Pillar 2 GloBE rules technical series: Getting to know top-up taxes and safe harbours

With the Organisation for Economic Co-operation and Development’s (OECD) Pillar 2 Global anti-Base Erosion (GloBE) Rules now in play, understanding who, what, and how the regime will impact multinational enterprises (MNEs) is vital. With new OECD guidance being steadily released, keeping abreast of changes affecting how the rules are interpreted and what options an MNE has is essential. In the first of a series of technical briefs on the GloBE rules, we address some of the key issues as they currently stand and how they will impact in-scope MNEs. 

Recognising the general Pillar 2 Framework, who it applies to and how 

Based on complex jurisdictional tax computations, Pillar 2 offers a framework to deliver a unified approach to global tax through a minimum rate of taxation equal to 15%. Importantly, this minimum rate of 15% can be applicable and collectable with respect to any jurisdiction, regardless of whether that jurisdiction has enacted Pillar 2.

In terms of who is in scope, the rules apply to all multinational enterprise (MNE) groups with annual revenue of €750m or more in two of the last four fiscal years and aim to ensure that a minimum tax rate of 15% is paid in each jurisdiction and there are separate information reporting requirements. It’s an approach first put forward at the G20 Summit in 2021 when over 140 Member States agreed to adopt Pillar 2 of the OECD’s Base Erosion and Profit Shifting (BEPS) initiative.

In December 2021, the model rules for the GloBE tax were released. Since then, various administrative guidance on how to implement aspects of the GloBE rules have been issued. These include, but are not limited to, additional and revised guidance on safe harbour tests, top-up and blended CFC tax regimes, the interplay of anti-hybrid rules with GloBE, and allocation of cross-border current deferred taxes. 

While the rules are still evolving, it’s essential to recognise the jurisdictional nature of GloBE by identifying constituent entities (CEs) in scope, where they are located, and the removal of any excluded entities. This is needed to ensure that calculations can correctly adjust financial accounting net income or loss to the GloBE base. Where a safe harbour applies to a CE, GLoBE calculations may be significantly simplified, although there will still be a reporting requirement.

Any GloBE income or loss of entities with permanent establishments (PEs) will need to be allocated between its permanent establishments and its home jurisdiction.  Any GLoBE income or loss of  flow-through entities will need to be allocated to the constituent entity owners of that flow through entity where necessary. Covered taxes adjusted for temporary differences and losses will also need to be allocated to other CEs as necessary. After considering safe harbours and other reliefs, top-up tax calculations can be used for low-taxed jurisdictions to ensure the 15% minimum tax is met.

Interpreting top-up taxes and what makes a QDMTT qualified

In jurisdictions where an MNE is subject to an effective tax rate (ETR) below 15%, a top-up tax is applied after considering substance-based carve-outs relating to tangible assets and qualified payroll expenses. These top-up taxes are based on a hierarchy of one mechanism and two rules, of which the Qualified Domestic Minimum Top-Up Tax (QDMTT) is the most powerful. A QDMTT is a minimum tax imposed by a country’s domestic law that, where implemented, computes its top-up tax following the Pillar 3 rules. At a basic level, QDMTT should offset any top-up tax due. In this respect, the QDMTT is a charging mechanism and an MNE’s first line of defence.

There is also an income inclusion rule (IIR) that imposes a top-up tax on an MNE group’s ultimate parent entity (UPE), or in some cases an intermediary holding company, for any low-taxed income of CEs. An undertaxed payments rule (UTPR) operates as a backstop to the IIR, applying only in specific circumstances where the top-up tax is not brought into charge under an IIR or QDMTT. 

For example, if a UPE owns an entity based in a low-tax jurisdiction, it must apply the IIR. However, if there is no provision to apply the IIR in the UPE’s jurisdiction, then the IIR requirement cascades down the group to the next parent company in a jurisdiction where the IIR operates. If the relevant top-up taxes can’t be allocated under an IIR, the UTPR comes into play and is applied to the group entities located in jurisdictions that do apply the GLoBE rules. This is applied to transactions with CEs in jurisdictions where no GloBE rule provisions have been accepted or implemented, with, the ones to pay tax being allocated to CEs in jurisdictions within GLoBE rules until the right level of global tax is paid.

