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Pillar Two GloBE Rules - Introduction

Table of Contents

Pillar Two evolved as part of the OECDs Base Erosion and Profit Shifting (BEPS) initiative.

Background to Pillar Two

The first real detail we had was in the October 2020 Pillar Two Blueprint. This is a lengthy read (at 244 pages) but gives useful background to the Pillar Two Rules and the intention behind some of the key provisions. Nevertheless this was just a consultation, and some aspects have since changed.
After the Blueprints, there was political agreement in the July 2021 and October 2021 OECD Statements. They were relatively brief but did outline the broad operation of both Pillar One and Pillar Two, as agreed by members of the Inclusive Framework.
On December 20, 2021 the OECD released the Model GloBE Rules for Pillar Two.  These are the basis of the Pillar Two Rules and represent what domestic jurisdictions should be aiming to enact into their local tax law to implement Pillar Two.
Finally, on March 14, 2022, the OECD released its Commentary to the Pillar Two Model GloBE Rules. Again, another lengthy read (226 pages), but the Commentary explains how the OECD sees the Model Rules applying.
Pillar Two was initially planned to generally apply from January 1, 2023, however, this has now been pushed back to January 1, 2024.

What is Pillar Two? 

Pillar Two consists of two main rules that seek to ensure that multinationals pay a minimum level of tax on their profits. The rules are:
The GloBE Rules are the main Pillar Two Rules. They apply a 15% minimum rate of tax on in-scope multinationals on their foreign profits.
In essence, the STTR is effectively a treaty-override provision. It allows a source state to tax the gross amount of interest, royalties and a defined list of other payments received by a connected company, up to a globally agreed 9% minimum rate, even if a relevant tax treaty only permits the source country to impose withholding tax on the payment at a rate below 9% or allocates exclusive taxing rights over the payment to the recipient’s country of residence.
Where a jurisdiction applies a tax rate on the receipt of relevant payments that is less than the globally agreed 9% minimum rate, the payer jurisdiction has the right to “top up” the tax payable with a withholding tax.
For example, if a jurisdiction applied a tax rate of 5% for royalty receipts, this would mean that the payer’s jurisdiction could collect a top-up tax of 4% on the payment.
The STTR, as a treaty-based rule, can only be implemented through bilateral negotiations and amendments to individual treaties or as part of a multilateral convention.
The 2021 Statements provide that members of the IF that apply nominal corporate income tax rates below the STTR minimum rate will implement the STTR into their bilateral treaties with developing country members of the IF when requested to do so.
Very little detail has been released on the STTR to date. A model treaty provision to give effect to the STTR is expected during 2022, along with a multilateral instrument for its implementation.
For more information on the STTR, see Subject-To-Tax Rule.

An Overview of the GloBE Rules

As stated above, the intention of the GloBE Rules is to ensure that a multinational entity (MNE) is subject to tax on its profits at a minimum 15% rate.
It does this 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.
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.
The amount of top-up tax payable is then reduced by any Qualified Domestic Minimum Top-Up Tax (QDMTT).
A QDMTT is a domestic minimum tax that operates in a similar way to the GloBE rules. Many jurisdictions are likely to implement 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.
These mainly apply to investment funds, joint ventures and other split ownership situations, and group reconstructions.
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

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 an overview, the broad operation of the rules is as follows:

  1. Identify whether the MNE group is within the scope of the Pillar Two GloBE rules
  2. Identify entities that an MNE group has in a jurisdiction
  3. Calculate the profits of those entities for Pillar Two purposes (referred to as GloBE income)
  4. Calculate the taxes that relate to those profits for Pillar Two purposes (referred to as Adjusted Covered Taxes)
  5. Calculate the taxes and profits per jurisdiction
  6. Calculate the Pillar Two GloBE ETR for the jurisdiction by dividing the total taxes by the total profits.
  7. If the Pillar Two GloBE ETR is less than 15%, subtract the ETR from 15% to determine the top-up tax percentage
  8. Deduct the substance-based income exclusion from GloBE income (unless an election is made not to). This is effectively 5% of tangible assets and payroll costs in the jurisdiction. This is referred to as ‘excess profits’.
  9. Apply the top-up tax percentage to excess profits
  10. Deduct any qualifying domestic minimum tax
  11. Attribute the top-up tax to the entities in the jurisdiction
  12. Apply the income inclusion rule or undertaxed payments rule

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