The new normal:
Global minimum tax

^{Published in Mauritius Finance Issue 3 magazine}

The US has always been the trend setter in matters of international tax. For instance, it initiated the automatic exchange of information under FATCA. The rest of the world followed suit and adopted the Organization for Economic Cooperation and development’s (OECD’s) Common Reporting Standard¹. Likewise, after the US introduced two rules aimed at putting in place a mechanism to ensure that the foreign profit of a US company is subject to a minimum tax, this act inspired the Inclusive Framework² (“IF”) members to propose the global minimum tax (GMT).

How challenges linked to the digital economy led to the global minimum tax

Back in October 2015, when the Base Erosion and Profit Shifting (BEPS) package was released, the action 1 report dealing with tax challenges linked to the digital economy remained a half-baked product. While IF members agreed that the whole economy is digitalising and measures should not target digital companies, no consensus could be reached on a proposed solution.

Several countries introduced unilateral measures such as the digital services tax (DST) which seeks to levy tax on the gross revenue a company like Facebook or Google earns from activities and users within its borders. Since many digital companies are headquartered in the US, this created tension between the US and these countries.

For instance, when France announced that it would go ahead with its DST, the Trump administration’s reaction was immediate. Tariffs would be imposed on certain French goods including makeup, soap, and handbags.

Realising that a consensus would be a better deal than unilateral measures, the US pushed for any proposed solution to be extended to non-digital companies. In this way, they would also be able to tax multinational enterprises (“MNEs”) with strong brands that were headquartered in other parts of the world.

A two-pillar solution was proposed. Under Pillar One, IF members proposed to grant more taxing rights to market jurisdictions, that is, those territories where sales arise. In parallel, some IF members proposed the introduction of a global minimum tax under Pillar Two so as to address the tax base shifting problem.

Many countries saw this as an opportunity to shore up dwindling government tax reserves. Pillar Two would allow them to tax the income of MNEs that is outside their jurisdiction through a set of rules known as the GloBe rules.

For the OECD, it was clear that, in order to reach a consensus, an agreement was needed for both Pillar One and Pillar Two on 01 July 2021, the OECD hailed that 130 countries had joined a new framework for international tax reform. Countries had hastened to sign an agreement that remained vague on many issues. For instance, the global minimum tax was announced to be at least 15%.

The devil is in the details 

As IF members continue to work on the design elements of Pillar Two, many open questions remain. Although the rate has now been fixed at 15%, the challenge would be to contain the appetite of those wishing for a higher rate.

While there is consensus that companies in scope of Pillar Two are those with global turnover above EUR 750m, that is, those with Country-by-Country reporting (“CbCR”) obligations, jurisdictions are given the leeway to apply the Pillar Two rules to smaller MNEs. 

While EU members are expected to stick to the EUR 750m threshold, some countries may choose to apply the global minimum tax to smaller MNEs. Pillar Two includes a treaty-based rule, the Subject to Tax Rule (STTR) which allows a jurisdiction to charge a top up withholding tax on certain payments between related parties where such payments are taxed at a rate less than 9%. 

In the October 2021 Pillar Two blueprint, mention is made that payments covered under the STTR are interest, royalties, and a defined set of payments. Would fees for technical services or capital gains also be in scope of the STTR?

The interplay between the global minimum tax which is calculated on a jurisdictional basis and the US GILTI³ rule which is calculated on a global basis is yet to be canvassed. It remains unclear whether the US GILTI rule would be a compliant Pillar Two regime. Should this happen, the effect of the global minimum tax would be diluted.

The jury is out: Should developing countries be concerned about the GMT?

Pillar Two is part of the global political agenda to levy more tax on MNEs while targeting investment hubs. It is set to be the new normal. Like any OECD-led tax initiative, the rules are dictated by and are unjustly skewed in favour of powerful nations. They are the real winners of the project. Developing countries have always been concerned about the imbalance in taxing rights between the source state and the residence state.

The Pillar Two proposal provides no remedy for them. In addition, it will take away incentives given by these countries to attract investment that is needed to create more jobs and generate growth. With BEPS 1.0, in spite of steps taken to eliminate harmful features in preferential tax regimes and others that require countries to incorporate an anti abuse provision in their tax treaties, nothing has materially changed.

While it is estimated that some 1,000 companies have CbCR obligations, Pillar Two is likely to hit only those claiming partial exemption. All in all, assuming the threshold of EUR 750M is adopted by a majority of jurisdictions, should we lose sleep over the Pillar Two proposal?

Only time will tell, but for now, a wait and watch approach appears to be on the cards, as developing countries hold their breath and hope that the rules will not further skew the tax balance in favour of advanced economies, making a level playing field in the financial services domain a more distant dream than ever before.

1. ^{The Common Reporting Standard (“CRS”) was developed by the OECD Council and calls for automatic exchange of information between jurisdictions on an annual basis}
2. ^{The Inclusive Framework on BEPS (“IF”) was established to review and monitor the implementation of the OECD/G20 BEPS Project and currently consists of 141 member countries (including Mauritius)} 
3. ^{The global intangible low-taxed income (“GILTI”) is a rule enacted by the US Senate to ensure that the foreign profit of a US company is subject to a minimum tax}