Evolution of Pillar II resulted minimum 15% tax for MNEs

The Organisation for Economic Co-operation and Development (OECD) was established in December 1960 replacing the Organisation for European Economic Cooperation (OEEC) which was formed in April 1948 to administer the European recovery programme. The OECD was set up to promote economic growth and cooperation among countries to improve the economic and social well-being of people worldwide.

In July 2013, the OECD initiated the base erosion and profit shifting (BEPS) project to combat tax avoidance. The project aimed to address the annual loss of tax revenue, estimated to be between $100 billion and $240 billion, resulting from multinational corporations engaging in base erosion and profit shifting. Subsequently, in October 2015, the OECD officially launched the BEPS 15 action points to tackle tax avoidance issues.

In June 2016, the OECD launched the inclusive framework on BEPS involving 135 countries and jurisdictions, to collaborate on the implementation of the BEPS points. The UAE joined inclusive framework on BEPS in 2018.

Subsequently, in 2019, the OECD began a public consultation process on the tax challenges posed by digitalisation; and the OECD introduced the unified approach Pillar One in October 2020 to ensure a fair distribution of taxing rights, especially for digital businesses operating across borders. In same month, October 2020, the OECD unveiled Pillar Two, also known as the Global Anti-Base Erosion (GloBE) initiative. Pillar Two is centered on establishing a global minimum tax and an income inclusion rule to address lingering BEPS challenges; and Pillar One pitfalls.

In July 2021, the G20 finance ministers approved the agreement on the minimum tax rate proposed under Pillar Two. This endorsement signified support for the OECD’s framework for a global minimum tax of 15 per cent.

The Pillar Two aims to ensure that multinational enterprises (MNEs) with a combined revenue of EUR 750 million or more, in any of previous two years out of four years, are subject to a minimum tax rate of 15 per cent in respect of the excess profits derived from every jurisdiction through two interlocking domestic rules – the income inclusion rule (IIR) and under tax payment rule (UTPR) (GloBE Rules) – and a treaty-based, the Subject to Tax Rule (STTR).

The IIR, which is considered the primary rule, requires that the ultimate parent company or next intermediate parent entity down the ownership where IIR has been adopted, shall pay minimum top up tax of 15 per cent on the profits of entities where the tax rate is below 15 per cent or where there is no tax. Where the minimum top up tax of 15 per cent has not been applied through IIR, UTPR rule shall apply, which could involve disallowing deductions or introducing additional taxation measures, such as a withholding tax, to ensure that a MNE pays a minimum top-up tax of 15 per cent on undertaxed payments.

The STTR is a treaty-based provision that comes into play when specific cross-border payments within a multinational group are taxed at a rate lower than the STTR minimum threshold of nine per cent. It serves as a minimum requirement, mandating that jurisdictions include the STTR in their bilateral tax agreements with developing nations upon request.

In addition to the above, a jurisdiction may apply the Qualified Domestic Top-up Tax (QDMTT), which grants minimum taxing rights to the jurisdiction. The tax collected under QDMTT shall be deducted from the minimum top-up tax of 15 per cent if QDMTT has been applied in accordance with the GloBE rule.

The process for determining the top-up tax liability for a MNE involves several key steps. First, it is necessary to identify whether the MNE falls within the scope of the GloBE Rules and determine the location of each Constituent Entity (CE) of the group on a jurisdictional basis. Subsequently, the GloBE Income of each CE must be calculated. Following this, the amount of covered taxes for each CE needs to be established. Next, the Effective Tax Rate (ETR) of all CEs in the same jurisdiction should be computed to determine the resulting top-up tax. Finally, the top-up tax is to be imposed under an IIR or an UTPR, by considering any QDMTT payable from the top-up tax liability.

The UAE, as a member of the BEPS Inclusive Framework, initiated a public consultation process by releasing a digital consultation paper in March 2024. This consultation paper is open until April 10, 2024, allowing the global community of multinational enterprises operating in the UAE along with their advisors, service providers and investors to share their feedback as it will be instrumental in shaping the policy to address the implementation of GloBE rules.

The writer is a managing partner at Kress Cooper Management Consultants. The above article is not an official opinion of Khaleej Times but an opinion of the writer. For any queries/clarifications, please write to him at mahar@kresscooper.com.

• Business