Our regular updates seek to address questions on the OECD BEPS Inclusive Framework and explore what the international tax rules may mean for your business. For further information on specific issues, please reach out to your KPMG contact or one of our tax partners below.
What is BEPS?
Base erosion and profit shifting (BEPS) refers to tax planning strategies used by companies operating across different jurisdictions to exploit gaps and mismatches in tax rules to avoid paying tax.
What is the OECD/G20 Inclusive Framework on BEPS?
140 countries (including the United Arab Emirates, Bahrain, Oman, Qatar and Saudi Arabia) have signed up to the Inclusive Framework (IF) on BEPS. Signatories have committed to implementing 15 actions to tackle tax avoidance, improve coherence of international tax rules and ensure a more transparent tax environment.
What are the 15 BEPS actions?
The 15 actions seek to equip governments with rules and instruments to address tax avoidance, ensuring that profits are taxed where economic activities generating the profits are performed and where value is created.
What has the United Arab Emirates (UAE) done about BEPS to date?
The UAE has:
- implemented Economic Substance Rules (ESR) (BEPS Action 5);
- signed the Multilateral Instrument (BEPS Action 6 and 15);
- introduced Country-by-Country (CbC) Reporting (BEPS Action 13);
- implemented a Mutual Agreement Procedure (BEPS Action 14); and
- implemented the Common Reporting Standard (CRS) to allow the Automatic Exchange of Information and Ultimate Beneficial Ownership (UBO) rules.
More recently, on 1 July 2021, the UAE was one of the 1301 IF member countries to approve a statement providing a framework for international tax reform (also referred to as BEPS 2.0).
What does the 1 July 2021 IF statement say?
The BEPS 2.0 statement sets forth the key terms for an agreement of a two-pillar approach to reforms. It also calls for a comprehensive agreement by the October 2021 G20 Finance Ministers and Central Bank Governors meeting, with changes coming into effect in 2023. Pillar One of the agreement is a significant departure from the standard international tax rules of the last 100 years, which largely require a physical presence in a country before that country has a right to tax. Pillar Two secures an unprecedented agreement on a global minimum level of taxation which has the effect of stipulating a floor for tax competition amongst jurisdictions.
What is Pillar One and Pillar Two?
While Pillar One is focused on nexus and profit allocation (with wider transfer pricing and value creation related concepts), Pillar Two (also referred to as the Global Anti-Base Erosion (GloBE) proposal) is focused on a Global Minimum Tax (GMT) for large multinationals, intended to address the remaining BEPS issues.
What is a global minimum tax?
Pillar Two proposes that international businesses pay a GMT of 15%. There are four rules to enforce this:
- Income inclusion rule (IIR): subjects foreign income of branches and controlled entities to an agreed minimum tax in the parent jurisdiction.
- Undertaxed payments rule (UTPR): denies deduction or imposes source-based taxation for payments to a related entity if that payment was not subject to tax above the minimum tax rate.
- Switch-over rule (SOR): applies where a permanent establishment is “undertaxed,” switching off a treaty-based exemption in the head office jurisdiction and replacing it with a credit-based method of taxation.
- Subject to tax rule (STTR): complements the UTPR and would deny treaty benefits for certain deductible intragroup payments that are subject to no or low rates of taxation in the recipient jurisdiction.
Is there a threshold set for the GloBE rules?
The statement provides that the GloBE rules will apply to Multinational Enterprises (MNEs) with revenues exceeding the EUR 750 million (approximately AED 3.25 billion) threshold as determined under BEPS Action 13 (Country-by-Country Reporting).
Countries are, however, free to apply the IIR to MNEs headquartered in their countries whose revenue falls below this threshold. Some countries are likely to adopt a lower threshold as the number of MNEs caught within the net would otherwise be very small.
How does the IIR operate?
IIR operates in a similar way to the Controlled Foreign Company (CFC) rules that currently exist in many jurisdictions.
The IIR would trigger an inclusion at the level of the parent company when the income of a CFC is taxed below the GMT of 15%. The parent company would be subject to a “top-up tax” to bring the low-taxed entity’s effective tax rate (ETR) up to the agreed minimum.
In simple terms, the IIR imposes a top-up tax on the ultimate parent entity (UPE) in relation to the profits of group companies that are taxed at an effective rate of below the GMT of 15%.
How does the UTPR operate?
The UTPR is a secondary rule and will apply where the GMT is below 15% and the IIR has not been applied by the jurisdiction in which the UPE or intermediate holding company is tax resident. The UTPR will deny a tax deduction or will impose source based taxation (for example withholding tax) for a payment to a related party if that payment was not subject to tax at or above the GMT of 15% under the IIR.
How does the SOR operate?
In case a double tax treaty results in a jurisdiction exempting the income of a permanent establishment (PE) and the profits attributable to the PE in the parent jurisdiction are low taxed profits, the SOR would allow the switching off of the exemption. This means that there will be a credit given for tax paid rather than exempting the profits.
How does the STTR operate?
The STTR will complement the UTPR by subjecting related party transactions to withholding tax or other tax at the source for certain payments (such as interest, royalties, franchise fees) that present a high risk of profit shifting to low-tax jurisdictions.
What is the UAE likely to do?
Countries, such as the UAE, that only have a limited corporate income tax (CIT) or a CIT below the GMT of 15% will need to make some key decisions:
- Implement the IIR and CIT on all businesses; or
- Implement the IIR and CIT on select businesses.
If nothing is done, profits generated by companies in the UAE could be subject to tax in other jurisdictions. In essence, the UAE will lose out on taxing rights. For example:
- A UPE located in the UAE may still end up paying top-up tax in another jurisdiction on the profits generated by the UAE group;
- A UPE in a country that has implemented the IIR with subsidiaries in the UAE would include and pay the top-up tax in respect to the low taxed UAE subsidiaries.
In the above examples, the UAE would concede the tax revenue that may have been generated from the profits of the UAE group to another jurisdiction.
Is the UAE likely to take action?
The UAE is already committed to the IF, having introduced CbCR and ES rules. The UAE will want to continue to ensure that it is not included in the EU Blacklist of Uncooperative Jurisdictions – therefore, it is likely that the UAE will consider the implementation of the IIR and CIT.
What should businesses in the UAE do?
Businesses with a UPE in the UAE or GCC, or MNEs with subsidiaries in the UAE or GCC, should monitor the developments around BEPS Pillar Two, as its implementation is likely to have a significant impact on the UAE and the regional tax landscape.
Whilst the IF statement provides that the GloBE rules will apply to MNEs with revenues exceeding the EUR 750 million threshold (approximately AED 3.25 billion) as determined under BEPS Action 13 (Country-by-Country Reporting), countries are free to apply the IIR to MNEs headquartered in their countries whose revenue falls below this threshold.
We recommend that, at a minimum, UAE companies conduct a preliminary analysis to determine how Pillar 2 and a potential CIT will impact business.
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1 At the time of writing, 132 countries had signed up to the BEPS 2.0 proposals.