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Canada releases draft Global Minimum Tax Act to implement Pillar Two
August 2023
In brief
Canada on August 4 released draft legislation to implement the Pillar Two global minimum tax regime developed by the OECD/G-20 Inclusive Framework on Base Erosion and Profit Shifting. This regime generally would apply to multinational groups (MNE groups) with consolidated revenue of at least €750 million.
These MNE groups would be required to compute their effective tax rate (ETR) in each country where they have a subsidiary or permanent establishment. If the ETR for a particular country is below 15%, a top-up tax would be imposed to raise that ETR to 15%. (This top-up tax may be reduced by a Substance-Based Income Exclusion (SBIE), which is computed based on the payroll costs and net book value of tangible assets located in the jurisdiction.) The ETR calculation generally is based on financial statement information but includes numerous adjustments.
The OECD has released model rules to implement Pillar Two, as well as commentary and administrative guidance on those rules (the OECD commentary). Participating countries each must introduce domestic tax legislation based on the model rules for Pillar Two to take effect in those countries.
Canada has released its draft Pillar Two implementing legislation as a new act, called the Global Minimum Tax Act (GMTA). The GMTA generally is aligned with the model rules and OECD commentary. To ensure consistency, the GMTA includes a provision stating that this legislation is to be interpreted consistently with the model rules, the OECD commentary and future guidance released by the OECD. However, the structure and drafting of the GMTA differs from the model rules in many respects.
The takeaway: While the GMTA is generally aligned with the Pillar Two model rules, taxpayers should review the draft legislation to assess its application to Canadian entities of in-scope MNE groups. The draft legislation confirms that the Canadian Income Inclusion Rule (IIR) and Domestic Minimum Top-up-Tax (DMTT) would apply for fiscal years of MNE groups beginning after December 30, 2023. Since this implementation date is fast approaching, MNE groups should act now to analyze the potential impact of the GMTA, and to consider whether their current data, systems, technology, and processes can support the requirements of the draft legislation. Interested parties also should consider submitting comments to the Department of Finance by the September 29, 2023, deadline.
Overview
Under the OECD’s model rules, the new top-up tax would be collected under one of three charging rules:
- The IIR generally requires the ultimate parent entity (UPE) of the MNE group to pay the top-up tax computed for its foreign subsidiaries (and also can apply to other types of ‘relevant parent entities’ in certain other circumstances).
- The Undertaxed Profits Rule (UTPR) is a residual rule, which collects top-up tax that is not otherwise collected under other rules. This residual top-up tax is allocated amongst all countries in which the MNE group operates (and which have adopted the UTPR), based on the group’s employees and tangible assets in those countries.
- A country also may choose to adopt a Qualified Domestic Minimum Top-up Tax (QDMTT), which collects top-up tax on the income of entities located in that country (rather than allowing foreign countries to collect this tax under the IIR or UTPR).
The GMTA includes an IIR and DMTT, which would apply to Canadian entities of MNE groups that are within the scope of the Pillar Two rules. The IIR generally would apply to a Canadian entity that is the UPE (or other relevant parent entity) of a qualifying MNE group, when the group has an ETR below 15% in a foreign jurisdiction. The DMTT generally would apply to Canadian entities of a qualifying MNE group, when the group’s Canadian ETR is below 15%. In cases where the Canadian entity that has an IIR or DMTT amount is a partnership, the top-up tax computed at the partnership level generally would be paid by the partners, in proportion to their allocable shares of the partnership income.
The draft legislation includes a placeholder for a UTPR but does not include actual UTPR language. According to the Canadian federal budget released on March 28, 2023, Canada intends to release draft legislation for a UTPR at a later date.
The IIR and DMTT would apply to fiscal years of a qualifying MNE group that begin after December 30, 2023 (i.e., 2024 and later for calendar-year taxpayers), while the UTPR is expected to apply to fiscal years of a qualifying MNE group that begin after December 30, 2024 (i.e., 2025 and later for calendar-year taxpayers). This is consistent with the timeline adopted by most participating countries.
Notably, the package of proposed legislation released on August 4 does not include consequential amendments to other Canadian tax legislation to address interaction with the GMTA, such as:
- consequential amendments to Canada’s existing international tax rules (e.g., the rules for foreign accrual property income and foreign affiliate surplus computations) to address Pillar Two taxes;
- the allocation of top-up taxes between the federal and provincial governments; or
- guidance on what Canadian tax incentives would constitute Qualified Refundable Tax Credits under the Pillar Two rules (or whether any tax incentives may be modified in response to Pillar Two).
Observation: Legislation addressing the impact of Pillar Two on existing tax rules is expected to be released in the coming months. However, the GMTA does include a provision indicating that the general anti-avoidance rule (GAAR) in Section 245 of the Income Tax Act would apply to amounts determined under the GMTA (with such modifications as the circumstances require).
Safe harbours
The OECD guidance includes certain safe harbours, which provide temporary and permanent exemptions from the Pillar Two rules. These safe harbours generally are replicated in the GMTA.