It’s important to note that while a modest degree of variability is expected and acknowledged by the OECD, any domestic minimum tax set must be consistent with the design of the GloBE rules and provide the same outcomes for it to qualify as a QDMTT.  Whether a jurisdiction’s DMTT is a QMDTT will be monitored by the OECD. During the initial phase of the rules the OECD is publishing a list of jurisdictions that have received transitional qualified status.

Understanding transitional rules and safe harbours

In the early years of GloBE compliance, MNEs can identify low-risk jurisdictions by using readily available and easily verifiable country-by-country reporting (CbCR) data rather than seeking to achieve the high degree of precision involved in full GloBE calculations. The transition period is any fiscal year beginning on or before 31 December 2026, but not including a fiscal year that ends after 30 June 2028. During this initial period, the top-up tax in a jurisdiction for a fiscal year is zero, where one of three tests is satisfied and an election through a GLoBE return is made for each relevant year. The applicable tests include a de minimus test, a simplified ETR test or a routine profits test. The application of transitional application of these CbCR safe-harbours must comply with the filing requirements in GloBE Information Return (GIR).

However, there is a ‘once out, always out’ rule to the extent that if an MNE fails all three tests for a fiscal year during the transition period, or does not elect to apply a safe-harbour when it can, the MNE Group is no longer able to apply the transitional CbCR safe harbour tests for any subsequent fiscal year in the transition period. In such a scenario case, full GloBE calculations must be used.

Due to a high reliance on the accuracy of CbCR data for safe harbour calculations and any additional GloBE information not previously collected, it’s essential to review current CbCR data. Such an exercise will also help with the completion and accuracy of full model calculations further down the line.

It’s important to note that a number of entities and arrangements are excluded from transitional CbCR safe harbour arrangements. These include:

• stateless constituent entities,
• certain multi-parented MNE groups,
• jurisdictions with constituent entities that have elected to be subject to eligible distribution tax systems under Article 7.3 of the OECD Pillar II Model Rules, and
• jurisdictions that have not benefited from the Transitional CbCR Safe Harbour rules in a previous year.

For jurisdictions that do qualify, the MNE group would still have to complete the relevant sections in the GIR for safe harbour applications.

In addition, there is the opportunity to apply one of the transitional UTPR safe harbours:

• MNE groups that are in the initial phase of their international activities can elect to apply the UTPR transitional rule. This election is available where CEs are in no more than six countries, and the net book value of tangible assets of all CEs located in jurisdictions other than the reference jurisdiction is less than or equal to €50m. If these requirements are satisfied, UTPR is zero.
• The UTPR Top-up Tax Amount calculated for the UPE Jurisdiction shall be deemed to be zero for each fiscal year during the transition period if the UPE Jurisdiction has a corporate income tax that applies at a rate of at least 20%.

If a CE qualifies for both CBCR and UTPR safe harbours, it can choose which to apply.  However, if the UTPR is chosen over the CBCR safe harbour, it will not be possible to apply the CBCR safe harbour for a future year.

Challenges and next steps

There are undoubtedly several challenges MNEs face in complying with the GloBE rules. Not least, the number of data points – around 240 – required to complete full model calculations. There is also the complexity of applying new rules and tests, particularly where jurisdictions vary in their approach to GloBE or have not implemented the rules.

As a first step, reviewing and updating CbCR information will help to ensure that data is accurate and accessible. There are also certain planning opportunities relating to the number of jurisdictions in which MNEs are based. For example, if an MNE has CEs based in less than six jurisdictions, UTPR will not apply in some circumstances. By shrinking the number of jurisdictions where there is a permanent establishment, MNEs can streamline and simplify GloBE compliance.

For a more comprehensive explanation of top-up taxes and safe harbours please listen to our podcast #1: Pillar Two Technical Series: Overview & Transition Years | Forvis Mazars where you can download technical slides giving examples and more in-depth details and calculations.