As all the world knows by now, in October 2021, 136 countries in the OECD/G20 Inclusive Framework on BEPS agreed on the so-called Pillar One and Pillar Two proposals to change the taxation of large multinational enterprises. The new rules are meant to be implemented by 2023.
The first batch of new rules to be unveiled, on Dec. 20, 2021, were Model Rules regarding Pillar Two’s global minimum effective tax rate of 15% on so-called “excess profits” of multinationals with annual revenue of at least 750 million euros ($850 million). The Model Rules consist of 70 pages of highly technical provisions, including 10 full pages of definitions, all drafted with the intention of being ready for enactment into the domestic tax laws of the 136 countries that agreed to follow this so-called “common approach” to global minimum taxation. The Foreword to the Model Rules states that “the implementation of these new rules is envisaged by 2023.” That effectively gives countries a single year, 2022, to introduce and enact conforming legislation.
Consistent with this “big bang” approach to implementation, the European Commission immediately issued, on Dec. 22, 2021, a draft EU Directive based on the Model Rules, adapted to conform to EU legal requirements regarding non-discrimination. If approved by the Member States, the provisions of the Directive would be incorporated into their domestic laws and would take effect on Jan. 1, 2023, except for the “backstop” Undertaxed Payment Rule regime, which would begin to apply a year later, on Jan. 1, 2024. Multinationals within the scope with one or more group members located in an EU Member State would then be subject to the new rules.
The Model Rules provide for top-up taxation with respect to the income of any group member taxed at an effective rate of less than 15% under the normally applicable income tax rules. The primary method for achieving this top-up taxation is the so-called Income Inclusion Rule, which requires the ultimate parent entity of the multinational group to pay all of the deficiency for the entire global group. If a parent company is located in a country that has not enacted a qualifying income inclusion rule, the Undertaxed Payment Rule comes into play, requiring a country to deny deductions or otherwise adjust the tax liability of locally taxable group members to the extent necessary to increase their local tax liability to the amount of the total group top-up tax allocated to the country. A country’s allocation of global top-up tax is based on the country’s share of the group’s total employees and tangible assets located in countries that have enacted the Undertaxed Payment Rule provisions.
The top-up tax computation for each country includes a substance-based exclusion that allows a certain amount of income to be taxed at less than the minimum 15% effective rate. The excluded income is initially 10% of local payroll costs and 8% of the value of tangible assets used locally, reducing steadily over ten years to 5% of each of those bases.
The Model Rules use financial statement income as the base for computing group members’ effective tax rates, with certain adjustments. They also provide for the possibility that a country will enact a domestic minimum top-tax using the 15% rate and the same computation method with respect to income from operations in that country, in which case no top-up tax attributable to low-taxed income from that country would be allocated to other countries.
The Model Rules give rise to a host of interpretive issues, and the OECD has already promised to deliver a Commentary on the Model Rules during the first quarter of 2022. The elephant in the room, of course, is whether Congress will agree to amend U.S. law to conform to the Model Rules. The U.S. has its own global minimum tax regime—GILTI—but it is inconsistent with the Income Inclusion Rule provisions of the Model Rules in a number of respects. The OECD and the EU have indicated that they will discuss the conditions in which the U.S. rules would be considered compliant with the Model Rules going forward. Thus there continues to be uncertainty as to how US-based multinationals will be treated if the Model Rules are adopted by other countries but not by the U.S.
Another issue that appears to need clarification is whether the Model Rules will apply to private investment structures that yield at least 750 million euros of annual investment income—e.g., a 5% return on 15 billion euros of invested assets. The Model Rules contain carve-outs for non-profits, government entities, pension funds, and regulated investment funds and real estate investment vehicles that are owned by a number of unrelated investors, but there does not appear to be a carve-out for other types of private investment structures, e.g., a trust or foundation for the benefit of a family that holds its investments in special-purpose entities. This issue was addressed under the country-by-country reporting rules on the basis that such structures are not considered MNE groups with 750 million euros of income because applicable accounting rules do not require consolidation of the income of investment entities. The Model Rules, in contrast, arguably require a deemed consolidation of the income of all group members—other than those explicitly carved out—in the case of an Ultimate Parent Entity that does not prepare consolidated group financial statements.
There is no doubt that the implementation of the Model Rules will add greatly to the compliance burdens of large multinational businesses, if not to their actual global tax liability. The OECD intends to issue draft provisions on safe harbors next year, which it is hoped will help reduce the time and effort necessary to comply with these new rules.
This column does not necessarily reflect the opinion of The Bureau of National Affairs, Inc. or its owners.
Jeff VanderWolk is a partner at Squire Patton Boggs (US) LLP.
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