On July 17, 2023, the Organisation for Economic Co-operation and Development (OECD) released administrative guidance (the 2023 July Administrative Guidance)1 concerning implementation of the Pillar Two global minimum tax (GloBE Tax) that is to be integrated into a revised version of the original commentary relating to the OECD Model Rules released on December 20, 2021. The revised commentary of the OECD Model Rules is expected to be released on a later date during the 2023 calendar year. In addition to the 2023 July Administrative Guidance, the OECD released an updated GloBE information return (GIR) template and guidance with respect to the Subject To Tax Rule (STTR). The 2023 July Administrative Guidance represents the second administrative guidance released by the OECD this year as it comes in direct response to the administrative guidance on February 2023 with respect to Qualified Domestic Minimum Top-Up Taxes (QDMTTs) and blended controlled foreign corporation (CFC) tax regimes (the 2023 February Administrative Guidance). Specifically, the 2023 July Administrative Guidance contains the following:
- Currency conversion rules for applying the GloBE Tax;
- Commentary on the application of tax credits, including refundable tax credits, with respect to adjusted covered taxes and other GloBE Tax components;
- Clarification of substance-based income exclusion (SBIE) principles with respect to interjurisdictional assets and employees, stock-based compensation, and other guidance with respect to SBIE in the GloBE Tax computation;
- Additional principles for jurisdictions implementing QDMTTs that were not covered in the 2023 February Administrative Guidance, including joint venture rules, allocation of QDMTT to constituent entities, and other important guidance related to QDMTTs;
- Introduction of a new QDMTT Safe Harbour test; and
- Introduction of a Transitional Undertaxed Payments Rule (UTPR) Safe Harbour test for ultimate parent entity (UPE) jurisdictions during the transition period.
Below is an overview of the updates provided in the 2023 July Administrative Guidance with FORsights™ and implications. Discussion around the new GIR template and the STTR framework will be discussed in a later FORsights article.
Currency Conversion Rules
Under the current framework, neither the GloBE rules nor the Commentary provide specific guidance regarding how the relevant GloBE items are to be presented and calculated in accordance with the accounting standards used in preparing the consolidated financial statements of the ultimate parent entity (UPE), including the relevant currency the amounts are required to be in for purposes of the GloBE calculations.
The 2023 July Administrative Guidance states that multinational enterprise (MNE) groups are required to undertake their GloBE calculations for each relevant jurisdiction in the presentation currency of their consolidated financial statements. Under the guidance, amounts that are relevant to the GloBE calculations that have not been translated in the consolidated financial statements have to be translated to the presentation currency pursuant to the relevant currency translation principles of the Authorised Financial Accounting Standards used to prepare the consolidated financial statements. Furthermore, the guidance continues that after the top-up tax has been allocated to a constituent entity in the MNE group’s presentation currency, jurisdictions are free to apply their own foreign currency translation rules to convert the top-up tax due to their jurisdiction into local currency as long as the exchange rate used is reasonable and relevant to the fiscal year (including, but not limited to, an average exchange rate for the year, exchange rate on the last day of the tax year, or rate on which payment is required). In addition, the MNE group must translate any relevant threshold amounts from the presentation currency to the currency used in the implementing jurisdiction’s domestic law based on the same average foreign exchange rate for the December month of the calendar year prior to the commencement of the relevant fiscal year. Finally, the guidance states that where a threshold amount has been calculated in relation to the previous fiscal year, e.g., the EUR 750 million threshold, MNE groups will not be required to recalculate and retranslate the amount based on the December average exchange rate applicable to the current fiscal year.
FORsights & Takeaways
The 2023 July Administrative Guidance with respect to the currency conversion rules is helpful in translating relevant items for GloBE calculations as the prior framework was silent on such translations.
Application of Tax Credits
Under the initial framework of the GloBE rules, the treatment of tax credits generally has an unfavorable impact on the GloBE effective tax rate (ETR) of a jurisdiction. To the extent a tax credit reduces GloBE income similar to a qualified refundable tax credit (QRTC), the effect of the tax credit mostly has a less significant effect to jurisdictional ETRs than it would if it were to serve as a non-qualified refundable tax credit (non-QRTC), which reduces the covered taxes affecting the jurisdictional ETR. The GloBE rules set forth a broad definition of the meaning of “refundable” in the context of QRTCs by referring to the amount of the credit that has not been used to reduce covered taxes and is either payable as cash or a cash equivalent. Acknowledging the lack of clarity with respect to the treatment of all tax credits, the 2023 July Administrative Guidance provides clarity with respect to how all credits are to be treated for purposes of the GloBE rules, i.e., as an increase to GloBE income or a reduction of covered taxes, by creating three categories of tax credits: Marketable Transferable Tax Credits (MTTCs), Non-Marketable Transferable Tax Credits (Non-MTTCs), and Other Tax Credits (OTCs).
