On 17 July 2023, the OECD (i.e. the Inclusive Framework, “IF”) published various new documents relating to the introduction of Pillar Two. Through the article that can be retrieved below, we would like to provide you with an initial overview of the main features of these documents. Please note that these regulations are quite comprehensive and highly complex; as a result, this overview makes no claims to completeness.
1. Global anti-base erosion (“GloBE”) Information Return (“GIR”)
In December 2022, the IF published a public consultation document with a detailed description of the contents of GIRs, or minimum tax returns. The IF > report published on 17 July 2023 following the public hearing process specifies which information and data points need to be included in the GIR. This reflects the IF’s goal of creating a standardised sample template for the minimum tax returns that have to be submitted to the respective local tax authorities (e.g. in accordance with section 73 of the discussion draft of Germany’s Minimum Tax Act (Mindeststeuergesetz, MinStG). Nevertheless, this shall not affect the national format of local tax returns or the setting of tax payments, which shall continue to be subject to the respective individual local legal situation (for more on this in Germany, see section 90 of the discussion draft of the MinStG).
On the one hand, the document provides tables that specify and explain the detailed information that must be provided in the reports, e.g. regarding the group structure, calculation of the top-up tax and, where appropriate, exceptions/simplifications that apply (e.g. temporary safe harbours).
On the other hand, during a transitional period, a simplification is allowed under which this information can be reported on an aggregate basis for a jurisdiction rather than separately for each constituent entity. However, that applies only to jurisdictions in which either no top-up tax is due or in which – if such a top-up tax is due – at least it is not necessary to allocate such tax to various constituent entities. Timewise, this simplification is limited to financial years beginning on or before 31 December 2028 and not ending after 30 June 2030.
The transitional period is intended to give MNE Groups operating internationally time to adjust their accounting systems and to set up processes that make it possible to collect data for each constituent entity.
During the initial years of application of these rules, tax administrations should use their experience from auditing and compliance with the requirements to assess the scope and quality of the information received as part of the GIRs.
Efforts should also be made to check whether some simplified data collection processes could be applied on a permanent basis for each constituent entity. In addition, the IF could also examine additional permanent safe harbours and simplifications, e.g. relating to tax consolidated groups that are not yet covered by a reporting simplification (for example for domestic tax groups).
The document also specifies the following rule order for distributing the information contained in the GIR to the respective local tax authorities:
- The jurisdiction in which the ultimate parent entity (“UPE”) is domiciled receives the entire GIR, along with all information.
- Jurisdictions allocated taxation rights pursuant to GloBE rules (including a domestic top-up tax) for low-taxed income of the MNE Group shall receive those sections of the GIR relating to calculation of the effective tax rate and the top-up tax (and allocation thereof to the respective constituent entities), to the extent this is relevant for exercising the jurisdiction’s taxation right.
- All other jurisdictions in which the MNE Group’s constituent entities are domiciled shall receive general information (including on the group structure under corporate law) that contains the data points required for them to check whether they are entitled to a right of taxation (including a domestic top-up tax) for low-taxed MNE Group income.
The IF also announced that it is continuing to work on a framework for agreements under international law regarding automated mutual exchanges of information on minimum tax returns between the competent tax authorities. This is to be supported by a technical solution (XML schema) that will make it possible to exchange information digitally.
Inasmuch as the first minimum tax returns for financial year 2024 do not have to be submitted until 2026, we are still awaiting the specific design of minimum tax returns at national level. Overall, it is a positive sign that the IF is already providing specific instructions on the information that will have to be submitted. This will allow the companies affected to start identifying and considering these data points now while the Pillar Two Compliance Framework is being set up.
2. Agreed Administrative Guidance (“AAG”)
In February 2023, the IF published an initial AAG paper which is meant to facilitate or simplify the interpretation and application of the OECD Model Rules from December 2021. The AAG items are to be understood as amending or supplementing the OECD Commentary from March 2022. It was in this spirit that, on 17 July 2023, the IF published >additional rules that likewise must be followed when applying the Pillar Two rules. In addition, the IF announced that in future, it will publish additional AAG rules and a consolidated version of the AAG.
Below, we present an overview of some individual aspects of the AAG dated July 2023, summarised under keywords.
2.1 Currency conversion aspects
MNE Groups operating internationally typically include constituent entities in different currency zones, meaning that currency conversion issues also play a significant role in the accounting used for financial reporting purposes. Beginning in 2024, this shall apply, mutatis mutandis, to the adoption of Pillar Two, since it raises the question of which currency the top-up taxes will be calculated and paid in and how to deal with changes in exchange rates. Practical work on projects demonstrates that these issues are particularly complex.
In response to this, the IF stipulates the following approaches:
- The top-up tax should always be calculated based on the currency that is used to prepare the MNE Group’s consolidated financial statements. Therefore, for the purposes of Pillar Two, calculations shall be based on the currency conversions already made for financial reporting purposes (i.e. prepared in accordance with the German Commercial Code (Handelsgesetzbuch, HGB)).
