Global Minimum Taxation Deal To Impact Multinational Enterprises by 2023

In 2022 we are likely to see a shift of assets from territories without double tax treaty protection towards onshore territories due to new tax rules that are anticipated to come into play from 2023. A landmark international tax deal late last year saw 136 countries signing their agreement to a partial redistribution of tax rights for the largest global companies and a global minimum tax of 15% for multinational enterprises (MNEs). This ‘two-pillar solution’ was formulated by the OECD on 8 October 2021 and approved by the G20 on 31 October 2021. Industry professionals engaged in supporting such structures may find it more difficult to operate offshore and are likely to move to onshore locations.

Profit reallocation of MNEs to enrich all countries of operation

The objectives of the two-pillar solution are yet to be outlined in detail, but the deal has essentially proposed to “address the tax challenges arising from the digitalization of the economy,” according to the OECD’s official statement. While the initial draft rules tried to address this, it is becoming increasingly apparent that there are incompatible views in different territories on issues such as the definition of a digital company, and who should have additional rights regarding tax, among others. The final compromise now shifts the view from a qualitative to a quantitative assessment. The most important features of the new rules relate to minimum taxation, and what can be done when such a provision does not exist.

Pillar 1 affects MNEs with a global turnover above EUR 20 billion and profitability above 10%, by essentially reallocating 25% of the profit exceeding the 10% margin to countries where the MNEs generate turnover. Pillar 2 affects MNEs with a turnover above EUR 750 million, by requiring them to pay income taxes of at least 15% in each country in which they are active.

If a country does not provide for such minimum taxation, the jurisdiction of the holding company has the right to include such low-taxed income under an income inclusion rule (IRR) in the first place. If no such IRR exists at holding levels, there is a second interlocking rule, the undertaxed payment rule (UTPR), which denies deductions of payments if such income is not subject to 15% income tax at the receiving end. Both IRR and UTPR together are summarized under the global anti-base erosion  (GloBE) rules. Along with the GloBE rules, additional double tax treaty measures have been proposed. It is currently predicted that Pillar 2 will have far greater consequences on the international tax planning of MNEs than Pillar 1, where it is not yet entirely clear how territories such as the USA will adhere to the new regulations.

Offshore taxation becomes more stringent, and tougher on shell companies

The new rules set minimum standards of taxation on a global basis. Together with the 15% minimum tax rate comes an alignment of accounting regulations, and consequently a harmonization of the taxable basis. This, combined with the ever-increasing exchange of information at both individual and corporate levels, will render business activities increasingly transparent in terms of profit generation, staff numbers, and other important metrics.

It is almost certain that target countries with significant international businesses, but income tax rates below 15%, such as Ireland and Switzerland, will increase their tax rates for MNEs falling within the scope of Pillar 2. Additionally, tax benefits granted to certain industries or businesses, such as incentives in Singapore, will likely come under pressure. As a result, these countries will generate more income tax and possibly shift their business incentives to more subsidy-type actions that may be beneficial under the new regime.

These countries already host substantial business activities performed by a local, skilled workforce. On the other hand, typical offshore jurisdictions may find it difficult to cope under the new regime, and certain businesses will likely be discontinued. These include territories such as the Channel Islands, and some Caribbean countries that rely on zero-rated entities active in the financial industry. The following extract from the OECD’s frequently asked questions (FAQs) on the two-pillar approach may be illustrative in this respect:

Tax havens have thrived over the years by offering […] shell companies (where the company doesn’t need to have any employees or activity in the jurisdiction) and no or low tax on profits booked there. The […] OECD Base Erosion and Profit Shifting (BEPS) Project requires companies to have a minimum level of substance to put an end to shell companies along with important transparency rules so that tax administrations can apply their tax rules effectively. Pillar Two will now ensure that those companies pay a minimum effective tax rate of 15% on their profits booked there (subject to carve outs for real, substantial activities). The cumulative impact of these initiatives means that ‘tax havens’ as people think of them would no longer exist. Those jurisdictions that offer international financial services may continue to find a market for their services, but on the basis that they add real economic value for their customers and support for commercial transactions that are not tax-driven.

There are additional national and multinational initiatives aimed at fighting taxation structures that seem to lack real substance. One of the most prominent is the EU’s Business Taxation for the 21^st Century, announced in May 2021. Aimed at international tax transformation in general, this initiative also seeks to neutralize the misuse of shell companies for tax purposes, under a new anti-tax avoidance directive (ATAD 3).

Bankable assets for private companies a pivotal tax issue

Considering what we know today, holding of bankable assets in private companies in legal jurisdictions with very low or even zero-rated taxes will almost certainly be challenged in future. This is especially likely if there is not an adequate number of professional staff on the ground to manage the assets.

It is anticipated that ‘classic’ public fund structures will not be negatively affected by the new rules. This is because pension, endowment, and other similar funds would otherwise be heavily affected. However, it is unclear how structures that serve only one individual, or one family, will be addressed by the newly implemented taxation rules going forward. Given the new measures on the horizon, one would assume that countries that implement the GloBE policy might criticize those that do not accommodate minimum taxation. Not only will the overall tax burden on bankable assets increase to 15%, but lengthy disputes may arise should more than one jurisdiction charge additional tax on such low-taxed income.

As a consequence, there will likely be a shift of assets away from smaller territories without double tax treaty protection, towards onshore territories where substantial staff is available for managing the assets. Should this occur, the professionals engaged in supporting such structures may find it more difficult to operate from offshore locales. Auxiliary workers such as accountants, trustees, attorneys, and tax advisors, are likely to relocate to onshore locations.