Qualifying Domestic Minimum Top-Up Tax

Qualifying Domestic-Minimum Top-Up Tax, Generally 

Jurisdictions are free to introduce QDMTTs or not.

They are taken into account when calculating jurisdictional top-up tax under Article 5.2.3 of the OECD Model Rules, as jurisdictional top-up tax is calculated as:

Top-up tax % * excess profits + additional top-up tax-QDMTT

They therefore operate as a pound-for-pound reduction in any top-up tax liability charged by another country under either the IIR or the UTPR and are part of  the final stage in the top-up tax calculation. If the qualifying domestic top-up tax exceeds the amount of top-up tax payable there is no refund or credit available.

Whilst jurisdictions are not required to implement a QDMTT there is a clear incentive to do so.

This is because a QDMTT would ensure that any additional tax on economic activities in a jurisdiction that results from the Pillar Two minimum tax framework is to the benefit of the domestic jurisdiction.

In other words, businesses would in most cases pay the same level of tax on their profits whether there was a QDMTT or not, but rather than allow another country to collect that tax, a QDMTT would ensure the tax is paid to the domestic government.

If there was no QDMTT, the GloBE rules would mean that low-taxed profits would be topped up in foreign jurisdictions.

There would also be a simplification benefit for MNEs headquartered in a jurisdiction that would otherwise, be subject to the UTPR on their profits.

This would require MNEs to report tax liabilities to multiple jurisdictions and would inherently lead to an increased risk of disputes and could increase compliance costs through the MNE having to deal with audits from a number of different tax administrations.

What is a Qualifying Domestic-Minimum Top-Up Tax?

A qualifying domestic top-up tax is defined in Article 10 of the OECD Model Rules as a minimum top-up tax included in domestic law that:

• calculates the excess profits of constituent entities located in the jurisdiction in a way that is equivalent to the GloBE Rules;
• increases the domestic tax liability to the minimum rate on the domestic excess profits for a fiscal year; and
• is implemented and administered in a way that is consistent with the GloBE Rules and the Commentary.

Given the clear benefits for jurisdictions in implementing a QDMTT, many have already expressed a desire to do so, including the UK, Hong Kong, Switzerland and Singapore.

Of the detailed draft legislation released to date, only the Netherlands and Switzerland includes a QDMTT.

Chapter 3 of the Dutch draft legislation includes a qualifying domestic minimum top-up tax, to ensure that the Netherlands has taxing rights over Dutch low-taxed entities.

The method of incorporating this is relatively simple. It relies on the standard top-up tax calculation and then effectively provides that this is reduced by the domestic top-up tax which again is calculated under the GloBE rules.

It should also be noted that the OECD Report on Tax Incentives and Pillar Two, recommends jurisdictions look at implementing a QDMTT whilst they undertake an assessment of tax incentives that they offer to in-scope MNEs.

See our: QDMTT: Legislative Tracker

Designing a QDMTT

The OECD Administrative Guidance provides details on which aspects of the GloBE Rules need to be reflected in the QDMTT regime and which aspects don’t. 

In order to be a qualified domestic minimum top-up tax (QDMTT), a domestic minimum tax is generally required to follow the GloBE rules so that the calculation of the ETR and top-up tax is substantially the same. An MNE should be able to use the same data points for calculating its minimum tax liability that it uses for calculating its GloBE tax liability.

One option would be to just apply all of the GloBE rules with changes for the income inclusion rule (IIR) and under-taxed payments rule (UTPR) (as the IIR and UTPR mainly apply to the income of foreign constituent entities, whereas a QDMTT applies to domestic constituent entities).

However, it is beneficial to adapt the design of the QDMTT to reflect the domestic tax regime as otherwise this could exacerbate the complexity of a QDMTT and include provisions that aren’t even relevant to the jurisdiction (eg the stock-based compensation election would not be relevant if the jurisdiction did not allow companies to deduct the value of stock-based compensation based on the market value of the stock).

See: Designing a Qualified Domestic Minimum Top-Up Tax (QDMTT)

One key difference between a QDMTT and the standard Global Minimum Tax (eg the IIR and UTPR) is that CFC taxes are not included in the QDMTT ETR but they are included in the GloBE ETR. This could therefore lead to a lower QDMTT ETR and higher top-up tax. 

The reason CFC taxes are excluded from the QDMTT ETR is to avoid a ‘feedback loop’ where the QDMTT is creditable in the parent jurisdiction. For more information, including a worked example of the feedback loop, see Treatment of CFC Taxes: QDMTTs vs GloBE Rules.

Initial Phase Exemption for Domestic Minimum Taxes

Another consideration is whether there should be an exemption for a QDMTT during the initial phase. 

The New Zealand Pillar Two Consultation for instance provides that if an MNE group is headquartered in New Zealand, a QDMTT would not apply to it during an initial phase.

That is because any undertaxed New Zealand profits would not be subject to any other country’s UTPR or IIR during the period.

If the group is not headquartered in New Zealand, another country’s IIR could apply, so the rationale for a QDMTT (to allow New Zealand priority in collecting top-up tax on low tax New Zealand profits) would potentially still apply. 

The Importance of a Domestic Minimum Tax Qualifying as a QDMTT