More than 140 countries have signed up to the OECD/G20 Inclusive Framework’s Pillar 2 15% global minimum tax for multinationals (MNEs). The basic design is as follows: If one country taxes entities at less than 15%, another country is allowed to levy an additional top-up tax, ensuring an overall taxation level of 15%.
Although the OECD, finance ministries and MNEs have been working on the reform for years, numerous implementation challenges are only now becoming apparent. In recent months, the OECD has published model rules and a commentary of over 200 pages to explain the methodology of the minimum tax. MNEs are now trying to implement the rules. In the process, it is becoming apparent that much of the required data for calculating the minimum tax is not readily available in MNEs. Nor can they be easily derived from existing calculations, such as tax accounting or financial accounting. Further information is needed for many transactions. De facto, the minimum tax demands the implementation of a third accounting system: In addition to tax accounting and financial accounting, a third accounting layer for calculating the global minimum tax must be added.
The starting point for the global minimum tax base is international financial accounting standards. However, a massive number of adjustments need to be made to fit the minimum tax purpose. The required adjustments have been announced by the OECD. One example is dividends. Intra-group dividends are in most countries tax free, but part of the accounting profit. The global minimum tax rules state that they need to be eliminated if shareholding is at least 10% for at least 12 months. However, MNEs usually do not have this number available: Total dividends received are known, but which shares and which holding periods are behind them cannot be seen in the aggregated figure. Each dividend must therefore be classified as adjustable or non-adjustable item. The same holds true for many other items, such as policy disallowed expense, accrued pension expenses or deferred taxes.
Furthermore, there are even entities for which there is no separate accounting at all, e.g. in case of a permanent establishment. Currently, its profit is only part of its parent’s profit. Therefore, no separate accounting exists in the permanent establishment’ jurisdiction, so that no data is available to determine the minimum tax. Now the new global minimum tax rules require firms to catch up and perform a full accounting profit calculation from scratch. A comparable situation exists with respect to entities which are classified as “not material” and therefore not included in consolidated group statements. Under the minimum tax rules, these entities must still be included in the GloBE income, but the rules allow a deviation from the parent’s accounting standard if the differences between local GAAP and the minimum tax base are below 1 million Euros. Nevertheless, MNEs report that this threshold is often exceeded. As a consequence, full documentation according to the parent’s accounting standard has to be set up for the global minimum tax.
If these complex documentations are necessary to implement a globally desired tax reform, this high effort should be accepted. But one detail gives food for thought: Both MNEs and tax administrations often estimate that 15% taxes are paid in most countries anyway. In these cases, the complex tax calculation would only lead to the result: "No top-up tax necessary." Here, it is not the minimum tax that represents an additional burden for MNEs, but the compliance costs. A burden, however, that benefits no one, as it does not generate tax revenue for any state, but only causes further costs for audits by tax authorities.
This disparity has also been recognized by the OECD, which is now analysing the practicability of the new minimum tax with impressive energy and which is currently working on exemption and simplification regulations. Probably the most far-reaching “simplification safe harbour” was developed by Cedric Döllefeld, Joachim Englisch, Simon Harst, Felix Siegel and me at the Universities of Münster and Munich in close consultation with the OECD Secretariat. It aims to assess the risk that entities in a country may have a tax burden below 15%. It would be carried out in two stages, a country-level test and, if necessary, an MNE-level test. If a high tax rate and a jurisdiction’s tax base ensures that taxes would exceed 15%, then all entities in that country would be exempt from calculating the minimum tax. Compliance costs would be eliminated for both MNEs and tax administrations. Only in low-tax countries would corporate entities still have to perform the full calculation for the global minimum tax. If a country is between those extremes and if there are some tax incentives in that country, the country-level test identifies these incentives as “red flags”.
Only in these red flag cases would the second stage, the MNE-level test, come into play. In a largely simplified calculation, MNEs would add the income related to the red flags to the existing tax base and divide taxes paid by this new base. If the result was at least 15%, no top-up tax is imposed. Only if it is below 15% would a full minimum tax calculation become necessary.
This simplification safe harbour could be used for more than this 15% test. Another application could be the calculation of the 1 million Euros threshold. The global minimum tax is to be levied only if the local profit exceeds this threshold. However, to prove that the limit has not been reached, the profit must be determined according to minimum tax rules. The compliance burden would be just as high as if the minimum tax itself were determined. The simplified “tax base plus red flags” approach would greatly reduce compliance costs. The same applies to developing countries, whose tax administrations do not generally have the capacity to follow international accounting standards and the minimum tax calculations. In addition, countries such as Ireland, the United Kingdom, Canada and Switzerland are currently announcing their intention to introduce a “Qualified Domestic Minimum Top-up Tax” to ensure that a local 15% tax burden is always met and that no other country would impose top-up taxes on their profits. Again, unnecessary work would be saved if these taxes were determined on the basis of the simplification safe harbour.
The idea for a simpler, implementable, global minimum tax is there. Through the simplification safe harbour, the political goal of ensuring a 15% minimum tax can be reached whilst unnecessary compliance and audit costs would be avoided for MNEs and tax administrations alike. Now it is crucial that the simplification of the global minimum tax is implemented in the political process.
Deborah Schanz, Ludwig-Maximilians-Universität München. Deborah Schanz is currently an academic visitor at the Centre of Business Taxation of the University of Oxford.
The proposal is available at www.accounting-for-transparency.de/publication/no-70-tax-administrative-guidance-a-proposal-for-simplifying-pillar-two.
Other recent Centre for Business Taxation research on Pillar 2 includes:
Michael Devereux, John Vella and Heydon Wardell-Burrus, Pillar 2: Rule Order, Incentives, and Tax Competition
Heydon Wardell-Burrus, Should CFC Regimes Grant a Tax Credit for Qualified Domestic Minimum Top-Up Taxes?
Heydon Wardell-Burrus, Can Pillar 2 Be Leveraged to Save Pillar 1?