Introduction
According to a guide developed by the International Institute for Sustainable Development (IISD), the Pillar Two Global Anti-Base Erosion (GloBE) minimum tax proposal will have an impact on numerous countries, regardless of whether they take action within their own borders. The GloBE initiative establishes a reservoir of potential tax revenues from the incomes of corporate multinational entities that fall under its scope. These revenues will be collected by countries participating in GloBE (countries where a part of the multinational enterprise group operates) whenever the effective tax rate of an entity (or entities) within the group in a specific country goes below 15%. Some domestic tax strategies aimed at attracting and retaining foreign investment may lose their effectiveness as a consequence. Additionally, the effects of GloBE might not be straightforward and could indirectly influence tax policy reforms, even if a country doesn’t adopt GloBE itself.
The GloBE regulations consist of a pair of interconnected domestic rules:
Income Inclusion Rule (IIR): This rule enforces an additional tax on a parent entity (Resident State) for the low-taxed income generated by one of its subsidiary entities in a source state.
Undertaxed Payment Rule (UTPR): Under this rule, deductions might be disallowed or an equivalent adjustment may be required if the low-taxed income of a subsidiary entity is not subjected to tax as per the IIR.
These rule implementations will therefore impact both members of the Inclusive Framework and those outside of it.
The Inclusive Framework has reached a consensus that the GloBE rules will be treated as a unified approach. This signifies that members of the Inclusive Framework are not obligated to adopt the GloBE rules. However, if they opt to integrate these rules, they commit to executing and overseeing the regulations in a manner that aligns with the outcomes outlined in Pillar Two. This alignment encompasses adhering to the model rules and guidance endorsed by the Inclusive Framework. Furthermore, members of the Inclusive Framework agree to acknowledge the utilization of GloBE rules by other member countries. This includes consensus on the sequence of rule application and the utilization of any collectively established safe harbours.
It is against this backdrop that ATAF (African Tax Administration Forum) has formulated a recommended method for crafting domestic legislation related to Minimum Top-up Tax.
The Mechanics of GloBE (Global Anti-Base Erosion) Rules
The GloBE (Global Anti-Base Erosion) rules are a part of the broader international tax framework aimed at preventing multinational corporations from shifting profits to low-tax jurisdictions or eroding their tax base. The goal is to ensure that corporations pay a minimum level of tax regardless of where they operate.
Income Inclusion Rule (IIR): The IIR is effectively a backstop rule. Under this rule, if a subsidiary or a constituent entity of a multinational corporation is subject to tax in a foreign jurisdiction at a rate below the specified minimum (usually 15%), the parent company’s home country may impose an additional tax on the income of that subsidiary. This additional tax is known as the “top-up tax” and is designed to bring the effective tax rate on that income up to the minimum level.
For example, if a subsidiary’s income is subject to a foreign tax rate of 10%, the parent company’s home country may impose a top-up tax to ensure that the effective tax rate on that income is at least 15%. The top-up tax bridges the gap between the foreign tax rate and the minimum tax rate.
Undertaxed Payment Rule (UTPR): Undertaxed Payment Rule (UTPR) comes into play when the constituent entities within a multinational group subject to scrutiny fail to meet a minimum Effective Tax Rate (ETR) of 15% (in the absence of a Qualified Domestic Minimum Tax (QDMT) and no supplementary top-up tax is remitted based on an Income Inclusion Rule (IIR) in a different jurisdiction.
The fundamental concept behind the UTPR is that it functions as a safeguard. It upholds the primary prerogative of either;
- a relevant source country to prevent the activation of an IIR through a QDMT, OR
- the home country of the ultimate parent entity to gather the complete top-up tax, should it opt to do so. Simultaneously, it allows intermediary countries to collect the top-up tax in instances where other eligible jurisdictions opt not to undertake this responsibility.
Subject to Tax Rule (STTR): Countries that adopt GloBE may contemplate incorporating a subject-to-tax rule (STTR) if their tax treaties have withholding rates lower than the agreed-upon minimum rate of 9%. The STTR modifies the outcomes of existing tax treaties by enabling source countries to levy an additional top-up tax rate in conjunction with the existing treaty rate, when the gross income paid is taxed in the recipient’s country at a rate below 9%. As currently outlined, the STTR would exclusively apply to specific deductible payments made between affiliated entities. These payments typically encompass interest and royalties, while leaving unchanged the tax rate for other types of payments like those relating to services, capital gains, or offshore indirect transfers.
Qualified Domestic Minimum Tax: The GloBE regulations also provide endorsement for the adoption of domestic minimum taxes. Embracing GloBE’s Qualified Domestic Minimum Tax (QDMT) safeguards the initial taxation authority for the country of origin (Source State), thereby altering the jurisdiction responsible for collecting the supplementary GloBE Top-Up Tax from a nation implementing (Resident State) Income Inclusion Rule (IIR) or Undertaxed Payment Rule (UTPR) to the country where the income is generated.
The OECD has affirmed that QDMTs will be recognized as entirely offsetable against any financial obligation under GloBE. Recent administrative guidance from the OECD Inclusive Framework has affirmed that the priority for source countries’ QDMTs prevails over taxes at the shareholder level and will be accepted as creditable against taxes levied at the shareholder level by the parent country, just like other source country domestic taxes.
Other key mechanical aspects of GloBE rule include;
Covered Taxes: The computation of the top-up tax for each Constituent Entity within a country begins with Covered Taxes. These Covered Taxes encompass income taxes that are documented in the financial statements of the respective Constituent Entity, with specific modifications.
The determination of a Constituent Entity’s Effective Tax Rate (ETR) is intricate due to GloBE’s inclusion of taxes withheld from income payments (such as interest, royalties, and services) as Covered Taxes for the recipient entity.
Additionally, taxes withheld from distributions are considered Covered Taxes for the distributing entity, and certain shareholder-level taxes pertaining to unreleased earnings of a subsidiary are treated as if they were paid by the subsidiary (rather than the shareholder). Consequently, GloBE computes the ETR of a Constituent Entity by referencing a blend of its real (domestic) corporate income taxes documented in financial statements, subject to specific adjustments.
Lastly Substance-Based Income Carve-Out: This characteristic serves to exclude specific types of income from the calculation of the top-up tax, thereby diminishing the impact of GloBE on Constituent Entities that fall within its scope and possess income derived from substantial business activities. This reduction is linked to the tangible investment and payroll expenditure of these Constituent Entities within the source country. In essence, when a Constituent Entity with low-taxed status demonstrates tangible assets or payroll-related costs, the portion of income subject to GloBE’s top-up tax is reduced. If the Effective Tax Rate (ETR) remains below 15%, the income that falls under GloBE is lessened by this Substance-Based Income Exclusion (SBIE). The net effect is a reduction in the extent of the imposed top-up tax.
According to the OECD, the SBIE empowers jurisdictions to “maintain tax incentives that decrease taxes on routine profits stemming from substantial business activities, all while avoiding the activation of supplementary GloBE top-up tax.” In the end, the SBIE is established at 5% of the carrying value of tangible assets and 5% of payroll expenses. However, during a transitional period of ten years, the applicable rates are set at 8% and 10% respectively.
Author: Eddie Opiyo