Consequences of BEPS and the GloBE rules under pillar two
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Consequences of BEPS and the GloBE rules under pillar two

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Uday Ved and Wrutuja Soni of KNAV discuss the Inclusive Framework (IF) on base erosion and profit shifting (BEPS) and the pillar two Global Anti-Base Erosion (GloBE) model rules.

While the world faced unprecedented COVID-19 challenges, the international tax regime was in the process of taking a significant leap by introducing revolutionary change in the form of the pillar one and pillar two solution under the BEPS 2.0 framework.

The foundation stone for pillar two was laid in October 2021 when the landmark deal on a global minimum tax (GMT) took place with the OECD. Known as one of the major reforms in international tax, the GMT aims to ensure that companies pay a fair share of income tax wherever they operate and generate profits. Although 137 countries have agreed to the pact at the time of writing, some countries such as Nigeria, Pakistan, and Kenya are yet to make a step forward in this direction.

In this article, we have focused on the IF on BEPS and the pillar two GloBE rules.

History of the OECD pillar two solution

Interestingly, the concept of a GMT was not part of the original BEPS proposals, but political momentum for a minimum tax has gathered pace in recent years.

The OECD/G20 IF on BEPS agreed to a two-pillar solution to address the tax challenges arising from the digitization of the economy. The origin of the two-pillar approach lies in the groundbreaking project of the OECD on BEPS which was launched in 2013.

At the request of the G20, the IF continued to work on the issue and in January 2019, members of the IF agreed to examine proposals in two pillars, which could form the basis for a consensus solution to the tax challenges arising from digitalization. Therefore, the OECD / G20 progressed towards pillar one and pillar two.

The IF and pillar two

Pillar two is focused on a global minimum tax intended to address remaining BEPS issues related to a number of areas. The objectives include:

  • Eliminating tax avoidance and tax havens;

  • Addressing harmful tax competition;

  • Ensuring the coherence of international tax rules;

  • Creating a transparent tax environment;

  • Ensuring income is taxed at an appropriate rate; and

  • Setting forth a common approach for a GMT for multinational enterprises (MNEs) with a turnover of more than €750 million ($789 million).

Due to cross-border trade and multiple geographies, MNEs can park their profits in no tax or low tax jurisdictions and reduce their global effective tax rate. To address this issue, pillar two proposes a global minimum tax of 15%. This should discourage MNEs from artificially shifting profits to no tax or low tax jurisdictions.

Pillar two consists of two interlocking domestic rules: an Income Inclusion Rule (IIR) to be taxed in the jurisdiction of the parent entity, and an Undertaxed Payment Rule (UTPR), where a deduction can be denied, or an adjustment be made so that low income of a constituent entity (CE) is not subject to tax under an IIR.

There is also a treaty-based Subject to Tax Rule (STTR). This may allow source jurisdictions to impose source taxation on certain related party payments, such as interest and royalties, subject to tax below a minimum rate of 9% which will be a creditable tax.

Under the Model Rules announced on 20th December 2021, a low tax jurisdiction can itself elect to levy the additional tax due, rather than the tax being collected by a jurisdiction upwards in the ownership chain and levied on an ultimate parent entity (UPE) of an MNE group.

The model rules provide guidance on the scope of the GloBE rules, the application of the IIR and UTPR, and a host of other issues. However, the STTR and other aspects were left for future guidance.

Given that the OECD does not have the power to implement domestic legislation in any country, it will be up to each adopting country to make decisions as they develop their own domestic policy and legislation implementing the provisions.

It is not mandatory for IF members to adopt GloBE rules, but, if they choose to do so, they will implement and administer the rules in a way that is consistent with the outcomes provided for under pillar two. This includes the application of the GloBE rules applied by other IF members, including an agreement as to the rule order and the application of any agreed safe harbours.

With an ambitious timeline of 2023 set for implementation, many jurisdictions have initiated discussions on how to give effect to these global reforms in domestic law.

