In December last year, the OECD published draft rules for a minimum global effective corporate income tax of 15%. The European Commission subsequently issued a draft directive containing rules for the implementation of this tax by EU member states. It is proposed to take effect as early as 1 January 2023, by which time it should have been approved by the EU Council and the European Parliament and implemented in national legislation.
The minimum effective tax will apply to companies and permanent establishments of corporate groups whose consolidated revenue exceeds EUR 750 million in at least two of the last four consecutive years.
Two rules to fall under the minimum effective tax regime:
- Income Inclusion Rule – IIR
- Under Taxed Payments Rule – UTPR.
The Income Inclusion Rule is a basic rule that obliges holding or (sub)holding companies established in the EU to additionally tax the profits of the companies in a (sub)group, whether located inside or outside the EU, unless their effective tax rate reaches 15%. The effective tax rate will be calculated at the level of each state on a consolidated basis for all companies or permanent establishments having their registered office or place of business in that state. Profits from jurisdictions in which the effective tax rate is below 15% must then be topped up to 15% by the holding company. Both the OECD rules and the draft directive allow member states to adjust their legislation so that the top-up tax is collected by the state in which the group companies are located, regardless of the place of residence of the (sub)holding company (EU or non-EU).
The Under Taxed Payments Rule is a subsidiary rule that automatically allocates the top-up tax among the individual foreign (sub)group companies if the (sub)holding company state does not apply the basic Income Inclusion Rule.
Determination of profit to calculate an effective tax
The starting point for determining the profit from which effective tax is calculated will be the accounting profit or loss in the financial statements prepared for the purpose of preparing the consolidated financial statements before adjustments for intra-group transactions. The profit (loss) so determined will be further adjusted for selected items such as tax expenses, revaluation expenses or revenues, and dividend income. In line with its model rules, the OECD guidelines exclude income from international shipping.
Determination of tax to calculate an effective tax
The calculation of effective tax includes tax liabilities that have been recorded in the accounts and relate to profits (losses) from the relevant financial statements prepared by a corporate group, adjusted for selected items relating to, e.g., deferred tax.
Calculation of an effective tax rate per jurisdiction
The effective tax rate is calculated as the sum of the adjusted tax liabilities of all group companies within a jurisdiction divided by the sum of the adjusted profits and losses of all group companies in that jurisdiction. If the effective tax rate determined in this manner is lower than 15%, a top-up tax liability shall be calculated.
Calculation of a top-up tax liability
The top-up tax liability is determined as the product of the difference between 15% and the calculated effective tax rate and the adjusted profit within the given jurisdiction. In calculating the top-up tax, it is possible to reduce the adjusted profit by 10% of payroll expenses and 8% of the book value of tangible assets within the jurisdiction. Where the legislation of a particular state provides that the top-up tax liability must be borne by the companies in that jurisdiction, the tax liability shall be apportioned among the individual companies.
Some European countries (such as Spain) have already announced that the minimum effective tax will be introduced in respect of companies in their jurisdiction or have expressed their consent with such concept. Failure to adopt such legislation would essentially mean that the top-up tax relating to activities in that jurisdiction would be collected by the holding company's state.
The proposed rules do not address how to treat, e.g., tax losses from previous years, research and development allowances or tax credits under investment incentives granted based on national legislations, as all these may significantly reduce the effective tax rate under domestic legislation and lead to the occurrence of a top-up tax.