to bring down their effective rates.

The OECD's two pillar solution is designed to ensure that multinational enterprises pay a "fair share" of tax wherever they operate and generate profits. These Anti Global Base Erosion (GloBE) rules provide a 15% minimum tax rate for large multinationals which largely prevents any arbitrage of badly coordinated domestic measures and outdated rules that do not cater for today’s digitalised and globalised world economy.

Multinational groups will need to follow these steps:

Step 1 – Identify groups within scope and the location of each entity within the group to which the GloBE rules apply

Step 2 – Determine the income of each of these entities

Step 3 – Determine the taxes attributable to that income

Step 4 – Calculate the Effective Tax Rate of all entities subject to the GloBE rules that are located in the same jurisdiction, and determine the resulting Top-up Tax

Step 5 – Impose the Top-up Tax either under the Income Inclusion Rule (IIR) or Under-taxed Payments Rule (UTPR) in accordance with the agreed rule order

Scope

The GloBE Rules will apply only to groups with a foreign presence (including permanent establishments) and which have annual revenue exceeding €750m in the consolidated financial statements of the top parent company in at least two of the four previous fiscal years.

The rules do not apply to government entities, international organisations and non-profit organisations (preserving domestic tax exemptions for sovereign, non-profit and charitable entities), nor do they apply to entities that meet the definition of a pension, investment or real estate fund (preserving the widely shared tax policy of not wishing to add an additional layer of taxation between the investment and the investor). These entities are excluded even if the MNE group they control remains subject to the rules.

Calculating the effective tax rate

Top-up tax will be charged if the MNE group's effective tax rate falls below 15% in any jurisdiction in which it operates.

As was expected, the income (or loss) is first calculated based on the figures used for preparing the consolidated financial statements of the parent entity, and then adjusted for tax purposes. The OECD has endeavoured to keep tax adjustments to a minimum and are made only where necessary to reflect common permanent differences. As well as an exclusion for international shipping income, these adjustments include:

• Removing most dividends and equity gains so that the minimum tax does not apply to such income,
• Removing expenses disallowed for tax purposes on policy grounds,
• Adjustments to reflect stock-based compensation plans,
• Forex adjustments where the functional currencies used for accounting and tax are different,
• Correcting for prior year errors and changes in accounting principles,
• Accrued pension expenses.

The income tax (or equivalent tax payable on income and profits) attributable to that adjusted income must then be calculated. This will include income taxes charged as a withholding tax or charged under a CFC regime, but excludes non-income based taxes such as indirect taxes, payroll and property taxes.

Rules are set out to address temporary differences, which arise when income or loss is recognised in a different year for financial accounting and tax. The GloBE rules recognise that most businesses already use deferred tax accounting to reconcile differences between financial accounting and tax results and therefore, with some adjustments, use these existing accounting principles to simplify compliance.

The adjustments are intended to ensure that, generally, the minimum tax will not be owed by reason of a timing difference, but that using deferred tax accounting should not affect the integrity of the GloBE rules. Examples highlighted by the OECD include:

• the credit for deferred tax liabilities is capped at 15% to prevent any excess tax sheltering unrelated income;
• certain deferred tax expenses are excluded, e.g. those relating to items excluded from computation of the GloBE income, movements relating to "uncertain tax positions", and the impact of valuation adjustments;
• a recapture mechanism that adjusts for certain deferred tax liabilities that have not reversed (i.e. the tax has not actually been paid) within five years.

A GloBE loss election will be available for businesses that do not wish to carry out the detailed calculations involved in applying these deferred tax accounting rules. This will involve a simplified methodology whereby, effectively, 15% of the value of the GloBE losses may be carried forward for offset against future profits.

As a final step, the ETR is calculated on a jurisdiction by jurisdiction basis, and the difference between that and the 15% minimum rate is applied to the GloBE income in that jurisdiction after deducting a substance based income exclusion. This is calculated as a percentage mark-up on tangible assets (8%) and payroll costs (10%), with each being reduced to 5% over the first ten years of operation of the GloBE rules as part of a phased introduction of the rules.

Charging the top-up tax

The primary GloBE rule is the IIR (income inclusion rule). Under this, the parent entity pays the additional tax in proportion to its ownership interests in the entities that have low taxed income, with other intermediate holding entities down the ownership chain also taking on their proportion to the extent not met by the parent.

Where the entity with low taxed income is held through a chain of ownership that does not result in the low-taxed income being brought into charge under an IIR, the UTPR comes into play to increase the tax payable at the subsidiary level, e.g. by way of denial of a deduction, in proportion to the relative share of assets and employees of the group companies. This ensures that all top-up tax is ultimately payable, whether by parent companies under the IIR or group companies under the UTPR.

Next steps

The GloBE model rules published this week contain a huge amount of detail. As well as the above overview, there are rules relating to corporate restructurings and holding structures, tax neutrality and distribution regimes and transitional rules, not to mention the administrative provisions. The immediate task therefore will be to absorb, understand and consider the application of the rules.

To follow in early 2022 is the OECD Commentary on the model rules and OECD consideration of how the US Global Intangible Low-Taxed Income (GILTI) rules will co-exist with the GloBE rules. Also expected in early 2022 is a model provision for a Subject to Tax Rule, which will allow jurisdictions to impose withholding taxes on certain related-party payments, together with a multilateral instrument for its implementation.

The focus will then shift to the development of an implementation framework looking at administrative, compliance and co-ordination issues, with an expectation that MNEs within scope will be subject to the minimum tax by 2023.

You can find a full list of our global tax partners here.

Authors: Nicholas Gardner, Eduardo Gracia and Paul Miller