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Qualifying Domestic Minimum Top-Up Tax

Qualifying Domestic Minimum Top-Up Tax

Table of Contents

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 draft legislation released to date, only the Netherlands includes a QDMTT.

Chapter 3 of the 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.

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 the 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

This is because the substance-based income exclusion is taken into account in the formula above when calculating excess profits.

This is easier to explain by using an example.

Example

Domestic Tax Position

Let’s assume a country levies a domestic top-up tax.

Income in the jurisdiction is 1,000,000 euros.

Adjusted covered tax is calculated under the domestic implementation of the GloBE rules as 100,000 euros. There is therefore an ETR of 10%.

The Substance-Based Income Exclusion is 200,000 euros.

Under the domestic top-up tax excess profits are 800,000 euros (1,000,000 – 200,000).

Domestic top up tax is therefore 5% (15%-10%) * 800,000 = 40,000 euros.

The total tax is 140,000 euros.

If the Domestic Top-Up Tax is a QDMTT

In this case covered tax is 100,000 euros. The top-up tax calculation is:

5% * 800,000 = 40,000 – 40,000 (QDMTT) = 0

Treating the domestic top-up tax as a QDMTT eliminates any top-up tax under the GloBE rules.

If the Domestic Top-Up Tax isn’t a QDMTT

The position is different if the domestic top-up tax isn’t a QDMTT, as the domestic top-up tax is simply added to covered taxes.

As such, covered taxes would 140,000 euros and income would be 1,000,000 euros. The GloBE ETR
would then be 14%.

The GloBE top-up tax calculation would be:

800,000 * 1% (15%-14%) = 8,000 euros.

This illustrates that if a domestic minimum tax doesn’t meet the requirement to be a QDMTT the tax rate would need to be higher to fully cover the top-up tax which would be charged under the IIR or UTPR.

In this case, the jurisdiction applied a minimum domestic tax of 15% but due to the substance-based income exclusion, this did not fully cover the top-up tax liability.

The rate would therefore need to be above 15% to fully offset any top-up tax under the GloBE rules.

FAQs

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.

A QDMTT is a Qualified Domestic Minimum Top-Up Tax as defined in Article 10 of the OECD Model Rules.

The QDMTT is the final stage of the top-up tax calculation. Therefore the domestic tax paid under the QDMTT reduces any Pillar Two top-up tax. 

A QDMTT would be enacted in domestic law of individual jurisdictions. There would also need to be separate legislation to implement the Pillar Two GloBE Rules

It depends. In order to be a QDMTT a domestic top-up tax would need to use the same approach as the general Pillar Two calculation. However, differences in accounting standards between the UPE and the domestic entity could still result in top-up tax after the offset of the QDMTT.

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