This article is written by Sumathi Wadlamudi, pursuing a Certificate Course in Advanced Corporate Taxation from LawSikho.
With most of the companies having multinational presence, many governments are facing the problem of loss of tax revenue as these multinationals plan to shift their profits to less taxed or nil taxed countries called tax havens. For this purpose multinationals often try to benefit from the gaps and lacunas present in various tax laws in force in various countries. This is referred to as base erosion and profit shifting (BEPS). Not only that, some countries may offer lower tax rates compared to others in order to attract foreign investments into various fields of manufacturing production and service operations in their jurisdictions.
This has triggered the idea of bringing into existence a concept called global minimum corporate tax. The purpose is to ensure that all the participating countries have to agree upon a common minimum rate of tax to be imposed on the taxable earnings of the multinationals whether or not they have physical presence of operations in a country, in order to prevent the shifting of profits to tax havens. Thereby it is possible to make the multinationals pay their fair share of taxes to the governments of countries wherever they have earned by offering their products and/or services. Most of the companies which may be affected by these rules are tech giants like Apple, Facebook, Amazon, NetFlix etc though they are proposed to be made applicable to other multinationals also.
It would be easy to understand this, if we go a bit more detailed into the earlier pronouncements of Organisation for Economic Co-operation and Development (OECD). As a first step, OECD came up with a BEPS package for implementing required changes in domestic tax laws and tax treaties of various countries which was facilitated by multilateral instrument (MLI). G20 countries also became part of the same and implemented it as a sign to accept and support the initiatives of OECD. OECD has established a group of all interested and committed countries to bring them at par with the Committee on Fiscal affairs and its subsidiaries along with the other international bodies and regional tax authorities. This group is collectively referred to as Inclusive Framework and has nearly 140 member countries as of now. Its main objective is to monitor and peer review the implementation of BEPS standards and to set standardised procedures to address BEPS and related issues.
Who initiated the idea?
OECD in Nov’ 2019 came up with some rules in the form of a Consultation paper which were classified into “Pillar One” and “Pillar Two”. While Pillar One deals with the tax rights and profit allocation, Pillar Two deals with global minimum alternate corporate tax. It has been proposed to require various governments to impose tax even if the companies don’t have physical presence within a particular jurisdiction but earn from operations in that jurisdiction, if profits are not subject to any tax or subject to tax at a very lower rate in any other country(s).
It also proposed to require the countries to stop their race to the bottom in order to attract the companies to start their operations in their jurisdictions. These rules were proposed to be made applicable not only to tech giants but also other multinationals who earn significantly from intangible assets like brands, brand names, trademarks etc. OECD sought suggestions and concerns of G20 nations on the proposed global tax system. These nations have responded positively because they too want to put an end to prolonged litigations on international tax issues with multinationals and also not ready to implement any unilateral measures suggested by many European countries like digital services tax.
Though the progress is a little slow, the topic is occupying the headlines again with the recent public address by the US Treasury secretary Janet Yellen which gave a clue about the US’s interest to be part of this global project. However, the absolute figures of minimum tax rates or slab levels are not decided upon yet, emphasis is on achieving consensus among various member countries to agree with proposals made by OECD.
What is global minimum corporate tax?
It means rate of tax/slab levels (which is/are yet to be decided upon) that is applicable to the multinationals to calculate taxes payable on the profits earned by them, irrespective of its physical presence within the jurisdiction of any country if the same is subject to tax in that jurisdiction at a rate lower than the effective tax rate.
What is the actual concept?
Once the consensus on the proposed rules has been achieved, all the participating countries have to impose an agreed minimum rate of tax/slab rates on the profits earned by the multinational corporations who earn from various jurisdictions even without the physical presence. If the rate of tax in force in any country (Effective tax Rate (ETR)) is less than agreed global minimum rate of tax, then the home country will have the right to impose higher rate of tax on such profits (also referred to as top-up rate) to compensate the benefit of low tax rate.
Further, it is proposed to reduce the trade relations and other support if any country opts to be out of the network of the countries accepting the proposed global minimum tax rate. So far, nearly 140 countries have been undergoing negotiations with respect to the proposed rules of OECD and are expecting to come up with finalised terms by mid 2021 as published in international tax journals and various newspapers.
How does it work?
Policy Note issued by the OECD deals with the issues to be addressed by the two pillars in a much detailed manner. Public consultation document released by OECD contains proposed methodologies to implement both the pillars. Pillar Two specifically deals with income inclusion, taxability of base eroding and profit shifting and global minimum corporate tax.