The 2023 July Administrative Guidance specifies that the effect of MTTCs serves as an increase of the GloBE income as opposed to a reduction of the covered taxes in a jurisdiction’s ETR. In coming to this position, tax credits will meet the standard of an MTTC if the tax credit in question is used by the holder to reduce its tax liability in the issuing jurisdiction, meets the refundability standard imposed by the GloBE rules, and from the perspective of the tax credit holder, meets two new standards imposed under the 2023 July Administrative Guidance: (1) a legal transferability standard and (2) a marketability standard. Under the legal transferability standard, if an originator of the credit is permitted, under the relevant tax credit regime in question, to transfer the tax credit to an unrelated third party in the fiscal year where it meets eligibility or within 15 months from the end of that fiscal year where it met eligibility, the standard is met for the originator of the tax credit. The legal transferability standard also considers how a purchaser of a tax credit may satisfy this prong by providing that the purchaser must be eligible to transfer the credit to an unrelated third party in the fiscal year of the purchase of the tax credit. The marketability standard considers a threshold for an originator and a purchaser of the tax credit in question as well by considering the marketable price floor of the tax credit in question. The marketable price floor is equal to 80% of the net present value of the tax credit, whereas net present value is determined based on certain parameters that generally look to the yield to maturity on a debt instrument issued by the government issuing the credit. For an originator, the marketability standard is met if the tax credit is transferred within 15 months of the end of the fiscal year where eligibility was met at a price greater than or equal to the marketable price floor. On the other hand, purchasers may satisfy the marketability standard if the tax credit was acquired from an unrelated third party equal to or greater than the marketable price floor.
Non-MTTCs and OTCs are treated as a reduction to covered taxes under the 2023 July Administrative Guidance. A tax credit is a Non-MTTC if it fails the MTTC tests provided in the 2023 July Administrative Guidance, even in the case for an originator where the tax credit is transferable. OTCs are tax credits that are nonrefundable within the meaning of the initial framework of the GloBE rules and are non-transferable tax credits that can only be used to offset the originator’s tax liability in the relevant jurisdiction. Non-MTTCs for originators and OTCs are treated as a complete reduction in the context of covered taxes. Purchasers of Non-MTTCs will generally reduce their covered taxes by the face value of the tax credit in question over its purchase price in proportion to the amount of any credit used to satisfy its liability for a covered tax for a taxable period that ends during the fiscal year. Certain adjustments for purchasers of Non-MTTCs also are required to reduce covered taxes by the amount of any gain on the transfer of the Non-MTTC.
FORsights & Takeaways
The clarification of the types of tax credits that serve as a GloBE income increase (similar to QRTCs) instead of a reduction to covered taxes is much needed as the initial framework of the GloBE rules was relatively ambiguous with respect to what is a satisfactory transferability standard. While this guidance is certainly helpful, the role of certain energy tax credits considered in the Inflation Reduction Act of 2022 does not seem to be addressed and likely needs to be addressed in future administrative guidance as the GloBE rules evolve.
Clarification of SBIE
Under the current framework of the GloBE rules, the top-up tax liability for a particular jurisdiction is equal to the top-up tax percentage multiplied by the excess profits of the jurisdiction. The excess profits are generally the net GloBE income/(loss) by jurisdiction less two substance-based exclusions. The SBIE for each jurisdiction is the sum of the payroll carve-out and the tangible asset carve-out for each constituent entity. The payroll carve-out for a constituent entity located in a jurisdiction is equal to 5% of its eligible payroll costs of eligible employees that perform activities for the MNE group in such jurisdiction. The tangible asset carve-out for a constituent entity located in a jurisdiction is equal to 5% of the carrying value of eligible tangible assets located in such jurisdiction. An issue arises regarding how to calculate the payroll carve-out and the tangible asset carve-out for eligible employees and eligible tangible assets, which are sometimes located in the jurisdiction and sometimes located outside of the jurisdiction of the constituent entity employer/owner. The current framework was unclear regarding whether the amount of any stock-based compensation, impairment losses, and leases should be included in the payroll and tangible carve-out.