Overview of pillar two

The GloBE rules are targeted to be achieved via computation mechanisms rules. GloBE rules will impose a top-up tax using an effective tax rate to be calculated on a jurisdictional basis and using a common definition of covered taxes.

The tax base will be determined with reference to a MNE’s financial accounting income, with agreed adjustments.

Steps in determining the top-up tax liability of a MNE include:

  1. Identify the MNE group, its constituent entities, and their location

  2. Compute GloBE income or loss

  3. Compute covered taxes

  4. Compute the ETR and top-up tax at a jurisdictional level

  5. Payment of top-up taxes under IIR and UTPR

The scope of GloBE rules determines the MNE group to be covered. It also provides exclusions for entities with a specified investment type, and organizations with a special status in their residence jurisdiction.

The MNE group's total revenue under the consolidated revenue threshold is that reflected in the consolidated financial statements in any two out of four years immediately preceding the tested fiscal year. The OECD’s commentary indicates that the fiscal year is determined by reference to the annual accounting period of the UPE, and it aligns with the test used for country-by-country reporting (CbCR) purposes.

With respect to CEs, the commentary clarifies that entities that are joint ventures and associates for accounting purposes are not CEs under the model rules if the MNE group does not control them. The definition of a group is composed of a main entity and a permanent establishment (PE), and it further indicates that a main entity having only a stateless PE is not considered a group. Excluded entities are removed from the computations other than the application of the revenue threshold.


The model rules further provide the charging mechanisms of IIR and UTPR and the potential use of a switch-over rule in tax treaties to safeguard the application of IIR to a PE, in particular for those cases where the relevant tax treaty adopts the exemption method to eliminate double taxation of income.

With respect to the IIR, some jurisdictions may wish to extend the application of the IIR to domestic situations to avoid discrimination between domestic and foreign CEs in the same MNE group. If the IIR is applied domestically, it shall be treated as a qualified IIR, provided it meets the other requirements under the model rules.

With respect to the UTPR, priority rule in which any provisions of domestic law affecting the deductibility of expenses incurred by CEs takes precedence over the application of the UTPR applies. The denial of a deduction does not necessarily need to be attributed to a transaction with another CE.

Further, the fact that the UPE is required to apply a qualified IIR does not mean the operation of the UTPR is not applicable with respect to CEs located in the UPE jurisdiction. If the top-up tax arising in the UPE jurisdiction is not reduced to zero (because of a qualified domestic top-up tax (QDMTT) or the domestic application of a qualified IIR in such jurisdiction), it will be included in the UTPR top-up tax amount and allocated to each UTPR jurisdiction.

GloBE income and loss

GloBE income or loss plays an important role in calculation of the ETR. Financial accounting net income or loss (determined under an acceptable accounting standard) is the starting point for the computation, subject to the adjustments specified in the GloBE rules. The examples of adjustments exclude dividends, short-term portfolio shareholdings, and asymmetric foreign currency gains or losses.

The model rules identify the covered taxes and also explain the deferred tax attributable to the GloBE income or loss of each CE. Although dividends received from other CEs are excluded from the GloBE income or loss, taxes paid on such distributed income are included in the distributing CEs’ adjusted covered taxes and in the numerator of the ETR computation.

A deferred tax asset relating to a domestic tax loss is to be recorded in the same year as the economic loss for GloBE purposes. The OECD commentary also provides clarifications regarding the GloBE loss election, flow-through entity, and more.

In cases where the ETR of a jurisdiction is below the agreed minimum rate of 15%, the difference results in a top-up tax percentage which is applied to the jurisdictional income to determine the total amount of top-up tax. Any tax under a QDMTT is considered as credit in the computation of the GloBE top-up tax, offsetting any GloBE top-up tax and any additional current top-up tax calculated for the fiscal year.

Further, the OECD commentary specifies a substance-based income exclusion, de minimis exclusion, and more.