- If certain amounts calculated for financial reporting purposes have not already been converted at the level of the respective constituent entity, a separate currency conversion must be performed for Pillar Two purposes only. Such conversion must then follow the requirements for currency conversions stipulated in the HGB (e.g., IAS 21 for groups applying IFRS).
- When converting tax payment amounts (e.g. in order to receive a local tax credit for a domestic top-up tax paid abroad), in principle every country can determine its own exchange rate; however, it must be “reasonable” and must relate to the financial year in question (e.g., average exchange rates or exchange rates on the balance sheet date or on the payment date).
- In each case, to convert threshold values stipulated in the OECD Model Rules (e.g., the EUR 750 million revenue threshold), the exchange rate to be used is the rate applicable for December of the prior year, which in the euro zone is to be determined on the basis of the exchange rates published by the European Central Bank.
2.2 Treatment of tax credits
Previous work with the OECD Model Rules has shown that treatment of tax credits and refunds under the HGB is quite varied, as the accounting rules do not include unambiguous standards relating to these. Moreover, the local legal structure of tax credits is quite varied as well. This mixed picture has resulted in many complex issues relating to application of the law, with situations having been identified – in particular as regards transferable tax credits – in which the unfavourable treatment of certain tax credits compared to qualified refundable tax credits (“QRTCs”) does not appear to be justified. This applies, in particular, to the new tax credits introduced this year in the USA (under the Inflation Reduction Act); although not refundable, they can effectively be compared to QRTCs due to the economic impact of their “marketability”.
Against this backdrop, the AAG provides some clarifications regarding treatment of tax credits for Pillar Two purposes. In particular, a new definition of “favoured” tax credits is being introduced; these do not reduce the tax expense, but rather are “only” to be included as income and therefore reduce the effective tax burden less than unfavoured tax credits. This new definition encompasses so-called marketable transferable tax credits which, because of their transferability and marketability, effectively mean that countries which grant such tax credits actually disburse the corresponding amounts. In other words, the respective government budgets are effectively burdened by these tax credits; therefore, these tax credits should also be favoured under Pillar Two, although such tax credits are not (formally) tax credits that are refundable within four years of the accrual of such claim. The AAG items explain the criteria for transferability and marketability; the latter are effectively based on the prices at which the tax credits are transferred between/among external third parties.
2.3 Substance-based income exclusion (“SBIE”)
According to article 5.3 of the OECD Model Rules, affected companies may reduce their tax base (and therefore effectively reduce their tax burden) through certain SBIEs. This satisfies the Pillar Two goal of avoiding the unjustified “shifting” of the tax base to low-tax countries. If the company has sufficient resources (in the form of eligible employees or eligible tangible assets) in a relevant country, then a flat-rate routine profit that these can generate shall not be subject to the top-up tax.
However, with this in mind, pursuant to article 5.3 of the OECD Model Rules, the SBIE calculation is basically limited to the eligible employees and eligible tangible assets located in the same country as the constituent entity to which these assets are attributable. To date, it is still unclear, as far as cross-border situations are concerned, how to deal with eligible employees and eligible tangible assets that will be “deployed” in different countries within one year (e.g. employees who work for the constituent entity in different countries due to travel activities). The AAG governs some simplification requirements in this regard, e.g. the following: if an employee can be shown to be working more than 50% of the time in the same country as the constituent entity, then the corresponding eligible payroll costs for the employee (“payroll carve-out”) can be reported at 100%. On the other hand, if the employee spends 50% or less of his/her time working in the same country as the constituent entity, then the payroll costs may only be reported on a pro-rata basis (e.g. if he/she works only 30% of the time in the country, then only 30% of the payroll costs may be reported).
In the case of lease transactions, it was not clear to which party (the lessor or the lessee) the SBIE for the eligible tangible asset in question was to be allocated, and in what amount. The AAG provides clarity here, stipulating that, in order to avoid shortfalls in tax revenue, there must be no “double” allocations. However, there may be a “pro-rata” allocation; i.e. part to the lessee and part to the lessor. This applies, for example, to operating leases, in which the lessee from an economic standpoint is not allocated the entire “value-in-use” of the eligible tangible asset.
It also clarifies that an MNE Group does not necessarily have to identify the entire SBIE for a jurisdiction. Because use of the SBIE is optional, the MNE Group may also identify and apply only a partial SBIE, if this is deemed appropriate for avoiding disproportionate expense (e.g. expenses for independent employees satisfying SBIE criteria may be left out for the sake of simplification).
