The Organization for Economic Cooperation and Development (OECD) released on December 20, 2021 its much anticipated interim report concerning the implementation of a Global Anti-Base Erosion (GloBE) minimum tax under Pillar Two. The rate is currently set at 15 percent and is applicable to multinational enterprises (MNEs) with turnover over EUR 750 million. MNEs subject to country-by-country reporting are thus generally likely to be subject to the GloBE minimum tax and will need to maintain a new set of accounting records for that purpose. Additional filing requirements concerning Pillar Two compliance and notifications will be required and may prove as onerous to MNEs as those related to country-by-country reporting. The GloBE minimum tax rules will create a “top-up tax” to be applied on profits in any jurisdiction whenever the effective tax rate, determined on a jurisdictional basis, is below the minimum 15 percent threshold. The almost 70-page long document articulates in detail the complicated mechanics of the envisioned application of the GloBE minimum tax, including transition rules. The GloBE minimum tax is estimated by the OECD to generate around USD 150 billion in additional global tax revenues annually.
Although the OECD/G20 Inclusive Framework on BEPS (“the OECD Inclusive Framework”) is a continuation of the 2013-2017 Base Erosion and Profits Shifting (BEPS) work by the OECD aimed at curtailing certain tax strategies of MNEs viewed as harmful, Pillar Two is primarily targeting tax competition between tax jurisdictions. If discounted corporate tax rates are used as a sovereign tax policy instrument to attract foreign capital, imposing a 15 percent minimum tax effectively limits governments’ discretion to leverage that policy instrument for economic development purposes. The probable outcomes of such policy aimed at decreasing tax competition are: (i) low tax jurisdictions are likely to raise the effective tax rate offered to foreign capital to 15 percent, and (ii) economic costs caused by a decrease in competition are likely to indirectly affect, negatively or positively, depending on facts and circumstances of economic development, the long-term tax revenue (corporate and other) of all countries. In other words, as is often the case when tax laws change, there will be winners and losers.
The two basic concepts powering the GloBE minimum tax are (i) the Income Inclusion Rule (main rule) and (ii) the Undertaxed Payment Rule when the Income Inclusion Rule is not fully applied and the effective tax rate in a tax jurisdiction is less than 15 percent. The Income Inclusion Rule is the primary mechanism that will require a parent company of an MNE to top-up its effective taxes paid in any tax jurisdiction it does business in, through a subsidiary or through a permanent establishment, to yield a 15 percent rate. If the parent company is in a tax jurisdiction that does not implement the Income Inclusion Rule, the next intermediate holding company will perform the calculations and pay the top-up taxes to its low-tax counterparty tax jurisdictions. The Undertaxed Payment Rule applies in cases where the Income Inclusion Rule has not been fully applied and the resulting effective tax rate in a tax jurisdiction is still less than 15 percent. The Undertaxed Payment Rule also applies to a low-tax jurisdiction where the ultimate parent company of the MNE is located. The amount of tax under the Undertaxed Payment Rule is first calculated and then allocated formulaically to counterparty tax jurisdictions that have adopted the Undertaxed Payment Rule. A five-year exemption is granted, under certain conditions, to MNEs expanding internationally. The calculation of the Pillar Two tax liability of an MNE is determined after transfer pricing adjustments pursuant to Article 9 of the OECD Model Tax Convention; it is not a substitute to the transfer pricing rules.
Implications for U.S. MNEs
Since the Tax Cuts and Jobs Act of 2017, U.S. MNEs are already subject to a minimum effective tax on foreign earnings under the global intangible low-taxed income (“GILTI”) regime. A key difference between the U.S. GILTI regime and the Income Inclusion Rule under the OECD Pillar Two regime is that the former is applied relative to the MNE’s foreign income’s global effective tax rate, while the latter is applied on a jurisdiction-by-jurisdiction basis. Unless U.S. law is modified to be applied consistently with the OECD Pillar Two jurisdiction-by-jurisdiction design, U.S. MNEs will have to pay the minimum GILTI rate (often 10 - 15 percent) on their consolidated foreign earnings and pay a “top-up tax” in every tax jurisdiction in which it pays less than the average 15 percent; the order in which a GILTI tax liability and Pillar Two liability is calculated may also affect the ultimate tax liability of an MNE. The Build Back Better Act proposed by the Biden administration reversed the Trump administration’s position that GILTI, as currently written, should be treated as an approved minimum tax regime. It includes changes to the GILTI regime to reflect a roughly 15 percent minimum tax applied to each country where a U.S. MNE has profits. Given the political climate and the difficulties facing the administration in its legislative process, it is unclear whether consensus can be reached in Congress to better align GILTI with the GloBE minimum tax. The OECD is punting the issue of GILTI to 2022, leaving U.S. lawmakers a short window of time to revisit GILTI before the OECD adjudicates the issue.
A public consultation will be held by the OECD in February 2022. The Income Inclusion Rule is expected to become effective in 2023 and the Undertaxed Payment Rule in 2024. The model treaty article and implementation instrument are expected soon with public consultation in March 2022. Our firm will continue to closely monitor any development, including those in the U.S. Congress, (i) in connection to any change to the GILTI regime and (ii) in connection with changes in treaties necessary to implement the OECD rules discussed herein.
Please contact us for further guidance on how to prepare for the upcoming expected changes in international tax laws.