The commentary further covers corporate restructurings such as mergers and acquisitions (M&A), tax neutrality regimes, administrative aspects of the GloBE rules, and transition rules. It sets out an MNE group's obligation to file a standardised information return in each jurisdiction.

The pillar two solution may be more relevant for developed countries such as the USA and those in Europe. Developing countries like India may find jurisdictions such as the United Arab Emirates (UAE) and Mauritius more relevant for India outbound investments through special purpose vehicles (SPVs). Developing countries such as India may be more interested in seeing pillar one implemented soon.

Pillar two versus tax treaty provisions

It is pertinent to assess the possible points of friction between the pillar two GloBE rules and the existing tax treaty framework.

The question now arises as to whether the IIR conflicts with treaty provisions when applied by the state of the UPE. It could be argued that IIR disregards the concept of separate entities and, by doing so, disturbs the balance of allocating taxing rights as agreed by the countries in tax treaties.

In light of the fact that the allocation of taxing rights is a sensitive issue, it is worth exploring the option of inserting a safeguard clause in tax treaties, which would authorise the application of the IIR.

The UTPR is designed as a backstop. It could be possible that the rule is inapplicable if all countries in the world introduce IIR. If countries do not introduce IIR, it could be possible that UTPR applies. Therefore, it is important to discuss the treaty compatibility of this rule in an extensive manner.

It would be interesting to see the manner in which the rules are implemented in domestic tax law to determine the exact object of comparison.

Pillar two versus transfer pricing (TP)

The GloBE rules acknowledge calls from developing countries for more transparent, mechanical, and predictable rules to level the playing field and reduce the incentive for MNEs to shift profits out of developing low tax countries. The GloBE rules are expected to reduce pressure on governments to offer wasteful tax incentives and tax holidays, while still providing a carve-out for income that arises from real substance.

This is a clear move away from the long-standing and established arm’s-length principle towards a formulary apportionment method by the OECD. It mandates (if the states choose to accept the GloBE rules) a minimum tax to be levied on enterprises. This is an unprecedented shift in the international tax landscape, which previously has limited itself to TP principles, with the taxation and determination of profits solely based on the arm’s-length principle.

Public consultation comments on the GloBE implementation framework

More than 75 public comments across industries, MNEs, corporates, and law and chartered accountant firms have been received by the OECD and published. A very common observation that invites attention is that the primary goal in developing the GloBE implementation framework is to reduce complexity.

Complexity is one of the major contributors to the compliance burden for MNEs, as well as adding to the administrative burden for tax authorities across countries wherever MNE has presence.

It significantly aggravates the risk of inconsistency across jurisdictions, which in turn increases the likelihood of litigation and double taxation.

In addition to the above, companies welcomed improved clarity in relation to the computation of the ETR and the allocation of top-up tax for groups headed by an excluded entity UPE. The UTPR top-up tax does not provide enough certainty as to how the tax will be imposed, how it will be reported, and how it would be tracked.

The issue of the UTPR impact on domestic tax incentive regimes is an issue that has raised considerable political concern in countries such as the USA, on account of its domestic global intangible low-taxed income (GILTI) regime. Comments were also received with respect to confusing and seemingly inconsistent guidance in relation to the application of the arm’s-length principle in the model rules. Consideration should also be given to build a safeguard mechanism to mitigate the risk of unfounded TP adjustments.

Global reaction to the pillar two solution

With an ambitious timeline of 2023 for pillar two implementation, the world is accelerating to initiate discussions on how to give effect to these global reforms in domestic law.

The UAE introduced a corporate tax rate of 9% from June 2023 and is set to implement TP regulations. Singapore outlined a plan in its 2022 Budget to introduce a top-up tax in the form of a Minimum Effective Tax Rate (METR) targeting 2023 for the introduction of GloBE rules.

