GLOBAL MINIMUM TAX SERIES – PART 11 - Pillar Two Safe Harbours

[Amit Jalan]

Friends

In the previous edition we explained the key concepts of the GloBE Safe Harbour Rule as contained within chapter 8 of the GloBE Rules, particularly allowing MNE Groups to avoid ETR and Top-up Tax calculations for constituent entities in jurisdictions whose ETR equals or exceeds the Minimum Rate.

In this edition, we will discuss the safe harbours and penalty reliefs for the Pillar Two GloBE rules as issued by the OECD.

We hope this bulletin adds Value in your professional Sphere.

On December 20, 2022, the OECD issued the Safe Harbours and Penalty Relief for Pillar Two, which includes details of two safe harbours and a penalty relief mechanism for the Pillar Two GloBE rules.

The three published reliefs are:

• Transitional CbCR Safe Harbour
• Transitional Penalty Relief Regime
• Simplified Calculations Safe Harbours The first two are temporary, whereas the Simplified Calculations Safe Harbours are permanent.

The Inclusive Framework is also working on a fourth safe harbour, viz. the Qualified Domestic Minimum Top-up Tax (QDMTT) safe harbour that would provide compliance simplifications for MNEs operating in jurisdictions that have adopted a QDMTT. A QDMTT Safe Harbour, when released, is expected to would eliminate the need for an MNE to perform an additional GloBE calculation in addition to the QDMTT calculation required under local law.

Whilst the safe harbours/harbors represent a significant simplification for MNEs, qualifying for a safe harbour for a jurisdiction does not exempt an MNE Group from complying with the GloBE requirements such as the requirement to prepare and file its GloBE Information Return.

Transitional CbCR Safe Harbour

The Transitional CbCR Safe Harbour is a short-term measure that would allow an MNE to avoid undertaking detailed GloBE calculations, and the Top-up Tax would be zero in the transitional period (which is fiscal years beginning on or before December 31, 2026 but not after June 30, 2028), if based on its qualifying CbCR and financial accounting data, the jurisdiction meets at least one of the following tests:

 De Minimis test: the total revenue of less than EUR 10 million and profit before income tax of less than EUR 1 million in the jurisdiction in its CbC Report for the Fiscal Year.

Note that the de minimis test is similar to the de minimis exclusion under Article 5.5 of the GloBE rules except that it uses CbCR data and only applies to the current year;

• Simplified ETR test: a Simplified ETR that is equal to or greater than the transition rate in a jurisdiction for the Fiscal Year (the ETR test).

The Simplified ETR is the income tax expense in the MNE Group’s financial statements (after removing any taxes that are not covered taxes and uncertain tax positions) divided by the profit before income tax in the MNE Group’s CbC Report. This does not require any GloBE adjustments (e.g., the allocation of CFC or Main Entity taxes). The transition rate is 15% for Fiscal Years beginning in 2023 and 2024, 16% for Fiscal Years beginning in 2025; and 17% for Fiscal Years beginning in 2026.

• Routine Profit test: profit before income tax in the jurisdiction is equal to or less than the Substance-Based Income Exclusion (“SBIE”) amount for that jurisdiction calculated under the GloBE Rules. Therefore, the MNE would calculate the jurisdiction’s SBIE in accordance with the GloBE Rules and compare that to the jurisdiction’s profit before income tax in the MNE’s CbC Report. If the jurisdiction’s SBIE is equal to or exceeds the profit before Income Tax, it would qualify for the safe harbour. (The routine profits test).

Note that a jurisdiction with a loss or zero profits will not have an income that exceeds the SBIE amount, and therefore will always meet the routine profits test. It will not be necessary for the MNE to calculate the jurisdiction’s SBIE in these circumstances.

The safe harbour operates on a jurisdictional level. As such, once it has been determined that a jurisdiction meets one of the above tests, then any constituent entity that is located in the jurisdiction will qualify for the safe harbour.

The following are excluded from the Transitional CbCR Safe Harbour:

• Stateless Constituent Entities as 100% of their income is allocated to Permanent Establishments or to their Constituent Entity-owners;
• Multi-parented MNE Groups where a single Qualified CbC Report does not include the information of the combined groups;
• Jurisdictions with Constituent Entities that have elected to be subject to Eligible Distribution Tax Systems; and
• Jurisdictions that have not applied the Transitional CbCR Safe Harbour in a previous fiscal year in which the MNE Group is subject to the GloBE Rules (“once out, always out” approach), unless the MNE Group did not have any Constituent Entities in that jurisdiction in the previous year

Transitional Penalty Relief Regime

This is another temporary provision to relax penalties for MNEs that applies for fiscal years beginning on or before December 31, 2026 but not after June 30, 2028.