2.4 Qualified domestic minimum top-up tax (“QDMTT”)
To supplement the February 2023 AAG, the just published AAG specifies some elements that a domestic top-up tax must contain in order to qualify as a QDMTT. Such qualification is a prerequisite for crediting this domestic top-up tax against the primary top-up tax of the ultimate parent entity (for more on this, see section 51(1) of the discussion draft of Germany’s MinStG), as well as for applying the QDMTT safe harbour (for more on this, see section 76 of the discussion draft of Germany’s MinStG, as well as section 2.5 below).
In connection with this, the AAG examines, e.g., the following aspects:
- Application of the QDMTT to constituent entities in which the ultimate parent entity holds less than 100% (including joint ventures);
- Allocation of the QDMTT to different constituent entities;
- Application of the QDMTT to stateless constituent entities;
- Application of the QDMTT to transparent entities which are the ultimate parent entity;
- Application of the QDMTT to permitted distribution systems;
- Application of the QDMTT to investment entities;
- Application of the QDMTT to hybrid constituent entities;
- Application of the QDMTT in cases in which, according to the OECD Model Rules, the year of transition differs from a local transition year for QDMTT purposes;
- Application of the QDMTT in cases of subordinate international activity;
- Currency conversion issues involving the QDMTT;
- Issues relating to the tax return obligation for the QDMTT;
- Limitation of creditability of the QDMTT if it is challenged (on constitutional grounds);
- Application of the general definitions in the OECD Model Rules relating to the QDMTT.
2.5 QDMTT safe harbour
To avoid double-counting the top-up tax – once for the purposes of the income inclusion rule (“IIR”) and once for the purposes of the QDMTT – a simplification is being introduced which also is already included in section 76 of the discussion draft of Germany’s MinStG. Accordingly, an MNE Group shall generally be excluded from the separate calculation for purposes of the IIR if a local QDMTT calculation exists. In other words: at the request of the constituent entity, which is subject to a reporting requirement, the amount of the tax increase for a tax jurisdiction shall be reduced to zero if, for the financial year in question, a qualified domestic top-up tax is levied that satisfies a generally accepted accounting standard of the ultimate parent entity or that is based on international accounting standards.
However, this applies only to “qualified” domestic top-up taxes (in this regard, please refer to the criteria indicated above under section 2.4). In addition, the following three standards must be fulfilled, cumulatively:
- The QDMTT must be calculated on the basis of certain generally accepted accounting standards.
- The QDMTT calculation must be consistent with the calculation in the OECD Model Rules (however, certain “aggravating” aspects of the QDMTT are innocuous, such as failure to grant the “de minimis exclusion” or the SBIE or a minimum tax rate higher than 15%).
- Administration of the QDMTT must satisfy the conditions of a continuous process of supervision (in this regard, a peer review process – the details of which are still to be determined – needs to be set up).
2.6 Transitional undertaxed profit rule (“UTPR”) safe harbour
Application of the secondary top-up tax (under the UTPR) shall be suspended temporarily if a corporate tax rate of at least 20% applies in the country in which the ultimate parent entity (“UPE”) in question of the MNE Group is domiciled. Timewise, this exception is limited to financial years beginning on or before 31 December 2025 but ending before 31 December 2026. This is a political “accommodation” in favour of the United States of America, whose multinational groups feared that they would be heavily burdened by the secondary top-up tax. This transitional period gives the USA the opportunity to adjust its national tax law (e.g. the GILTI Tax) in accordance with GloBE Rules.
3. Subject to tax rule (“STTR”)
As already stipulated in the “early development phase” of Pillar Two (e.g. in the OECD Blueprint report of October 2020), the IIR is to be expanded to include another taxation mechanism in order to prevent low taxation of certain types of income. The STTR satisfies this goal by allocating an additional right of taxation to the source jurisdiction for certain types of income if the income of the recipient in question is not subject to a sufficient minimum tax burden of 9% of gross income.
In this regard, on 17 July 2023, a >document was published that specifies which income is subject to the STTR (e.g. interest, licences, rents and fees for services), as well as the group of people affected. Basically, it includes payments between affiliated companies, whereby certain anti-abuse rules must also be satisfied in this regard. In addition, it specifies the tax rate at which the source jurisdiction may tax the income – taking into account the rate at which the recipient’s income is being taxed. Further, certain rules regarding exceptions are to be created under which the STTR does not apply (e.g. a not-yet-defined tax-free amount, taking into account considerations of materiality).
Members that apply a nominal corporate tax rate of less than 9% to interest, licences and other defined payments have undertaken to incorporate the STTR into their bilateral double-taxation treaties at the request of developing countries which are members of the IF.
The STTR is to take effect through bilateral adjustment of the respective double-taxation treaties concluded (by adding a new/separate article to the treaty). Alternatively, the STTR may also be implemented through a multilateral agreement.
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Overall, we will have to wait to see what further legal developments there will be and how the recently published rules will be interpreted, and we cannot exclude the possibility that local tax authorities and/or the courts will interpret and/or apply them in a different manner. In that regard, it is always advisable to enlist the help of local tax experts in order to obtain greater legal certainty.