We also explore further complexities in our recent podcast, 'What could the global minimum tax mean for you?', where we discuss the political reaction to the rules, current views on implementation timelines, some complexities we see in applying these rules practically, and what businesses can do now to get ready for the introduction of Pillar 2.
What could the global minimum tax mean for you?
Background and new model rules
Pillar 2 aims to ensure that applicable multinationals pay a minimum effective corporate tax rate of 15%. The goal is to end the ‘race to the bottom’ on tax rates worldwide, under which countries are competitively cutting corporate taxes to attract businesses and hence forcing all countries to cut taxes to compete. Pillar 2 would also make it much harder to minimise tax by recording profits in low tax jurisdictions and costs in high tax counterparts.
The OECD provided pivotal information on the application of Pillar 2 in December 2021, with the release of its ‘model rules’. The model rules provide details on two interlocking measures, the income inclusion rule (IIR) and the undertaxed payment rule (UTPR), under which income taxed at less than 15% would be targeted for additional taxation. The IIR imposes a top-up tax on the ultimate parent entity of a low-taxed foreign subsidiary. The UTPR seeks to deny deductions, or take similar actions, with respect to deductions where low tax members of a group are not subject to the IIR.
Pillar 2 rules also include a subject to tax rule (STTR), This permits source jurisdictions to withhold tax on certain types of related-party payments (such as royalties) when such payments aren’t subject to a minimum tax rate. Additional information on the STTR will be made public later this year.
In an ambitious timeline, the OECD Pillar 2 rules are due to be passed into national legislation and then go live from the beginning of 2023. But with so much for legislators and businesses to put in place in such a short space of time, some jurisdictions may push back on 2023 implementation.
Implementation of Pillar 2 in the US. is currently stalled as a result of the difficulties facing President Joe Biden’s ‘Build Back Better’ (BBB) bill The US already employs a minimum tax – the global intangible low-taxed income (GILTI) – but it is not compliant with Pillar 2. The BBB legislation would amend GILTI to apply the tax on a country-by-country basis and increase the GILTI effective tax rate to 15.8%. Many lawmakers hoped the ultimate enactment of the BBB bill would largely bring the GILTI regime into conformity with Pillar 2.
While the BBB passed the House of Representatives in November 2021, the bill is stalled in the Senate, in large part due to that chamber’s 50-50 split between Democrats and Republicans. This even split means that Democrats must have complete unanimity in the Senate to pass legislation. Democrats have been unable to reach this threshold, largely due to pivotal Senate holdout Joe Manchin of West Virginia. Senator Manchin broke off negotiations over the BBB at the end of 2021, but recently he and President Biden have discussed resurrecting key pieces of it, including international tax reform. Thus, international tax legislation is certainly still possible this year, though there are significant hurdles.
If Democrats cannot pass legislation this year, President Biden will be forced to work with a new Congress in 2023. Recent polling suggests there is a very good chance Republicans could win the House and possibly the Senate. Republicans are unlikely to support the international tax provisions in the BBB without significant changes. Bipartisan international tax legislation could prove difficult, though the looming Pillar 2 deadline could help spur action.
With a current headline rate of corporate tax of 19%, which is due to go up to 25% in 2023, the UK government has broadly welcomed the interdiction of a global minimum tax.
The UK tax authority (HMRC) is carrying out consultations to help determine how the rules will be enacted and implemented in practice. Now that the UK has left the EU, the provisions could differ from the EU directive. A key proposal is the possible introduction of a domestic minimum tax alongside the Pillar 2 rules. In broad terms, this would ensure that any possible IIR is collected by the HMRC rather than the ultimate parent jurisdiction.
The Pillar 2 rules are due to be implemented from April 2023. But many companies are concerned that this leaves too little time for passing the legislation, issuing guidance and putting the necessary business processes in place. There therefore may be a delay.
United Arab Emirates
The UAE is undergoing a major overhaul of tax policies as the federal state brings its previously limited tax landscape into line with prevailing international regulations. Following the roll-out of FATCA and CRS, the UAE has introduced BEPS-aligned substance rules and country-by country reporting.
The next stage is the planned introduction of corporate tax and transfer pricing regulations, which are due to be effective from June 2023. While the legislation has yet to be published, the proposed standard headline corporate tax rate is 9%. In addition, official communications have included reference to a different rate for ‘large multinationals’ in line with the OECD guidelines. This can be construed as a move towards OECD Pillar 2.
