The European Union (EU) has recently adopted a new global minimum tax to help combat tax avoidance by multinational corporations (MNEs). The new tax, which is set at 15%, is intended to prevent companies from shifting profits to low-tax jurisdictions to reduce their overall tax burden. This will eventually be adopted by all member nations of the Organization for Economic Co-operation and Development (OECD), which includes the United States.
The methods of this tax base calculation consider revenue and costs associated with distribution and marketing activities of a company, which puts technology-based companies with international business activities particularly exposed to this minimum tax with an effective tax rate of 15%. Originally identified as a digital service tax, this will evolve into the Global Minimum Tax (GMT) once the new laws become enacted under a uniform regulatory administration, and all jurisdictions with a current digital service tax will eventually convert to GMT.
The GMT is a significant step forward in the fight against tax avoidance, as it will ensure that multinational corporations pay a fair amount of tax in the countries where they do business. This will help to level the playing field for small and medium-sized businesses, who often struggle to compete with larger companies that are able to take advantage of tax havens.
Before explaining GMT, it’ll be best to define digital service tax (DST) and the business types targeted, to get the idea of the MNEs that will have future GMT obligations….
DST is a transaction tax imposed on e-commerce type businesses digital products or services. The business types could vary from software, streaming/downloading to software service companies.
What Does This Tax Consist of?
The GMT tax consists of two Pillars: Pillar I is the sourcing and computation rules doctrine for companies making over €20 billion (21.6bil USD). Pillar II is the global minimum tax rules doctrine for companies making between €750 million to €20 billion.
Pillar I: Amount A
Multi-national entities (MNE) within the scope of €20 billion+, with profit margin above 10% will be taxed at 25% above the margin. In order for an MNE to be subject to tax in a foreign jurisdiction, it must have a nexus connection with that jurisdiction. Nexus is based on a fixed market revenue threshold.
Net profits per jurisdiction is determined by:
- Financial accounting income, with a small number of adjustments, allocated to the jurisdiction (allocation method to be determined)
- Should there be a loss, it shall be carried forward
- Profit safe harbors apply, which would ‘cap’ the tax base in jurisdictions that already have taxing rights under existing tax rules.
Pillar I: Amount B
A simplified method of determining the tax base, which is for companies to calculate the taxes on foreign operations such as marketing and distributions. MNEs with annual revenue within the €750 million – €20 billion range will be considered under this tax base method.
Pillar II imposes a minimum level tax to ensure MNEs pay a tax regardless of where they are headquartered or the jurisdictions they operate; known as the Global Minimum Tax (GMT). Pillar II rules rely primarily on book accounting rather than tax accounting data. The four rules that make up Pillar II are meant to apply to companies with revenue starting at €750 million.
- Domestic Minimum Tax (DMT) – countries get first right on taxing MNEs on profits currently being taxed below the minimum effective rate of 15%.
- Income Inclusion Rule (IIR) – imposes a top-up tax on a parent entity in respect of the low taxed income of an affiliated entity.
- Undertaxed Profits Rule (UPR) – allows a country the ability to increase taxes on a company if an affiliated entity in a different jurisdiction is taxed below the 15% effective rate.
- Subject To Tax Rule (STTR) – With a lower tax rate of 9%, this rule is to be used in tax treaty frameworks to give countries the ability to tax profits that would otherwise be taxed at a lower or no rate.
What are the compliance impacts of GMT?
Starting this year, EU will require digital platform facilitators to collect information on transactions of targeted MNE sellers who have activities such as rental of immovable property, provide personal services, sell tangible goods, and rent out transport using the platform. Companies can no longer get away with ignoring reporting and payment requirements. Most companies must register to do business in a jurisdiction. Failing to comply with reporting requirements, facilitator or seller, results in penalties for non-compliance, along with being barred from operating in a jurisdiction, and revocation of business registration. Sellers can also have their financial accounts closed and revenue withheld.
Member states with more than 12 MNEs must implement the Income Inclusion Rule (IIR) in December 2023, and the Undertaxed Profits Rule (UPR) in December 2024, including the U.S. This targets domestic MNEs who, in the past, avoided paying any tax on profits made abroad. Member states with fewer than 12 MNEs can elect to defer implementing both rules for six years.
Revenue neutral concerns are also rising from U.S. taxing authorities relating to the larger MNEs (under Amount A of Pillar I) because they feel that for revenue neutrality to happen, they will need to collect significant revenue from foreign companies or from U.S. companies that sell to U.S. customers from foreign offices. So, expect an increase in tax reporting and liabilities on inbound sales from foreign operated companies doing business in the U.S, for both federal and state taxes.
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