BEPS OECD – Global Pillar Two Rules

OECD – Global Pillar Two

Introduction to Pillar Two

• OECD - What is it?– Organization for Economic Co-operation and Development - Works with mainly governments and policy makers. They work on establishing evidence-based international standards and finding solutions to a range of social, economic and environmental challenges.
• Pillar Two Adoption - On 10 July 2021, the G20/OECD endorsed the key components of the Pillar Two tax reform that was recently endorsed by 132 countries and jurisdictions, constituting the vast majority of the OECD/G20 Inclusive Framework (inclusive framework) on Base Erosion and Profit Shifting (BEPS).
• Pillar Two – What is it? - Pillar Two, the key components of which are commonly referred to as the "global minimum tax" or "GloBE" introduces a minimum effective tax rate of at least 15%, calculated based on a specific rule set.
• Thus the 15 percent tax rate will be introduced by mostly all countries around the world.
• The global minimum tax attempts to limit tax competition by introducing a globally uniform floor, below which the effect of low tax rates or fiscal policy measures would be largely obviated.

How will GLoBE Operate?

• The global minimum tax consists of three principle rules:
  • The income inclusion rule (IIR)
  • The undertaxed payments rule (UTPR)
  • The subject to tax rule (STTR)

• In combination, the IIR, UTPR and STTR are referred to as the GloBE.
• The IIR will apply in priority to the UTPR, which will act as a backstop to the IIR. The IIR and UTPR will operate differently but in a complementary fashion.
• Both rules will refer to the same minimum effective tax rate, which, as outlined above, will be at least 15% and calculated based on a uniform set of rules.
• The STTR is a treaty-based rule and fundamentally different from the IIR and UTPR. The STTR will reference a rate of 7.5% to 9% and apply in priority to both the IIR and the UTPR. However, the STTR is narrower in scope.

What is the Income Inclusion Rule

• The IIR is similar in operation to controlled foreign company (CFC) rules. The IIR will be applied by and collected in the jurisdiction of the head office. It will apply in respect of each jurisdiction in which the group has a subsidiary or branch. However, it will not apply to the head office jurisdiction itself
• Under the IIR, the effective tax rate of each jurisdiction, calculated in accordance with specific global minimum tax rules, will be determined based on all of the consolidated companies or branches in that jurisdiction. It will then be compared with the minimum tax rate of at least 15%. Top-up tax will be charged to the head office to make up for any shortfall.
• Per the below example if there is an Ulitmate Parent Entity (UPE), a subsidiary company and a Low Taxed Entity (LTE) which operates in a jurisdiction which has 0 percent tax rate (like Cayman Islands) or lesser than 15 percent tax rate, then the shortfall in tax rate (from 15 percent) shall be payable by the UPE.

What is the Undertaxed Payment Rule?

• The secondary rule under the global minimum tax is proposed to be the UTPR. The UTPR will apply after the IIR and serve as a backstop to the IIR.
• One scenario in which the UTPR would apply is where the jurisdiction in which a group is headquartered has an effective tax rate below the minimum tax rate
• This is because the IIR itself does not apply to the headquarters’ jurisdiction. Any top-up tax then would be collected under the UTPR by the countries in which other group companies are located.
• The implementation of the UTPR could be delayed, such that the IIR is implemented before the UTPR. This could offer a temporary reprieve for groups that have their headquarters in low tax jurisdictions.
• This means that if the entity is headquartered in a low tax jurisdiction and has subsidiaries outside its territories, all of those territories/countries will receive the taxing rights of the difference in the global minimum tax rate in a fixed ratio prescribed by OECD.
• The ratio in which the tax shall be recovered by each jurisdiction shall be in the weightage of number of employees, assets etc in each jurisdiction.
• It must also be noted that this rule shall apply only to those countries which have adopted the UTPR rules and there shall accordingly be divided accordingly amongst the countries which have adopted the UTPR rules.

What is the Subject to Tax Rule?

• The STTR is a treaty-based rule, which may override treaty benefits in existing treaties in respect of certain payments where those payments are not subject to a minimum level of tax in the recipient jurisdiction.
• There are several key differences between the STTR, the IIR, and the UTPR:
  • Firstly, the STTR may apply irrespective of the size of the group (i.e., the EUR 750 million threshold may not apply).
  • Secondly, the STTR only applies to certain categories of related party payments (i.e. Interest, Royalty Payments)
  • Thirdly, the STTR does not reference the same calculation methodology or rate as generally applied under the global minimum tax. The STTR applies on a payment-by-payment basis and is triggered where the full amount of a payment will not be subject to tax at a nominal rate of least 7.5% to 9%.

• Where the STTR applies, treaty relief that would otherwise have been provided may be denied, with the maximum applicable withholding tax being 7.5% to 9%.
• The STTR applies before the IIR and UTPR and any tax collected under the STTR should be factored into the global minimum tax calculations used for the purposes of the IIR and UTPR.
• It also is anticipated that the majority of jurisdictions requesting the introduction of the STTR will be developing countries. Accordingly, treaties entered into between larger economies are less likely to be affected by the STTR or may not be affected at all.

Impact on India

• As part of the OECD Inclusive Framework on base erosion and profit shifting, India is committed to a consensus-based solution for implementing Pillar Two, comprising global anti-base erosion, or GloBE, rules and the subject to tax rule.
• It is necessary to consider the current corporate tax regime. India offers taxation of corporate income at different rates varying from 15% to 30%.
• Separately, an entity is also under an obligation to pay minimum alternate tax at the rate of 15% (plus applicable surcharge and cess), calculated on the basis of book profits of the entity.
• Given the above, it appears that there should be no tangible impact by the GloBE Rules on the income of constituent entities located in India, as the effective tax rate applicable in the case of Indian entities is already more than the agreed minimum rate of 15% under the GloBE Rules.
• Secondly, India, being a developing economy, offers several tax benefits by forgoing its taxing rights to attract investment. It remains to be seen to what extent India will carry out changes in these incentive schemes to align them with the GloBE rules.
• At a policy level, India has pushed for a fair allocation of revenue to market jurisdictions primarily comprised of developing economies to safeguard their tax revenue, a principle that is at the core of Pillar Two. It is expected that India would implement qualified domestic minimum top-up tax rules that will ensure that the income of an Indian constituent entity from its economic activities in India would be taxed in India only, and any taxing right wouldn’t be surrendered to the resident jurisdiction of the ultimate parent entity.