Implementation of Pillar Two: new tax planning strategies for multinationals in a changing regulatory landscape
December 2023 | SPECIAL REPORT: CORPORATE TAX
Financier Worldwide Magazine
December 2023 Issue
On 8 October 2021, 136 countries agreed to implement a minimum corporate tax rate for certain multinationals as part of the second of the two pillars in the Organisation for Economic Co-operation and Development’s (OECD’s) groundbreaking taxing the digital economy framework.
In December 2022, the European Union (EU) adopted Pillar Two minimum taxation rules. It introduces a 15 percent global minimum effective tax rate for multinational enterprise groups (MNEs) with consolidated revenue of at least €750m, or $868m, also known as Global Anti-Base Erosion (GloBE). This new tax regime aims to discourage shifting of profits by establishing a global minimum level of taxation in relation to each country where an MNE operates. Based on various surveys, around 8000 MNEs should be impacted by base erosion and profit shifting (BEPS) Pillar Two.
In accordance with the GloBE model rules of the OECD/G20 Inclusive Framework, the Directive provides for an income inclusion rule (IIR), an undertaxed payment rule (UTPR) and the qualified domestic minimum top-up tax (QDMTT). The IIR imposes a top-up tax at the parent entity level that effectively allows countries to ‘top up’ the tax on earnings of foreign subsidiaries with effective rates below 15 percent. The UTPR would deny deductions with respect to members of a group with an effective rate below 15 percent that are not otherwise subject to an IIR. Nevertheless, countries could be allowed to impose a QDMTT that will take precedence over either an IIR or UTPR. It will effectively ‘top-up’ the tax on domestic entities to 15 percent to prevent another country’s IIR or UTPR from capturing the revenue.
The Pillar Two rules are expected to begin for accounting periods starting from 1 January 2024 but will come into effect on a country-by-country basis.
Impact on tax planning strategies of multinationals
Pillar Two brings major changes to the global tax system and tends to impact large multinational companies that operate under the international tax framework.
The OECD published in 2022 the ‘transitional safe harbour’ rules, relying on country-by-country reports (CbCR), aiming to limit the administrative and compliance costs of conforming with the new international tax framework and to allow some corporations additional time to fully prepare for the compliance and reporting obligations.
An MNE group must comply with the relevant filing requirements to access these safe harbour rules, signifying that MNE groups will have to invest significant effort to obtain the data regardless of whether the safe harbour can be applied. Further, the ‘Safe Harbours and Penalty Relief’ document published in December 2022 required that a ‘Qualified’ CbCR be used, which is a more stringent standard than that required for CbCR reports today.
As countries are reaching agreement, the OECD expects to release further guidance on an ongoing basis, generating future uncertainty about divergence in GloBE rules and creating significant challenges in how taxpayers will incorporate each implementing jurisdiction’s unique adoption of the rules into their Pillar Two calculations.
Applying a 15 percent tax may sound straightforward, but it presents several operational complexities that corporations should be aware of as they kick off their new tax reporting journey.
First, where additional taxes apply, companies will have to review their global structures, value chains and location of operations to mitigate material impacts. The potential tax impact could be significant, increasing cash tax costs and reducing earnings per share.
In addition, MNEs will have to provide new disclosures in their financial statements, notably indicating the jurisdictions potentially exposed to additional tax. They will thus have to prepare themselves by anticipating the payment of an additional tax and, if applicable, its amount.
Pillar Two rules also raise various data and tax technology related questions such as access to the data, tools and processes needed for compliance. The calculations under BEPS Pillar Two require companies to collect data from hundreds of new sources, per entity, in several countries. Collecting and standardising this data may present a challenge for companies that use different systems in different regions.
To comply with these data and reporting requirements, companies need to coordinate tax, financial, IT and legal contributions end-to-end. This includes accessing the right data at the right level of detail, assessing existing technology, generating calculations, preparing and training resources and managing stakeholder expectations.
Pillar Two therefore requires tax and finance departments to work closely together in a collaborative manner. Shared data and integrated systems will need to be considered by MNEs.
EU member states will also need to make decisions based on the minimum tax provisions, taking into consideration the impact on planning intellectual property agreements and research and development activities, and also where to set up overseas companies and where to conduct secondary operations in order to minimise or manage material impacts.
As each implementing country adopts domestic legislation, taxpayers can expect further variances as laws change and evolve.
Practical implementation in France as part of the French Finance Act 2024
The French Finance Bill for 2024 transposes the Pillar Two Directive into domestic law and inserts new articles in a chapter specifically dedicated to the minimum worldwide taxation of multinational and domestic groups.
The multinationals concerned will be subject to minimum annual taxation in the form of a supplementary tax determined, depending on the case, by applying the IIR, UTPR and QDMTT. France has thus opted for the introduction of a supplementary national tax to transpose the Pillar Two Directive. This supplementary tax is completely independent of corporation tax and is not deductible from the latter.
In practical terms, the minimum annual tax charge would apply to multinational groups of companies with a presence in France, with consolidated annual sales of €750m or more in at least two of the previous four financial years, as well as national groups meeting the same sales threshold. The scope of these groups, which is distinct from that of tax consolidation, is slightly broader than that used for consolidation.
The main purpose of the system is to charge the parent entity of the group additional tax when the effective tax rate of the entities making up the group located in the same state or territory, taken together, is lower than the minimum tax rate of 15 percent.
The effective tax rate is determined, for each state or territory in which the group operates and for a given financial year, by the ratio between: (i) the amount of tax ‘covered’, which includes income tax and equivalent taxes borne by the constituent entities (companies, permanent establishments, etc.) established in that state or territory, including deferred tax; and (ii) the income earned by these same entities (GloBE income). The results of the constituent entities taken into account for the purposes of this calculation are derived from the financial statements drawn up for the purposes of consolidating the group’s accounts, before any adjustments relating to transactions between group entities. In order to avoid distortions between states, it is subject to specific and harmonised restatements enabling a ‘qualified result’ to be determined for each of these constituent entities.
In the event of under-taxation of entities established in a given state or territory, an additional tax is levied, the base of which is determined on the basis of the qualified result used to calculate the effective tax rate, the rate of which is equal to the difference between the minimum rate of 15 percent and the effective tax rate in that state or territory. This additional tax may be collected, depending on the case, by applying the IIR, UTPR or the QDMTT.
The French Finance Bill for 2024 also includes the provisional protection regime recommended by the Inclusive Framework in its December 2022 document. The additional tax payable under the aforementioned rules is therefore not due in respect of constituent entities established in a given state or territory where the following alternative conditions are met: (i) the sum of the turnover of the constituent entities located in that state or territory is below a de minimis threshold; (ii) a simplified effective tax rate is higher than a transitional minimum tax rate; and (iii) the under-taxed profits are lower than the amount of the deduction based on the substance of those same entities. This protection regime is intended to apply to financial years beginning no later than 31 December 2026 and ending no later than 30 June 2028.
The minimum taxation rules will apply to financial years beginning on or after 31 December 2023, with the exception of the rule on insufficiently taxed profits, which will in principle apply to financial years beginning on or after 31 December 2024.
Bruno Knadjian is a partner at Herbert Smith Freehills (Paris) LLP. He can be contacted on +33 1 53 57 76 67 or by email: bruno.knadjian@hsf.com. The author would like to thank Alexandra Pereira, a tax trainee and student at Herbert Smith Freehills (Paris) LLP, for her assistance with this article.
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Bruno Knadjian
Herbert Smith Freehills (Paris) LLP
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