It provides that during this period, no penalties or sanctions should apply relating to the filing of a GloBE Information Return where an MNE has taken “reasonable measures” to ensure the correct application of the GloBE Rules.

The tax authorities may consider that an MNE has taken reasonable measures where the MNE can demonstrate that it has acted in good faith to understand and comply with the relevant domestic application of the GloBE Rules and the QDMTT.

The term “reasonable measures” is not defined by this document. It must be assessed based on the facts and circumstances of the case, for e.g., this could include:

a) a mistake of fact that is reasonable in the circumstances;

b) the errors can be reasonably attributed to unfamiliarity with the rules in the initial implementation years (e.g., isolated mathematical or transposition errors);

c) no reduction of top-up tax liability in the current or future year

In practice, the transitional penalty relief would not apply to cases of avoidance, fraud, or abuse.

Simplified Calculations Safe Harbours

Unlike the above transitional safe harbours this one is a permanent safe harbour that reduces or simplifies the number of computations and adjustments an MNE is required to make, without altering the MNE Group’s GloBE outcomes or undermining the integrity of the GloBE Rules.

Under this safe harbour, the Top-up Tax (other than Additional Current Top-up Tax, including one that arises under Article 4.1.5) for a jurisdiction shall be deemed to be zero for a Fiscal Year when the Tested Jurisdiction meets anyone of the following requirements:

a) De Minimis Test: if the average GloBE Revenue of a jurisdiction, as determined under the simplified income calculation, is less than EUR 10 million, and the average GloBE income is less than EUR 1 million or has a loss in accordance with Article 5.5 of the GloBE Rules.

b) Routine Profits Test: if the GloBE Income of a jurisdiction, as determined under the simplified income calculation, is equal or less than the SBIE amount in accordance with Article 5.3 of the GloBE Rules.

c) ETR Test: if the ETR of the jurisdiction, as determined under the simplified income and tax calculation, is at least 15% as determined in accordance with Article 5.1.1 of the GloBE Rules.

The current guidance is silent on the actual simplified calculations to be used. It states that the Simplified Income Calculation, Simplified Revenue Calculation, and Simplified Tax Calculation (together “Simplified Calculations”) are alternative calculations to the GloBE Income, Revenue and Adjusted Covered Taxes that will be provided in an Agreed Administrative Guidance, that would provide for the same final outcomes as GloBE Rules and not undermine its integrity.

One exception to this safe harbour is in relation to Non-Material Constituent Entities (NMCEs) which are excluded from the MNE Group’s audited consolidated financial statements solely on size or materiality grounds. It would typically include subsidiaries with no or minimal operations, or with operations that are in winddown or liquidation phase. It also includes any permanent establishments of these entities.

NMCEs are, however, included in the scope of GloBE and CbCR because they may play a role in achieving low tax outcomes, and therefore could pose a GloBE integrity risk if excluded entirely from the GloBE calculations.

It is specifically provided that NMCE whose revenues exceeds EUR 50 million, the financial accounts used to qualify for the Simplified Calculations Safe Harbour must be prepared in accordance with either an Acceptable Financial Accounting Standard or an Authorised Financial Accounting Standard.

NMCEs can benefit from the following simplifications:

• The GloBE revenue and GloBE income of an NMCE is the total revenue of the NMCE as determined in accordance with the CbC Regulations, which is broadly defined to capture revenues of any description and includes any “extraordinary income and gains from investment activities” without a deduction for current expenses. It excludes intra-group dividends and “comprehensive income/earnings, revaluation and/or unrealised gains reflected in net assets and the equity section. This is consistent with the requirements for calculating GloBE income under GloBE rules.
• The adjusted covered tax of an NMCE is the income tax accrued as determined in accordance with the relevant CbC regulations. Under the OECD CbCR regulation, this excludes any deferred tax expenses, other non-current items (such as transfer pricing adjustments), and provisions for uncertain tax liabilities.

Given the broader definition of income and the narrower definition of taxes, the Simplified Income, Revenue and Tax Calculations under this safe harbour are expected to result in a higher income and lower ETR than that provided under the GloBE Rules. Accordingly, the Inclusive Framework considers that the Simplified Calculations for NMCEs should not undermine the integrity of the GloBE Rules.