The Organisation for Economic Co-operation and Development (OECD) has been working on a 15-point action plan since February 2013 to address base erosion and profit shifting (BEPS) caused by multinational enterprises (MNEs) exploiting weaknesses in the legacy international tax rules, which have arguably failed to keep up with global commerce.
In October 2021, over 135 jurisdictions joined a two-pillar solution, referred to as BEPS 2.0, to reform the international taxation rules and ensure that multinational enterprises pay a fair share of tax wherever they operate and generate profits.
In this article, we aim to provide a concise overview of the Pillars One and Two, alongside an exploration of their practical implications within the New Zealand corporate tax landscape to help businesses prepare for their implementation.
Pillar One aims to reallocate certain amounts of taxable income based on the market jurisdictions where the relevant customers are located, rather than based on the current “source-based” income allocation method. Importantly, Pillar One comprises of two parts, namely Amount A and Amount B, each summarised below:
Amount A broadly seeks to redistribute 25% of any residual profits which are above the MNE’s profit before tax margin of 10% (i.e. profit before tax (PBT) over total revenue) (PBT Margin).
Upon implementation, Amount A will only apply to the largest and most profitable MNEs, with the global turnover threshold being €20 billion. With revenues and profits relating to the extractive and regulated financial services industries being excluded, the OECD anticipates that approximately 100 MNEs will qualify for Amount A.
For example, if a MNE’s global revenues were €20 billion, with PBT of €4 billion, this would equate to a 20% PBT Margin, and €500m would be redistributed to local market jurisdictions based on the revenue generated in each jurisdiction. Local tax authorities would then be able to tax the additional allocated profits.
For Amount A to come into force, a Multi-lateral Convention (MLC) must be signed by at least 30 jurisdictions where more than 60% of the MNEs captured under Amount A are headquartered. Amount A will then run for a 7-year review period, and if successful, the revenue threshold is expected to be reduced to €10 billion.
In contrast, Amount B does not have a turnover threshold and, therefore, applies to all MNEs with marketing and distribution activities, including commissionaires and sales agents.
The intention of Amount B is to simplify the existing transfer pricing rules and provide increased tax certainty to taxpayers. The OECD plans to achieve this by performing global dataset analyses in line with the Transactional Net Margin Method (TNMM) to determine appropriate return on sale (ROS) margins for in-scope transactions.
Commodity related transactions are excluded from Amount B. Further, entities which also perform non-distribution activities and are unable to reliably segment their financial performance between distribution and non-distribution will also be excluded from applying Amount B.
While taxpayers will still be required to prepare appropriate transfer pricing documentation establishing the functional characterisation of relevant entities and confirming eligibility to apply Amount B, taxpayers will no longer be required to undertake separate benchmarking analyses to support the arm’s length nature of in-scope transactions.
The OECD expects to incorporate Amount B into the OECD Transfer Pricing Guidelines by January 2024.
In May 2023 the New Zealand Government introduced a Bill to adopt the OECD’s Global Anti-Base Erosion (GloBE) Rules, a key element of the Pillar Two framework. The bill proposes to incorporate the OECD Model Rules, Commentary, and Agreed Administrative Guidance into New Zealand legislation.
Pillar Two will broadly operate to apply to MNEs with a group turnover exceeding €750 million, calculated based on a four-year test (i.e. the threshold must be exceeded for at least two of the previous four years). Out-of-scope MNEs include investment funds which are ultimate parent entities (UPEs), holding vehicles and pension funds. Government and not-for-profit entities are also excluded along with tax transparent entities, although the revenue of out-of-scope MNEs still counts towards the turnover test. Certain types of income are excluded from the €750 million turnover test including revenues from transactions with other Group Entities which are eliminated in the consolidation process.