The 2023 July Administrative Guidance takes a simplified approach to the allocation of the payroll carve-out and tangible asset carve-out when such employees/assets are located part of the time in the jurisdiction and partly out of the jurisdiction. Thus, the Guidance has taken a threshold approach that allows a full payroll carve-out with respect to an employee if the eligible employee is located within the jurisdiction of the constituent entity employer for more than 50% of their working time. However, the constituent entity will only be entitled to the proportion of the payroll carve-out attributable to the employee’s working time spent within the jurisdiction of the constituent entity if such employee undertakes 50% or less of their activities within the jurisdiction of the constituent entity employer. Similarly, a full tangible asset carve-out is allowed with respect to an eligible tangible asset that is located within the jurisdiction of the constituent entity owner for more than 50% of the time. However, the constituent entity will only be entitled to the tangible asset carve-out in proportion to the time the asset was located within the jurisdiction of the constituent entity owner. Furthermore, the Guidance has stated that the MNE could choose only to claim those eligible payroll costs and eligible tangible assets for which it was willing and able to support.
The Guidance also clarified that the amount of eligible payroll costs included with respect to stock-based compensation is intended to be the amount included in the financial accounts used to determine the constituent entity’s financial accounting net income or loss. In addition, the Guidance clarified that the carrying value of eligible tangible assets is intended to include adjustments for impairment losses. Such impairment losses (and reversals of any such losses) should be taken into account in determining the carrying value of the asset at the end of the reporting fiscal year. Furthermore, the Guidance clarified that the lessee under a finance lease will be permitted to include the accounting carrying value of its right-of-use asset in calculating its SBIE.
FORsights & Takeaways
The 2023 July Administrative Guidance takes a practical threshold approach to employees and tangible assets that are working/located outside of the jurisdiction of the constituent entity as it relates to the substance-based exclusions. This approach prevents UPEs from determining the time that each employee and tangible asset spends or is located within the relevant jurisdiction and without. The Guidance also provided welcomed guidance on the treatment of stock-based compensation as it applies to the payroll carve-out, as well as the treatment of impairment losses and leases as it relates to the tangible asset carve-out.
The 2023 July Administrative Guidance supplements the 2023 February Administrative Guidance and the initial GloBE rules by providing clarity to a number of specific issues not previously addressed with respect to QDMTTs. Below is a non-exhaustive list of some of the QDMTT guidance addressed in the 2023 July Administrative Guidance:
- Joint Ventures (JVs), JV Subsidiaries, & Minority-Owned Constituent Entities (MOCEs). With respect to JVs, JV subsidiaries, and MOCEs, the 2023 July Administrative Guidance specifies that the top-up tax under a QDMTT is to be imposed on the entities themselves to help ensure owners in these types of entities bear their share of the QDMTT tax liability. In addition, the OECD suggests jurisdictions concerned about the possibility that a QDMTT results in a greater tax charge than the tax charge that would arise for a parent entity under the GloBE rules to design their QDMTT legislation in a manner that applies only where all the domestic constituent entities in the respective jurisdiction are 100% owned by the UPE or a partially owned parent entity for the entire fiscal year.
- Jurisdictional Blending. The OECD addresses issues with jurisdictional blending regarding QDMTTs. Under the initial GloBE rules, the average ETR is computed by reference to all constituent entities of an MNE group in a specified jurisdiction. Acknowledging that some jurisdictions may adopt QDMTTs that do not permit the jurisdictional blending permitted under the initial GloBE rules, the 2023 July Administrative Guidance provides specific rules allowing jurisdictions to blend income and taxes at a sub-national level or on a constituent entity basis.
- QDMTT Liability Allocation for IIR Purposes. Under the initial GloBE rules, it is noted that the top-up tax needs to be allocated for income inclusion rule (IIR) purposes even though it is not generally necessary to allocate a QDMTT liability among constituent entities. Acknowledging this distinction may present ambiguities to MNE groups for purposes of allocating top-up tax for IIR purposes, the 2023 July Administrative Guidance presents methodologies for the allocation of the QDMTT liability to specific entities based on certain criterium and also permits application of the QDMTT to flow-through entities under a variety of scenarios to address anticipated allocation issues.
- QDMTT Rules Regarding Flow-Through UPEs, Deductible Dividend Regimes, & Investment Entities. For UPEs that are flow-through entities or subject to a deductible dividend regime, the initial GloBE rules require the UPE to reduce GloBE income with respect to certain ownership interests. To provide outcomes consistent with the GloBE rules, the 2023 July Administrative Guidance notes that QDMTTs must respect the initial GloBE rules by including similar rules. In addition, the 2023 July Administrative Guidance requires the annual election afforded to eligible distribution tax systems be included in QDMTT jurisdictional legislation to the extent the jurisdiction has an eligible distribution tax system. This annual election computes the ETR for a jurisdiction each year based on deemed taxes paid and re-computes the ETR at the end of a four-year period based on actual taxes paid. The 2023 July Administrative Guidance extends this requirement for jurisdictional QDMTTs with respect to similar elections afforded to investment entities.
