OECD releases 'Pillar Two' model rules for 2022 local introduction - minimum 15% international tax (2nd of 'two-pillar' response to digitalisation of economy)

The OECD has released detailed rules to assist countries to implement the second of a ‘two pillar’ reform of the international tax rules (addressing ‘digitalisation’ of the economy) – that is: ‘Pillar Two’. This 15% minimum global tax regime was agreed, in October 2021, by 137 countries and jurisdictions under the OECD/G20 Inclusive Framework on BEPS.

Pillar Two will apply to Multinational Enterprises (MNEs) with revenue above EUR 750 million. The rules create a “top-up tax” to be applied on profits in any jurisdiction whenever the effective tax rate – determined on a jurisdictional basis – is below the minimum 15% rate.

The latest release sets out what is termed a “precise template” to assist countries to bring the rules into domestic legislation by 2022.

This will involve rules that:

define the MNEs within the scope of the minimum tax;
set out a mechanism for calculating an MNE’s effective tax rate on a jurisdictional basis, and for determining the amount of top-up tax payable under the rules; and
impose the top-up tax on a member of the MNE group in accordance with an agreed rule order.

OECD Overview (Pillar two ‘in a nutshell’)

The Pillar Two Model Rules (also referred to as the “Anti Global Base Erosion” or “GloBE” Rules), released on 20 December 2021, are part of the Two-Pillar Solution to address the tax challenges of the digitalisation of the economy that was agreed by 137 member jurisdictions of the OECD/G20 Inclusive Framework on BEPS and endorsed by the G20 Finance Ministers and Leaders in October. They were developed by delegates from all Inclusive Framework member jurisdictions and agreed and approved by consensus.

The Pillar Two Model Rules are designed to ensure large multinational enterprises (MNEs) pay a minimum level of tax on the income arising in each jurisdiction where they operate. The rules run to about 45 pages with another 15 pages of definitions. They are drafted as model rules that provide a template that jurisdictions can translate into domestic law, which should assist them in implementing Pillar Two within the agreed timeframe and in a co-ordinated manner.

Scope – Taxpayers that either have no foreign presence or that have less than EUR 750 million in consolidated revenues are not in scope of the Model Rules.

15% ETR Top-up – Taxpayers in scope of the rules calculate their effective tax rate for each jurisdiction where they operate, and pay top-up tax for the difference between their effective tax rate per jurisdiction and the 15% minimum rate. Any resulting top-up tax is generally charged in the jurisdiction of the ultimate parent of the MNE.

Mid-year acquisitions etc – Taxpayers that have engaged in mergers or acquisitions during the year also need to consider the rules in Chapter 6.

Coordinated internationally – Chapter 8 provides an internationally co-ordinated approach to administering the rules.

Financial accounts based – Under Chapter 3, the income (or loss) is calculated based on financial accounts, which provides a base that is harmonised across all jurisdictions. Certain adjustments are needed to better align the financial accounts with tax purposes.

Tax attributable towards 15% test – Under Chapter 4, the tax attributable to that income is calculated. It includes income taxes, defined in a way to provide consistent and flexible recognition across a wide range of tax systems, but does not include non-income based taxes such as indirect taxes, payroll and property taxes.

Top-up tax – Chapter 5 then determines how much top-up tax is owed. The rate of tax owed is the difference between the 15% minimum rate and the ETR in the jurisdiction. That top-up tax percentage is then applied to the GloBE income in the jurisdiction, after deducting a substance based income exclusion. The substance based income exclusion reduces the exposure to the minimum tax and is calculated as a percentage mark-up on tangible assets and payroll costs.

Top-up liability – The primary rule is the Income Inclusion Rule (IIR). Under the IIR, the minimum tax is paid at the level of the parent entity, in proportion to its ownership interests in those entities that have low taxed income. Generally, the IIR is applied at the top, at the level of the ultimate parent entity, and works its way down the ownership chain.

Back-up rule – A liability to top-up tax for a member of an in-scope MNE group arises under two types of provisions contained in Chapter 2. The primary rule is the Income Inclusion Rule (IIR). Under the IIR, the minimum tax is paid at the level of the parent entity, in proportion to its ownership interests in those entities that have low taxed income. Generally, the IIR is applied at the top, at the level of the ultimate parent entity, and works its way down the ownership chain. Rules are also provided to allow the IIR to be applied by a parent entity in which there is a significant minority interest, to minimise leakage of low taxed income.

A backstop is needed to ensure the minimum tax is paid where an entity with low taxed income is held through a chain of ownership that does not result in the low-taxed income being brought into charge under an IIR. This backstop is the UTPR. This rule works by requiring an adjustment (such as a denial of a deduction) that increases the tax at the level of the subsidiary. The adjustment is an amount sufficient to result in the group entities paying their share of the top-up tax remaining after the IIR. The share of the top-up tax is calculated based on a formula, in proportion to the relative share of assets and employees. This helps to ensure the rule is administrable, but also attaches the adjustment to entities that are most likely to have the capacity to pay the required amount of top-up tax.

The same calculations under Chapter 5 are applied whether the top-up tax is being charged under the IIR or the UTPR, to ensure co-ordinated outcomes. However, given that there will typically be subsidiaries in several different jurisdictions, the UTPR requires a higher level of administrative co-operation, which underlines the importance of the standardised information reporting requirements contained in Chapter 8. It is also one of the reasons the UTPR is a backstop rather than the primary rule.