The UK has released a paper inviting public comments on the implementation plan for pillar two. It plans to introduce a Domestic Minimum Top-up Tax (DMT) effective from 2024 to ensure any additional tax on profits in form of top-up taxes benefit only the UK. Ireland is expected to introduce a QDMTT to protect its tax revenues and is likely to implement a GMT by 2023.

In addition, the USA recently proposed tax legislation making major changes to the GILTI regime in line with the model rules and raising the effective rate in 2023. Meanwhile, Mauritius and Switzerland, investment-friendly jurisdictions, plan to implement rules close to the model rules in 2023. However, India until now has not taken any steps to change domestic tax legislation.

Two days after the OECD release, on December 22, 2021, the European Commission (EC) published a draft directive implementing the OECD’s pillar two rules for EU member states. Based on recent discussions, the directive stated that EU member states would implement the rules into local law no later than December 31, 2023 (IIR) and December 31, 2025 (UTPR). Estonia, Sweden, and Malta requested a broader scope, while Poland emphasised the importance of implementing pillar one.

Pillar two: what’s next?

The latest OECD commentary on the pillar two model rules states that a jurisdiction that joins the common approach is not required to adopt the GloBE rules. However, if it chooses to do so, it agrees to implement and administer them in a way that is consistent with the outcome provided under the GloBE rules and the commentary on the GloBE rules (including the agreement as to rule order).

Countries have also placed a lot of emphasis on implementing TP regulations, especially where such rules are not present or are present but not strictly implemented.

Tax-friendly jurisdictions may still choose to host holding entity structures and continue to attract foreign investment. However, where GloBE rules are implemented in the parent entity jurisdiction, the cash tax outflow in the form of top-up taxes cannot be avoided. The implementation timelines of 2023 look ambitious.

What do tax leaders need to look out for and prepare?

As the international community moves towards implementing pillar two, tax leaders and directors across the globe need to be prepared to address practical challenges that could arise due to timing differences, difficulties in aligning accounting policies within the MNE group, different TP models adopted at the CE level, and the domestic implementation of the GloBE rules.

Tax directors should also be prepared to address issues related to the denial of deduction, new income tax return (ITR) forms, and the filing of revised returns.

The key aspect of implementation will be necessary changes in domestic tax rules to make pillar two effective. The timing of implementation is critical for tax leaders to understand systems and make sure appropriate data are captured and produced for implementation. Transparent reporting and consistent disclosures will be required.

Global tax leaders will need to keep pace with changing tax landscapes in each country where the MNE operates. There is a great deal of collaboration required among finance, tax, TP, customs, and other departments. This will allow for the production of necessary reports for computing the tax base, including the reconciliation of tax and financial accounts.

Tax leaders also need to collaborate with business leaders to appraise them on how pillar two could impact their overall tax costs and how they would optimize this. Continuous fine-tuning will be necessary as the implementation progresses. It will be good to conduct impact analysis considering the global changing landscape and tax changes in each jurisdiction.

The road ahead and implementation status

Gaining global consensus on the pillar two plan is a monumental accomplishment for the OECD and has demonstrated the power of global tax policymakers collaborating on an otherwise contentious issue. That said, complexity and compliance burdens remain top of mind for MNEs facing the new rules. As companies prepare for the arrival of pillar two legislation in their country, there are several opportunities and hurdles to consider.

As previously discussed, the new rules are set to take effect from 2023, leaving lawmakers very little time to transcribe the rules in a way that considers existing systems and tax frameworks. Taxing authorities will have to deal with administering the new laws, including the implementation of systems and processes for enforcement and collection. This monumental effort could play out unevenly from country to country.

By the end of 2022, an implementation framework will be developed which will consist of administrative procedures and safe harbours. This framework should facilitate compliance by MNEs and administration by tax authorities.

The agreement indicates a real ambition for a robust global minimum tax with a limited impact on MNEs carrying out real economic activities with substance. It is a unified approach and, if implemented well, should pave the way for addressing tax challenges related to the digital economy under the BEPS regime.

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