- QDMTT Payable. As discussed below, the 2023 July Administrative Guidance introduces a QDMTT Safe Harbour test designed to simplify the compliance burden for MNE groups. In so doing, the concept of a “QDMTT payable” is further articulated as a prerequisite before the QDMTT Safe Harbours can be applied. To the extent a QDMTT is not a QDMTT payable, the QDMTT Safe Harbours cannot be applied. The 2023 July Administrative Guidance specifies that a QDMTT payable is essentially a QDMTT that is not challenged by the MNE group or is determined not assessable or collectible by a local taxing authority on the basis of jurisdictional arrangements, i.e., constitutional law limitations or special governmental agreements. Specific rules are further addressed for QDMTTs that are later deemed to be a QDMTT payable.
The synopsis above addresses certain issues addressed in the 2023 July Administrative Guidance. It is important to note that the 2023 July Administrative Guidance also contains foreign currency rules used for computing QDMTTs, priority rules for allocating taxes with respect to CFC regimes and permanent establishments in the context of QDMTTs, additional rules for jurisdictional QDMTTs on the allocation of taxes for hybrid entities and distributing constituent entities, clarifying guidance for the treatment of QDMTTs during the transition years with respect to the IIR and UTPR, specific rules for how QDMTTs are to be framed when dealing with multi-parented MNE Groups, and requirements for incorporating definitions in the GloBE rules with respect to QDMTTs. Furthermore, the 2023 July Administrative Guidance acknowledges that QDMTT information returns can follow a different format than the GIR but generally must use equivalent datapoints to that required on the GIR issued by the OECD with the 2023 July Administrative Guidance.
FORsights & Takeaways
The 2023 July Administrative Guidance addresses key issues not addressed in the 2023 February Administrative Guidance in a manner that clarifies many of the ambiguities associated with QDMTTs and the initial GloBE rules used to implement the IIR and UTPR. While this guidance is certainly helpful, the timing of this guidance may present problems with respect to QDMTTs that have already been drafted and submitted for enactment or have already been enacted, e.g., the recent QDMTT enacted in the United Kingdom. Furthermore, while the acknowledgement of QDMTT informational returns different than the GIR is expected, the requirement of equivalent data points may create further ambiguities in jurisdictions where the GloBE rules are applied in different contexts due to differences in jurisdictional laws. The OECD may need to address this in future guidance.
QDMTT Safe Harbour Test
The 2023 July Administrative Guidance introduces a QDMTT Safe Harbour test, which intends to address an issue regarding QDMTTs created by the 2023 February Administrative Guidance and the initial framework rules. Under the initial framework of the GloBE rules, QDMTTs were introduced as a mechanism designed to help ensure that domestic minimum taxes collected at a jurisdictional level account for a sufficient amount of tax to help ensure no top-up tax is owed for a particular jurisdiction in an MNE group. Recognizing variability between jurisdictions, the 2023 February Administrative Guidance attempted to provide parameters for what makes a QDMTT enacted by a jurisdiction a “qualified” QDMTT. Under this guidance, a domestic minimum tax achieves “qualified” status if it is consistent with the design of and provides for outcomes consistent with the GloBE rules enumerated in the initial framework. The 2023 July Administrative Guidance recognizes that MNE groups may still be faced with increased compliance burdens for computing a local QDMTT and a GloBE jurisdictional top-up tax calculation (for IIR and UTPR purposes) due to slight deviations between the local QDMTT and the GloBE framework rules. As an attempt to alleviate duplicative compliance burdens, the QDMTT Safe Harbour test provides a QDMTT payable will be zero if the QDMTT in question satisfies the QDMTT Accounting Standard, Consistency Standard, and Administration Standard. In so doing, the 2023 July Administrative Guidance carefully notes that this safe harbour only applies to QDMTTs that achieve “qualified” status under the 2023 February Administrative Guidance and applies only to a QDMTT payable.
