By: Gonzalo Manzano
In a previous installment (see here), we discussed the evolution of the Organization for Economic Trade and Development (OECD) in reducing competition between different tax jurisdictions through the global standardization of tax rules, and in changing the policy that determines where companies must pay their taxes. The creation of the “BEPS Plan” (Base Erosion and Profit Shifting Avoidance Plan) in 2013, and its 15 proposed actions to achieve it, were noted. Those actions had their iteration in the current Pillars One and Two. Our previous installment explained, in simple terms, Pillar One, which seeks to change the rules on where large multinational companies pay taxes. Today, we will address Pillar Two, which essentially seeks to establish a global minimum tax.
The first thing that needs to be established is that this pillar seeks to have Multinational Enterprises (MNEs) pay at least a minimum tax with the objective of reducing competition from tax jurisdictions to a uniform minimum, in the face of those that have opted for low or no tax burdens. The Pillar Two global minimum tax is applicable to MNEs with income over €750 million, which are taxed at a rate of 15% on net income, to be paid following the Global Base Erosion Rules (GloBE Rules), in the jurisdiction where the parent company is located, or where the operation is located, or in one of the jurisdictions where its subsidiaries reside. This is the easy part.
These rules are applied according to the reality of each MNE, depending on the effective taxation applicable to them (i.e., adding all net income and their respective taxes paid). Thus, the global minimum tax is composed of three rules that are superimposed one on top of the other until the global minimum is reached.
The first one is the income inclusion rule (IIR), where those MNEs to which a tax rate lower than 15% is applied in any of the jurisdictions where they are present (as long as the lower rate is not the one applied in the jurisdiction of their parent entity), should pay a complementary tax (until reaching that 15% rate) in the jurisdiction where their parent entity is located, thus reaching their global minimum taxation.
The second is the under-taxed payments rule (UTPR), where -taking the previous case- if the lower rate is applied in the jurisdiction of its parent entity, the complementary tax should be applied in any of the jurisdictions where its subsidiary entities reside, until reaching the global minimum tax of 15%.
Finally, although being the first rule to be applied, there is the taxable person rule (STTR), where, in the existence of a treaty to avoid double taxation, certain payments – by application of the rules of such treaty – end up being taxed at a nominal rate of less than 7.5% – 9% (the range depends on special rules to be determined when implementing the GloBE model rules). These payments must be made between related entities, in some cases regardless of whether the MNE has less than €750 million. If STTR applies for such payment, the nominal rate to be applied to the tax should be 7.5% – 9% (as set in the implementation of the model for the jurisdiction). This payment must be included in the calculation base of the IIR and UTPR rules, which will be applied subsequently, in the manner indicated above.
In short, Pillar Two seeks that MNEs, which to date have managed to avoid paying taxes by using aggressive tax planning models and taking advantage of the immateriality of a large part of their operations, be obliged to pay at least 15% tax on their income, often regardless of the source of the income.
Although it could be said that the jurisdictions that would benefit most from these rules would be those in developed countries, where most of them would see the IIR applied as they have tax rates higher than 15%, it is no less true that the size of the MNEs, to which the global minimum tax would apply (MNEs with income of €750 million or more), broadens the range of taxation substantially, being able to include large corporate groups with parent entities located in developing countries, including jurisdictions that apply a territorial income principle, allowing to increase their tax collection on worldwide source income.
However, the beginning of the end of the tax exemption model that supports the implementation of Free Trade Zones is observed, where the application of GloBE rules tacitly repeals these tax incentives. It is to be expected that the different jurisdictions that have these incentives will think of new alternatives (beyond the tax incentives) to maintain the interest of MNEs to set up under these special legal statutes, and to continue attracting foreign investment.