OECD has issued a Program of Work in order to give a detailed framework for implementation of Pillar Two. It clarifies that the member countries can implement any tax structure according to their preference. But, if the effective rate in any country is less than the agreed upon minimum rate of tax, then other countries in which any multinational operates irrespective of its physical presence can impose an additional rate of tax which is called top-up rate. This is referred to as the Global Anti-Base Erosion (GloBE) proposal. All the member countries have agreed to this proposal.
This proposal contains two complementing rules to be implemented to avoid base erosion and profit shifting.
- Income Inclusion Rule (IIR)
- Tax on eroding payments
Income inclusion rule
As per this rule, income of an associated enterprise is to be taxed if the effective rate of tax on such income is lower than the agreed minimum rate. This rule is proposed to be implemented in addition to the applicable international tax treaties in force in various member countries.
This is where the concept of top-up rate comes into picture. It is nothing but the difference between the agreed minimum rate and the effective tax rate. However, if such income has been benefited from preferential tax rates in any other jurisdictions, then it can be subject to tax at the higher of domestic tax rate or agreed minimum tax rate instead of top-up rate.
It has been proposed to make it as fixed percentage or some levels of fixed percentage to ensure simplicity and uniformity across the member countries.
It has also proposed simplification rules in order to improve the compliance, ease of administration, transparency and co-ordination among member countries for smooth implementation of the proposed rules, wherever possible.
- Taxable income of associated enterprises will be determined as per the applicable domestic tax rules which may require to compute it either as per domestic tax rules or as per tax treaties in force.
- Applicable accounting standards, International Financial Reporting Standards (IFRS), Generally Accepted Accounting Principles (GAAP), treatment of foreign exchange losses, carry forward and set off losses etc also to be considered appropriately.
Tax on base eroding payments
It acts as complementary to the IIR and protects the country from base erosion of taxable income. It proposes two rules:
- Under Taxed Payments Rule (UTPR)
- Subject To Tax Rule (STTR)
Under Taxed Payments Rule (UTPR)
According to this rule, if the income of an associated enterprise is taxed at lower than agreed minimum rate it proposes to:
- Deny the double tax benefit which would otherwise allowable; or
- Require deduction of tax at source by making necessary changes in tax treaties.
Subject To Tax Rule (STTR)
This can be referred to as a complementary to the under taxed payments rule. As per this rule it has been proposed to deny treaty benefits on certain payments and to implement withholding tax along with other taxes to be deducted at source if the effective tax rate was less than the agreed minimum rate.
However to decide upon a minimum rate to be applied it was decided to first develop the key design elements of the proposal. The Consultation document mainly focuses on three major issues namely:
- Determination of tax base
- Determination of effective tax rate
- Thresholds to be considered
Determination of tax base
For this purpose it has been proposed to use the financial statements of the enterprise as a base for determining the taxable income. However, appropriate changes can be made to account for various differences in terms of time, volume of transactions etc.
Determination of effective tax rate
Deals with the determination of effective tax rate suffered by the taxable entity, by combining incomes from various jurisdictions, taxed at various rates as applicable.
Thresholds to be considered
Deals with the thresholds that can be fixed to make the GloBE proposal applicable for taxable incomes of multinationals.
Also suggested to include was a transition rule in order to consider the existing losses and taxes as on the effective date of implementation of GloBE rules or the date on which the same are applicable to the multinational on crossing the specified threshold limit in terms of gross revenue.
However, all the above mentioned are only proposals and feedback was sought from various participating countries, statutory bodies and the public at large in order to make them as simple and implementable as possible.
The Consultation document also contains a specific request to the inclusive framework seeking inputs on various features and mechanisms to be implemented into GloBE to ensure certainty and compliance with the Pillar Two rules once made mandatory.
In order to prevent multinational companies from moving their taxable incomes to nil tax or low tax jurisdictions, OECD had come up with two proposals named Pillar One and Pillar Two. While Pillar One deals with the Base Erosion and Profit Shifting (BEPS) Global Minimum Corporate Tax Rate has been dealt with under Pillar Two. To achieve the said objective, it has been proposed to impose a minimum tax rate on the global earnings of multinationals, irrespective of the physical presence of its operations, if the effective tax rate is less than the agreed minimum rate. This can be achieved by imposing tax at a top-up rate calculated according to the given method. As the consensus on proposed rules is yet to be achieved, the global minimum corporate tax rate or slab levels as the case may be, are yet to decide upon for implementation.
- https://taxnews.ey.com/news/2020-2508-oecd-releases-beps-20-pillar-two-blueprint-and-invites-public-comments#:~:text=Pillar%20Two%20is%20described%20as,no%20or %2 0very%20low%20taxation
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