On 20 December 2021, the OECD/G20 Inclusive Framework on BEPS (IF) published a 70-page document on the GloBE model rules under Pillar Two of BEPS 2.0. The GloBE model rules consist of the Income Inclusion Rule (IIR) and Undertaxed Payment Rule (UTPR) and can be accessed via this link: Tax Challenges Arising from the Digitalisation of the Economy – Global Anti-Base Erosion Model Rules (Pillar Two) (oecd.org)
What do the model rules cover?
The December 2021 document set out, among other things, the following key aspects of the GloBE rules:
For both the IIR and the UTPR:
- the scope of the rules, including the consolidated annual revenue threshold of EUR 750 million or more in at least two of the four immediately preceding accounting periods of the ultimate parent entity (UPE), the definitions of “MNE group”, “constituent entity”, “ultimate parent entity” and “excluded entity” (which includes an investment fund and a real estate investment vehicle as defined that is an UPE), and the exclusion of international shipping income and qualified ancillary international shipping income;
- the minimum effective tax rate (ETR) of 15%;
- the rules for computing the jurisdictional ETR, including the exclusions for the GloBE tax base and covered taxes, adjustments for permanent and timing differences (including an election to determine the gains or losses from revaluation of assets and liabilities based on the realisation principle for the purposes of computing the GloBE income), and consolidation adjustments;
- the use of the “deferred tax approach” in dealing with certain timing differences and losses;
- substance-based income exclusion / carve-outs for tangible assets and payroll – initially at 8% of the carrying value of the eligible tangible assets and 10% of the eligible payroll costs of eligible employees respectively and ultimately at 5% for both;
- the special provisions applicable to minority-owned constituent entities (i.e. where the UPE’s ownership interest is of 30% or less), joint ventures and multi-parented MNE groups; and
- other administrative provisions, including the de minimis exclusion for jurisdictions with insignificant revenue (i.e. average GloBE revenue of less than EUR 10 million) and profits (i.e. average GloBE income of less than EUR 1 million), the GloBE safe harbour (which has yet to be defined in the GloBE implementation framework) and the MNE group’s obligation to file a standardised GloBE information return in each jurisdiction.
For the IIR:
- the split ownership rule as an exception to the top-down approach to applying the IIR when more than 20% of the equity interest of an intermediate parent in a MNE group is directly or indirectly held by persons outside the group (i.e. persons that are not constituent entities); and
- the IIR offset mechanism for the parent entity in case the intermediate parent entity or a partially-owned parent entity applies the IIR.
For the UTPR:
- the UTPR is now not limited to related-party transactions and applies to all tax-deductible payments;
- the two substance-based allocation keys for allocating top-up tax to UTPR taxpayers (i.e. the number of employees and net book value of tangible assets); and
- other special rules of applying the UTPR (e.g. the exclusion from the UTPR of MNE groups in the initial phase of internationalisation).
The model rules contain a number of changes to the rules previously set out in the Pillar Two blueprint issued in October 2020, such as the computation of the GloBE income or loss, the computation of adjusted covered taxes and the mechanism for allocating the UTPR top-up tax amount. In particular, any qualified domestic minimum top-up taxes will now be creditable against the top-up tax under the GloBE rules instead of being treated as a covered tax. With these and other changes in mind, in-scope businesses will need to understand the model rules and identify the impact of these rules on their holding structures and business activities. A Hong Kong BEPS publication with more detailed discussion of the model rules and the changes as well as our analysis on their implications to Hong Kong businesses will be issued shortly.
The next steps
According to the OECD’s announcement, the Commentary relating to the GloBE model rules and the model treaty provisions on the Subject to Tax Rule (STTR) are expected to be released in early 2022. This will be followed by the development of the GloBE Implementation Framework focused on administrative, compliance and co-ordination issues relating to Pillar Two. A public consultation on the implementation framework and the STTR will be held in February and March of 2022 respectively.
Specific considerations for the Hong Kong SAR
The release of the GloBE model rules brings the international community one step closer towards the implementation of an unprecedented global minimum tax under the BEPS 2.0 project. The HKSAR Government has previously indicated that the Hong Kong SAR (Hong Kong) will actively implement the OECD’s BEPS proposals according to international consensus. In doing so, the government has emphasised that it will minimise the compliance burden on affected corporations and strive to maintain the simplicity, certainty and fairness of Hong Kong’s tax regime.
We believe that in formulating Hong Kong’s response to Pillar Two of BEPS 2.0, the government needs to consider the specific issues or challenges that Hong Kong is facing given Hong Kong’s unique tax system. From a tax policy perspective, such issues and challenges include:
- the tax treatments of offshore profits, capital gains, portfolio dividends, bank interest income, profits from qualifying debt instruments, etc. going forward given this income is currently either not taxable or specifically exempt from tax in Hong Kong;
- the impact of Pillar Two on the effectiveness of the existing concessionary tax regimes (e.g. for insurance, aircraft/ship leasing and corporate treasury businesses) and special tax deductions (e.g. for regulatory capital securities and research and development expenditure) and how to address the impact;
- the pros and cons of introducing a domestic minimum tax (DMT) regime in Hong Kong (which will effectively neutralise the benefits of the existing tax incentives for in-scope businesses) and whether the DMT (if implemented) should apply to both Hong Kong and foreign headquartered groups in respect of their low-taxed subsidiaries in Hong Kong;
- the differences in the tax treament of losses under the existing profits tax regime and the DMT regime (if any) / the GloBE rules (since there is currently no group loss relief in Hong Kong); and
- the interaction between the potential changes to the Hong Kong tax system driven by BEPS 2.0 and the changes to the Hong Kong offshore regime (in respect of passive income) that are required for Hong Kong to be removed from the European Union’s grey list for tax purposes.
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