Background
The new global minimum tax is expected to come into effect from 2024 onwards
Although the political decision on the actual introduction of the global minimum tax within the EU has not yet been finalised due to lack of unanimous approval from all member states, it can be assumed that Germany and other member states will introduce and implement these rules on January 1, 2024. This intention was recently confirmed in the decision by the German ruling coalition on September 3, 2022 regarding the "Relief Package III" and in a joint declaration from the Finance Ministers of France, Germany, Italy, the Netherlands and Spain on September 9, 2022.
When putting the highly complex rules for calculating the tax into practice, companies must follow the five-step approach defined in the OECD guidelines. The following comments set out which special procedural features and technicalities have to be considered when completing these five steps.
Step 1: Scoping
The new global minimum tax is expected to come into effect from 2024 onwards
Pillar Two is based on the consolidated financial statements of an international group of companies. The question, however, is for which group entities a calculation of the Pillar Two top-up tax actually has to be made (known as "scoping").
These are, first and foremost, the fully consolidated companies of the corporate group, depending on the applicable accounting standard (e.g., IFRS). In addition to these consolidated entities, there are companies that could be included in the consolidation even though they are not actually consolidated, for example, for materiality reasons. Furthermore, permanent establishments are treated as separate companies for Pillar 2 purposes. On the other hand, certain group entities are to be excluded from the top-up tax calculation due to their "excluded entities" status. In this first step of scoping, any further special features or exceptions must also be considered, e.g., those for joint ventures, i.e. companies that are not fully consolidated and are accounted for in the consolidated financial statements using the atequity method.
Practical project experience shows that the scoping phase requires close cooperation and communication between the department responsible for the consolidated financial statements (accounting) and the tax department in order to ensure a correct implementation of the complex rules for identifying and qualifying the "constituent entities". Especially when there is a large number of constituent entities and countries to be included, a careful and diligent approach is essential in order to have a correct starting point for the subsequent calculation steps of the Pillar 2 top-up tax.
Step 2: Income calculation ("GloBE Income or Loss")
In step 2, there are extremely complicated rules to be observed when calculating income on the basis of the applicable accounting standard.
In principle, the relevant sum of income is calculated based on the result of the constituent entities in accordance with the applicable accounting standard of the consolidated financial statements (e.g., IFRS). The result of each constituent entity prior to consolidation bookings is decisive. Practical difficulties arise when calculating the income per constituent entity, especially with respect to the points described in the following.
There are certain constituent entities that do not apply the group accounting standard to calculate the income attributable to them. This may, for example, relate to controlled entities that are not actually consolidated for materiality reasons, or also to permanent establishments that are to be treated as separate constituent entities but do not usually prepare their own financial statements. A simplification rule exists whereby the income of such entities can, under certain circumstances, also be calculated on the basis of the (local) accounting standard that actually applies. However, the applicability of this complexly structured simplification rule is unclear in many cases. Therefore, in individual cases it may be necessary to use the accounting standard applicable within the group for such entities in future.
In addition, it has been observed in practice that not all accounting standards (e.g., IFRS) are always applied correctly and consistently when calculating the income per individual entity. From a group perspective, this is usually unproblematic in terms of accounting purposes, e.g., if IFRS 16 is not observed for intragroup leasing agreements because these transactions are consolidated in the financial statements anyway. However, for Pillar Two purposes it can be assumed from today's perspective that all standards must be applied correctly and consistently at individual entity level in order to arrive at a "correct" qualified income for tax purposes. In this respect, it may be that affected companies have to adjust their accounting processes accordingly for tax purposes, which can create an enormous amount of work.
Overall, the income calculation presents great challenges to companies due to the highly complex regulations, which remain subject to interpretation. In addition, the calculations require a great deal of information that has not previously been collected or recorded separately due to lack of necessity. In this respect, new data points have to be identified and a procedure established as to how these data can be structured to ensure tax compliance and a full incorporation into a company's tax calculations. Many companies will introduce IT-supported processes and calculations for this purpose.
Step 3: Calculation of the Tax Burden ("Covered Taxes")
The tax burden recorded in the individual financial statements has to be adjusted for Pillar 2 purposes, which affects deferred taxes in particular.
Calculating the tax burden in step 3 is just as complex as the income calculation of step 2. Again, this is due to the unclear wording of the regulations, among other reasons.
In addition to this, Pillar Two regulations stipulate that the current and deferred taxes booked in accordance with the accounting standard have to be applied. However, there are certain adjustments that have to be made, especially in the case of deferred taxes, which are difficult to manage in practice.
This affects, for example, the deferred tax burden, which - subject to a complex exemption rule - must be eliminated if it is not "reversed" within five years of the accounting year. Quantifying the tax burden on "excluded income" in respect of Pillar Two is also very difficult from a practical and individual perspective.
Step 4: Calculating the Tax Rate ("ETR") and Top-up Tax
If there is a risk of top-up tax if the ETR is below 15%, affected companies should check if an exemption applies.
If the calculation of the ETR in step 4 – as the fraction of the tax burden (step 3) and income (step 2) – results in a tax rate of less than 15%, a top-up tax will usually be incurred to ensure an income taxation of at least 15%.
However, this can be avoided if or to the extent that the group can prove investments in "substance" (i.e., tangible fixed assets and employees), because in this respect a routine return on such investments is effectively tax-free.
Exemptions from tax liability also apply in certain other situations and it is generally expected that the OECD and the EU will introduce significant simplifications ("safe harbours") to facilitate the application of the rules for taxpayers and tax authorities.
Step 5: Tax Liability under the Income Inclusion Rule ("IIR")
A tax liability can arise at ultimate parent level, at intermediate holding company level or even at the level of a low-taxed company.
If a top-up tax cannot be avoided, the question arises as to which constituent entity should be subject to the respective tax payment obligation.
In principle, it would be the ultimate parent entity which has to bear this tax. However, there are certain exceptions to this under the complex Pillar Two regulations. Calculating the tax liability is especially complicated, for example, in the case of fully consolidated holding companies with minority shareholders of over 20% ("partially owned parent entities"). It must also be considered that top-up tax may already be payable in the country of residence of the low-taxed group companies in the form of domestic top-up tax.
Conclusion
Companies would be well advised to familiarise themselves with the new global minimum tax already in 2022.
The complexity of calculating top-up tax, which results among other things from the unclear wording of the regulations, can only be mastered by following a strict implementation project. Many companies wish to cope with this huge challenge of tax compliance by means of IT-supported processes.
Even though local legislation on Pillar Two has not yet been finalised and there is hope that significant compliance simplifications will be offered by the lawmakers, companies would be well advised to familiarise themselves with the new global minimum tax and its impact on their internal processes as early as possible in 2022.