Singapore is a signatory to the ‘inclusive framework’ and would therefore be obliged to bring taxation into line with OECD Pillar 2. But the question of whether this is something Singapore would have chosen otherwise remains open.
There are currently around 1800 multinationals with consolidated revenues of over €750 million in Singapore. While the country’s headline corporate tax rate is 17%, an array of reliefs and reductions mean that most of this 1800 are currently paying less than 15%. The impact of Pillar 2 on Singapore could therefore be significant.
Tax incentives have helped Singapore to attract investment. But a peer review conducted in 2015 concluded that the most common tax incentives are not harmful tax practices. The country has always applied rigorous substance rules and many of these will continue. But under Pillar 2, Singapore would now be subject to a different set of formulaic substance based carve-outs. This could end up being just another layer of rules for rules sake.
Less attention has focused on what would happen if Singapore followed the UK in considering a domestic minimum tax alongside the OECD measures. As these are controlled foreign company (CFC) rules without the activity carve-out, they could turn the country’s source- based system of taxation on its head.
As a high tax economy (average tax rate of 30%), there is strong political backing for a measure that would reduce the differential and potential disadvantages when competing against low tax jurisdictions. The German government also sees these global rules as a welcome alternative to the patchwork of anti-avoidance provisions that have been springing up in different markets worldwide.
But German multinationals are calling for a simplification of the model rules to reduce the cost and administrative burden. Many are also concerned about how little time they may have to prepare for the overhaul ahead. There is therefore some talk of delaying the start date until 2024.
When implementation comes, it will be based on the EU directive. This is currently the focus of intense discussions among member state finance ministers. With a number of technical and political issues still outstanding, ministers failed to reach agreement on the directive at their March 2022 meeting.
With the clock ticking, the original timeline for the EU directive and subsequent legislation may be difficult to meet. But even if implementation is pushed back until 2024, many German businesses are worried that the EU will introduce Pillar 2 before other major economies follow suit. The resulting misalignment could heighten the risk of double taxation and disputes.
With a corporate tax rate of 12.5%, the 15% minimum could erode Ireland’s tax advantages. Nonetheless, Irish policymakers have broadly welcomed the Pillar 2 agreement as it removes the possibility of even higher increases. At 15%, the tax rate would also still be competitive when compared to rising rates in the UK, and possibly the US.
In addition, the existing 12.5% rate will be retained for groups with global turnover of less than €750 million. Only around 1,500 Irish businesses out of around 160,000 will fall into the net. However, corporate tax is hugely important to public finances in Ireland (22% of tax receipts). With the combined Pillar 1 and Pillar 2 proposals set to reduce tax revenue by up to €2 billion a year, the government may need to raise corporate tax to make up for the shortfall.
Like other EU states, Ireland’s domestic legislation will follow the EU directive. As outlined in the previous update for Germany, the directive is yet to be agreed and could be subject to delay.
The Italian government supports Pillar 2. But while discussions on tax reform are ongoing, they don’t include international taxation. This is a missed opportunity to create a modern and attractive tax system for multinationals.
When legislation on Pillar 2 does come, it will follow the EU directive. The big question is timing. If implementation does start in 2023, many Italian businesses are concerned that this leaves little time to assess the impact and properly prepare.
The Pillar 2 rules are complex in themselves. Businesses also need to work out how they interact with other provisions in areas such as transfer pricing and controlled foreign companies (CFC) regulations. In turn, Pillar 2 requires considerable international agreement over application and dispute resolution mechanisms. Without international co-ordination, successful implementation and operation of the rules are at risk.
In principle, the Dutch government has welcomed Pillar 2 as an opportunity to curb tax avoidance globally. Estimates also suggest that the government’s tax receipts could increase as a result.
But concerns over practical application remain. Only around 3000 Dutch multinationals are expected to fall into the scope of Pillar 2. But many more may need to assess whether they are liable. While legislation will follow the EU directive, the Dutch government may look for ways to simplify the model rules and ease the administrative burden on affected companies.
The way forward
With so many aspects of Pillar 2 still to be clarified in different countries worldwide, it’s important to keep a close eye on legislative developments and their potential impact.
It may be difficult to enact and implement Pillar 2 measures within the ambitious 2023 target. We may therefore see delays in some jurisdictions. But you shouldn’t bank in them. There is considerable political and societal pressure to stick to the 2023 timeline, even if this puts pressure on businesses. It’s therefore important to model the potential implications well in advance of the proposed 2023 effective date.
If you would like to discuss any aspect of Pillar 2 and how it may affect your business in further detail, please contact one of the authors below or speak to your local Grant Thornton expert.