Another milestone in global tax reform

On the evening of 8 October 2021, 136 member countries and jurisdictions of the OECD Inclusive Framework reached consensus on global tax reform. Since the signing of the statement establishing a new framework for global tax reform on 1 July 2021, the number of participants has increased, including the three EU countries that previously refrained from joining - Hungary, Estonia and Ireland.

As we reported in our July newsletter, this recent agreement finalised the remaining technical elements of the framework, which are briefly summarised below.

Above all, however, it is important to note that the European Union is working on its own major tax reform plans, of which the OECD tax reform is only the starting point. The OECD tax reform provisions will take the form of EU Directive(s), with the appropriate technical detail. Furthermore, the provisions, which for the time being only apply to the largest multinational groups, are likely be extended to smaller and smaller groups. For example, it is already included in the current OECD agreement that the scope of Pillar I (which would now cover only 100 groups worldwide) will be extended to smaller groups after a 7-year monitoring period. However, it is possible that the forthcoming EU directives will require Member States to take a more stringent approach. 

With the OECD tax reform, the so-called "digital services taxes" (in the context of Hungary, the Hungarian advertising tax is usually understood as such tax) introduced in some countries will be repealed, but the US GILTI regime will co-exist with the GloBE rules.

The OECD tax reform with its first provisions coming into force as early as 2023, is based on two pillars.

Pillar I promotes a fairer distribution of profits and taxing rights between countries:

• Multinational enterprises with a global turnover of more than €20 billion and a profitability (i.e. pre-tax profit/revenue) of more than 10% will have a proportion of their profits taxed in the countries where they derive their revenues from (at least €1 million of earned revenue, but up to €250,000 for smaller countries);
• The tax base will be determined by reference to financial accounting income, with a small number of adjustments. This tax base is multiplied by the tax rate of the country concerned. Losses will be carried forward;
• Double taxation is avoided through double taxation conventions;
• The tax compliance will be streamlined (including filing obligations) and allow in-scope multinational enterprises to manage the process through a single entity;
• Any related disputes (e.g. transfer pricing and business profits disputes) will be solved in a mandatory and binding manner;
• Extractives and Regulated Financial Services are excluded from the scope of Pillar I.

Pillar II aims to introduce a global minimum corporate tax rate:

• The provisions of Pillar II (the GloBE rules) will apply to multinational enterprises that meet the €750 million consolidated revenue threshold (such enterprises are currently subject to Country-by-Country Reporting requirement); 
• The minimum tax rate will be 15%;
• The in-scope multinational enterprises should calculate the effective tax rate on a jurisdictional basis (using a common definition of covered taxes and a tax base determined by reference to financial accounting income with agreed adjustments);
• Under the Income Inclusion Rule (IIR), the parent company has to pay top-up tax if the effective tax rate calculated is lower than the minimum tax rate set. However, if a low-taxed member company is not subject to tax under an IIR, then under the Undertaxed Payment rule (UTPR), the parent company is not allowed to deduct the related expenses from its tax base or must make an equivalent adjustment;
• Under a treaty-based rule (the Subject to Tax Rule (STTR)), source jurisdictions may impose a limited source taxation on certain related party payments subject to tax below the minimum rate of 9 per cent. (This tax will be creditable under the GloBE rules);
• The GloBE rules will provide for a formulaic substance carve-out that will exclude an amount of income that is 5% of the carrying value of tangible assets and payroll. In a transition period of 10 years, the amount of income excluded will be 8% of the carrying value of tangible assets and 10% of payroll, declining annually by 0.2 percentage points for the first five years, and by 0.4 percentage points for tangible assets and by 0.8 percentage points for payroll for the last five years;
• The GloBE rules will also provide for a de minimis exclusion for those jurisdictions where the multinational enterprise has revenues of less than €10 million and profits of less than €1 million;
• Multinational enterprises in the initial phase of their international expansion (the first 5 years) may benefit from certain exemptions.

To summarise the above, Pillars I and II of the OECD tax reform will enter into force from 2023 in all 136 participating countries, so it is recommended to follow the developments, in which VGD Hungary will be pleased to assist its clients.

12 October, 2021

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If you have any further questions on international taxation issues, please contact our tax experts.

This newsletter provides general information and does not constitute tax advice.