The Pillar Two GloBE Rules operate by calculating the
effective tax rate (ETR) of the MNE in the jurisdictions it operates in, and then comparing this with the 15% minimum rate.
If the ETR is less than the 15% minimum rate, additional tax (referred to as
top-up tax) may be payable. If the ETR is 15% or above, there is no additional taxation.
A key element of the GloBE Rules is the jurisdictional blending.
The OECD had two main approaches to calculating the ETR, a global blending approach, or a jurisdictional blending approach. They chose the latter.
A global blending approach would have blended all the profits and losses of an MNE internationally.
The jurisdictional blending approach just blends the profits and losses on a jurisdictional basis. Global blending would have significantly narrowed the scope of the GloBE rules.
Nevertheless, jurisdictional blending means that just because an MNE has a low taxed entity in a jurisdiction, doesn’t necessarily mean that the ETR for the jurisdiction would be less than 15%.
For instance, if an MNE had three subsidiaries in a jurisdiction:
Company 1 – Profits of 10 million and tax of 1 million
Company 2 – Profits of 10 million and tax of 1.5 million
Company 3 – Profits of 10 million and tax of 2.5 million
The overall ETR for the jurisdiction would be 16.6667% and the MNE group would not be subject to GloBE top-up tax.
This is irrespective of the fact that Company 1 had an ETR of 10% (ie below the 15% global minimum rate).
Application of the GloBE Rules
The actual application of the GloBE Rules is more complex.
Scope
Firstly, an MNE group needs to determine whether it is subject to the GloBE Rules. In general, MNE groups with revenue exceeding
750 million euros are within scope. However, not all group entities are subject to the GloBE Rules.
Excluded Entities are not subject to the ETR calculation or top-up tax liabilities.
If a group is in scope it also needs to determine where its subsidiaries are located for the purposes of the GloBE Rules.
ETR Calculation
Whilst the broad operation of the rules is simply calculate the ETR and compare it to the 15% global minimum rate, in order to do this the Model Rules apply a series of separate rules to adjust the financial results of the MNEs subsidiaries.
This is because the starting point of the GloBE Rules is the
financial accounts. The tax figure used to calculate the ETR for instance is not based on the tax payable in that jurisdiction in its corporate income tax return, but the tax expense in the financial accounts. The GloBE rules then adjust this figure before it can be used in the GloBE ETR calculation (referred to as ‘
Adjusted Covered Taxes‘).
Similar principles also apply to calculating GloBE income.
It’s worthwhile noting that Article 4.4 of the model Pillar Two GloBE Rules adopts
deferred tax accounting to address timing differences when calculating covered taxes paid by an entity.
It does this to prevent an MNE from incurring top-up tax in a year due to a low effective tax rate (ETR), where the income or expense may simply be taxed or deductible in a different period.
Therefore, the GloBE Rules take the current tax expense and deferred tax expense from the financial accounts and adjusts them.
Top-Up Tax Calculation
Once the GloBE ETR is calculated, if this is less than the 15% global minimum rate, the amount of top-up tax needs to be calculated. The top-up tax percentage (ie the amount by which the ETR is less than 15%) is multiplied by GloBE income for the jurisdiction after a deduction for the
Substance-Based Income Exclusion.
This is a reduction in the GloBE profits based on the amount of tangible assets and payroll costs in a jurisdiction.
A QDMTT is a domestic minimum tax that operates in a similar way to the GloBE rules. Many jurisdictions are implementing a QDMTT to ensure that they retain taxing rights over any low taxed profits of entities in their jurisdiction.
Who Pays the Top-Up Tax (and Where)?
If, after all this, there is top-up tax payable, then the question arises who is going to pay the tax?
We’ve already established that the top-up tax calculation is based on a jurisdictional approach. You may think that the top-up tax would therefore be paid to that jurisdiction, however, that is not how the GloBE Rules work.
The rules aren’t just designed to subject to MNEs to a 15% minimum effective tax rate, they are also partly designed to end the so called ‘race to the bottom’ with jurisdictions competing on inward investment by offering lower rates of corporate income tax via tax credits and tax incentives.