The QDMTT Accounting Standard generally requires that the QDMTT being tested be computed based on the UPE’s financial accounting standard or under the guise of an adjusted local country financial accounting standard. The Consistency standard requires that the QDMTT computation be the same as the computations required under the GloBE rules. In applying the Consistency Standard, the 2023 July Administrative Guidance considers that a QDMTT can be deemed to be the same as the GloBE rules where there is anticipated variability imposed by the 2023 February Administrative Guidance or other respected deviations from the GloBE rules. For example, the 2023 July Administrative Guidance elaborates that the Consistency Standard is met notwithstanding even if a QDMTT limits the ability to claim SBIE against GloBE income, contains a more limited de minimis exclusion, or has a minimum tax rate above the GloBE rate (currently 15%) for purposes of determining the tax amount. Furthermore, the Administration Standard requires the jurisdiction implementing the QDMTT meets the requirements of an ongoing monitoring process similar to the one applicable to jurisdictions implementing the GloBE rules as outlined in the initial framework released in December 2021.
FORsights & Takeaways
The QDMTT Safe Harbour generally eliminates duplicative compliance burdens MNE groups were facing after the 2023 February Administrative Guidance was released. Because the QDMTT Safe Harbour relies upon the premise that the QDMTT in question meets “qualified” status under the 2023 February Administrative Guidance and only applies to an amount that is a QDMTT payable, it is recommended that MNE groups seeking to apply this safe harbour test first review these components before application. While the QDMTT Safe Harbour test is mostly taxpayer friendly with respect to eliminating duplicative compliance burdens, complying with the nuances imposed by the QDMTT Accounting Standard might be challenging for some MNE groups that maintain differing accounting standards in a QDMTT jurisdiction. In addition, determining which variabilities between a QDMTT and the GloBE rules for the IIR and UTPR may pose additional questions as to whether the Consistency Standard is met. For these reasons, we recommend MNE groups seeking to apply the QDMTT Safe Harbour test consult with their advisors to better understand whether a local QDMTT is eligible for relief under the QDMTT Safe Harbour.
Transitional UTPR Safe Harbour Test
Under the current framework of the GloBE rules, the UPE to an MNE group that has not adopted a QDMTT may be subject to the UTPR to the extent the UPE jurisdiction is subject to an ETR below the GloBE tax rate of 15%. Recognizing the difficulty for a UPE to restructure due to a UPE jurisdiction’s rules against inversion activity, the 2023 July Administrative Guidance provides a temporary safe harbour test for the UPE of an MNE group that states the UPE’s share of top-up tax is equal to zero for the transition period if the UPE jurisdiction has a statutory corporate income tax rate of at least 20%. For purposes of quantifying the statutory corporate income tax rate, a jurisdiction’s federal and local corporate income tax rates are considered when measuring the 20% statutory corporate income tax rate threshold. The transition period for the Transitional UTPR Safe Harbour applies to fiscal years (running no longer than 12 months) beginning on or before December 31, 2025 and ending before December 31, 2026.
The 2023 July Administrative Guidance elaborates how this Transitional UTPR Safe Harbour interacts with the Transitional Country-by-Country Report (CbCR) Safe Harbour introduced in 2022. Under the Transitional CbCR Safe Harbour, MNE groups are permitted to apply three safe harbour tests, e.g., routine profits test, ETR test, and de minimis test, for each of the transition years in the transition period, but in the event a particular jurisdiction fails all three tests in one of those transition years, the jurisdiction must then apply the GloBE rules in their entirety and is required to do so going forward. The 2023 July Administrative Guidance provides that when a UPE jurisdiction passes both the Transitional UTPR Safe Harbour and the Transitional CbCR Safe Harbour, the MNE group may elect to apply the Transitional CbCR Safe Harbour first.
FORsights & Takeaways
The introduction of the Transitional UTPR Safe Harbour is generally a welcomed addition for U.S. parented MNE groups since it provides temporary relief as the U.S. corporate income tax rate is 21%, i.e., greater than 20%. While this relief is generally welcomed, it is important to note that this relief still doesn’t apply to members in an MNE group that are not the UPE and, thus, other low-taxed jurisdictions in the MNE group may still be subject to the top-up tax during the transition years. Moreover, the ability to elect whether to apply the Transitional CbCR Safe Harbour or the Transitional UTPR Safe Harbour also is a welcomed provision since it generally invites flexibility for the UPE jurisdiction during the transition period. Finally, the extension of the Transitional UTPR Safe Harbour for the two years following implementation of the UTPR, i.e., generally 2025 to 2026 for certain calendar-year taxpayers, also provides jurisdictions implementing the GloBE rules with additional time to implement QDMTTs.
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- 1“Tax Challenges Arising from the Digitalisation of the Economy – Administrative Guidance on the Global Anti-Base Erosion Model Rules (Pillar Two),” oecd.org, July 2023.