Transitional country-by-country reporting (CbCR) safe harbour
The GMTA includes a transitional CbCR safe harbour, which is consistent with the safe harbour rules outlined in the December 20, 2022 report of the Inclusive Framework published by the OECD. This safe harbour applies to an MNE group for a particular jurisdiction, if the group makes an election and satisfies one of the three tests listed below for that jurisdiction:
- De minimis threshold test – The MNE group must have less than €10 million revenues and €1 million pretax profits for the jurisdiction
- ETR test – The MNE group’s ETR for the jurisdiction must be, if the relevant fiscal year begins:
- before January 1, 2025, at least 15%,
- ·in 2025, at least 16%, or
- after December 31, 2025, at least 17%; or
- Routine profits test – The MNE group’s pretax profit for the jurisdiction cannot exceed its Substance-Based Income Exclusion for the jurisdiction.
These tests generally are computed using data from a qualifying CbCR, rather than full Pillar Two calculations. If a MNE group qualifies for the safe harbour in a jurisdiction, the top-up tax for the jurisdiction is deemed to be nil and reduced disclosure would be required. The transitional safe harbour would be available for fiscal years beginning before January 1, 2027 and ending before July 1, 2028 (i.e., 2024 to 2027 for calendar-year taxpayers).
Permanent QDMTT safe harbour
The GMTA also includes a permanent QDMTT safe harbour, which is consistent with the QDMTT safe harbour introduced in the OECD administrative guidance released on July 17, 2023. This safe harbour generally applies to an electing MNE group for a particular jurisdiction if that jurisdiction has a DMTT that is considered acceptable by the OECD/G20 Inclusive Framework—i.e., a DMTT that is consistent with the model rules and OECD commentary is applied using an acceptable accounting standard and is administered in an acceptable manner.
When the QDMTT safe harbour applies to an MNE group for a jurisdiction, the top-up tax for the group entities in that jurisdiction is deemed to be nil. The QDMTT safe harbour, when applicable, eliminates the need for an MNE group to undertake a second calculation of top-up tax under the Pillar Two rules.
Domestic minimum top-up tax
The DMTT is designed to qualify for the status of a QDMTT as determined by the Inclusive Framework. The DMTT generally applies to Canadian entities of an MNE group that is within the scope of Pillar Two when the group’s Canadian ETR is below 15%—in other words, the DMTT is computed at the jurisdictional level and not on an entity-by-entity basis. Unlike the domestic minimum taxes that have been introduced by some European countries, the DMTT does not apply to groups that are non-multinational (i.e., entirely Canadian).
The DMTT is intended to qualify for the QDMTT safe harbour—i.e., so that Canadian members of MNE groups would be exempt from the IIRs and UTPRs of foreign countries—and is meant to be interpreted consistently with the requirements outlined in the OECD guidance.
The DMTT includes an exemption for MNE groups that are in the initial phase of their international activities. This exemption would be available for up to five years, for an MNE group that is:
- located in no more than six jurisdictions, and
- holds no more than €50 million of net book value of tangible assets outside of its largest jurisdiction
However, this exemption would not be applicable where a relevant parent entity of the MNE group directly or indirectly owns Canadian entities of the group and is subject to a qualified IIR in a foreign jurisdiction. In other words, this exemption would not be available where the top-up tax of the Canadian entities otherwise would be collected under a foreign IIR.
Administration and enforcement
The GMTA includes detailed administrative and enforcement rules with stringent recordkeeping and filing requirements. These rules are similar to the administration and enforcement provisions in the Income Tax Act but go beyond those provisions in certain respects.
Filing obligations
The OECD has developed a standardized GloBE Information Return (GIR). The UPE of an MNE group (or another designated filing entity chosen by the group) generally can file this return on behalf of the group.
The GIR does not need to be filed in Canada, if the UPE (or designated filing entity) files the form in the foreign jurisdiction where it is located, and that jurisdiction has a qualifying competent authority agreement with Canada (which provides for the automatic exchange of these returns), although a Canadian notification would need to be filed in these circumstances. In other cases, the return would need to be filed in Canada—e.g., if the UPE or designated filing entity is located in Canada, or if there is no qualifying competent authority agreement with the relevant foreign jurisdiction.
The return is due within 15 months of the end of the relevant fiscal year (or 18 months for the first year in which the MNE group is subject to the GMTA). In addition, an entity that is liable to pay tax in Canada under the IIR or DMTT would need to file a separate return, which has the same due date as the GIR.
An entity would need to keep adequate records to determine whether it has complied with the GMTA for a period of eight years. The Canadian government reserves the right to specify the form that a record is to take and any information that the record must contain.
Penalties
Significant penalties may apply if an MNE group fails to comply with its obligations under the GMTA. However, transitional penalty relief may be available in certain circumstances.
Additional penalties may be imposed for repeated failure to file, false statements or omissions, and failure to provide the required information. Further, when an assessment is appealed to the Tax Court of Canada, and the Court determines that there were no reasonable grounds for the appeal, the Court may impose a penalty of up to 10% of the amount in dispute.
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