The GloBE Rules allocate top-up tax to jurisdictions using two main rules, an Income Inclusion Rule, and an Under-Taxed Payments Rule.
The
Income Inclusion Rule is the primary method of accounting for top-up tax under Pillar Two. The general rule is that an Ultimate Parent Entiry (“UPE”) is required to apply the Income Inclusion Rule (IIR) where it owns an ownership interest in a low-taxed constituent entity at any time during a fiscal year.
In this case the UPE accounts for the top-up tax in its jurisdiction providing that jurisdiction applies an IIR.
If it doesn’t then the right to account for the tax flows down the group to the next parent company where there is an IIR.
Special rules apply to certain intermediate parent companies and the partially-owned parent companies (POPEs).
The
Under-Taxed Payments Rule (UTPR) operates as a backstop to the Income Inclusion Rule (IIR) so that if not all top-up tax is allocated under an IIR (or for instance if there was no IIR in the relevant jurisdiction), the liability to account for the top-up tax falls on the group entities based on a ratio based on the number of employees and the value of tangible assets in their jurisdictions.
Special Rules
The Model Rules include specific provisions to deal with situations that may result in inaccurate ETRs and top-up tax if the general rules applied.
In many cases these seek to reconcile the domestic tax treatment of these entities with the GloBE rules and ensure that any impact on the top-up tax calculation does not hinder the application of the GloBE rules.
For example, under the general GloBE Rules, an MNE group’s share of the income of a Joint Venture (JV) that it did not control would not be brought into account as the JV is not consolidated on a line-by-line basis as is required by Article 1.2 of the
OECD Model Rules.
Therefore, there is a separate rule for JVs to address this.
GloBE Elections
There are a number of elections available to MNE groups under Pillar Two, including:
The Model GloBE Rules
The Model GloBE Rules apply all of the above (and more).
They are split into a series of Articles:
Article 1 – addresses the scope of the rules (ie which MNE Groups are subject to the rules)
Article 2 – provides for the IIR and the UTPR and who actually pays the top-up tax (and where)
Article 3 – the calculation of GloBE income (ie taking the financial accounting profit or loss and adjusting it for GloBE income purposes)
Article 4 – calculating adjusted covered taxes (the tax figure used in the ETR calculation)
Article 5 – this governs the calculation of the ETR and the top-up tax
Article 6 – special rules for corporate reconstructions
Article 7 – special rules for investment funds and other special regimes
Article 8 – administrative rules
Article 9 – certain transitional rules
Article 10 – definitions
How to Apply the GloBE Rules
We cover the detailed application of these rules in our ‘Pillar Two Detailed Analysis’ sections, however, in terms of a (very) broad overview, the operation of the rules is as follows:
- Identify whether the MNE group is within the scope of the Pillar Two GloBE rules
- Identify entities (including PE’s) that the MNE group has in a jurisdiction
- Ascertain the type of entity (eg a constituent entity, a PE, a tax transparent entity, a reverse hybrid entity, a hybrid entity, investment entity etc)
- Calculate the profits of those entities for Pillar Two purposes (referred to as GloBE income)
- Consider the de-minimis rule
- Consider the transitional CbCR safe harbour
- Calculate the taxes that relate to those profits for Pillar Two purposes (referred to as Adjusted Covered Taxes) taking account of the allocation rules
- Calculate the taxes and profits per jurisdiction using a jurisdictional approach (note that does not apply to investment entities or minority-owned entities/groups)
- Calculate the Pillar Two GloBE ETR for the jurisdiction by dividing the total taxes by the total profits.
- If the Pillar Two GloBE ETR is less than 15%, subtract the ETR from 15% to determine the top-up tax percentage
- Deduct the substance-based income exclusion from GloBE income (unless an election is made not to). This is effectively 5% (increased under transitional rules) of tangible assets and payroll costs in the jurisdiction. This is referred to as ‘excess profits’.
- Apply the top-up tax percentage to excess profits
- Add any additional tax
- Deduct any qualifying domestic minimum top-up tax
- Attribute the top-up tax to the entities in the jurisdiction
- Apply the income inclusion rule or undertaxed payments rule