The OECD recently released further guidance on Pillar Two which sets out the scope and operation of the rules. The guidance provides for some basic steps that an MNE must go through in order to calculate its top-up tax liability. These can be summarised as follows:
A central concept to the operation of Pillar Two is the 15% minimum tax rate. The minimum tax rate is the effective tax rate (ETR) which is determined on a jurisdictional basis. The starting point is the consolidated financial accounts which are then adjusted to better align the income or loss of the local entity with the local tax base and to ensure a correct allocation of income between jurisdictions. If the calculation results in an ETR that is below 15%, the MNE Group is required to pay a top-up tax to bring the total amount of tax in that low-tax jurisdiction up to the 15% rate.
The resulting top-up tax can then be collected under three types of provisions (in this order):
Relates to a top-up tax assessed by the low-tax jurisdiction itself under a computation consistent with the Model Rules. This ensures a minimum level of taxation paid in the low-tax jurisdiction.
The IIR applies second to impose a top-up tax on a parent entity in respect of the income of an entity in the MNE’s structure taxed under the minimum 15% rate. This would apply where the low-tax jurisdiction does not have a QDMTT but where the UPE or an intermediate parent entity has. Generally, the UPE would collect the tax unless the UPE is not subject to an IIR, in which case an intermediate parent entity may collect the tax.
Where the IIR cannot be applied to a jurisdiction’s low-tax income, the top-up tax is collected by all jurisdictions which have implemented a UTPR (effective for income years on or after 1 January 2025).
In a slight departure from the OECD Model Rules, New Zealand is proposing to implement a Domestic IIR which will be calculated using the same tax base as for the Pillar Two rules. The purpose of the Domestic IIR is to avoid New Zealand headquartered MNEs needing to pay any part of the GloBE top-up tax on undertaxed New Zealand income to other countries under the UTPR. The Domestic IIR will not result in any additional tax to pay, it will just change the country the tax is paid to.
Given the above provisions, it will be important to determine responsibilities within MNE groups for managing the collective response to Pillar Two given that the rules will impact New Zealand headquartered and foreign headquartered groups differently. In this regard, and broadly, foreign owned New Zealand groups will need to actively address the implications of a domestic minimum tax in New Zealand. This will involve local tax, finance, human resources, information technology and other teams undertaking the crucial task of gathering the requisite data. These obligations may become more intricate in cases where the UPE or other intermediate parent entities of the group are situated in a jurisdiction that has not yet chosen to adopt the Pillar Two rules (or may implement at a later date). On the contrary, and in the case of an MNE group headquartered in New Zealand, the responsibility for conducting Pillar Two calculations for the entire group and remitting top-up tax will likely rest with the New Zealand UPE.
It should also be noted that the OECD guidance provides for some compliance saving approaches such that:
The application date of the GloBE rules in New Zealand has not yet been confirmed but will be set by Order in Council once the New Zealand Government is satisfied that a ‘critical mass’ of countries have adopted the rules. The ‘critical mass’ test will likely be met within the next few years as a number of jurisdictions, including Australia, Canada, the European Union, and the United Kingdom, have committed to adopting the rules.
There is no doubt that the complexity of these rules and the demand for comprehensive data and information, particularly in respect of Pillar Two, potentially represent a cumbersome issue for the MNEs for which the rules are designed for. It is anticipated that the number of data points required to prepare a GloBE return is around double the current number expected to be available to even the most advanced tax functions. Therefore, collaboration between the tax and other business functions within a MNE is required.
As such, some practical considerations for businesses include:
Authors:
There is no doubt that these rules will significantly impact the tax function of MNEs due to their complexity, uncertainty and increased compliance and reporting obligations. In addition, MNEs will need to consider whether their teams, resources and systems are prepared to address the many questions that will arise during the course of their assessment of the rules.
Please contact our Tax Advisory team if you would like to discuss the above and the potential impacts to your group.
Disclaimer:
This document contains general information and is also not intended to constitute legal or taxation advice. If you need legal or taxation advice, we recommend you speak to a qualified adviser.
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December 2023