The adoption of the EU Minimum Tax Directive (2022/2523) ensuring a global minimum level of taxation for MNE Groups and large-scale domestic groups in the EU (also known as BEPS 2.0 Pillar Two) has raised some practical questions regarding how EU Member States will apply the global minimum corporate tax in their domestic legislation from the beginning of 2024 under the GloBE Rules1.
Although the latest OECD guidelines (released in February 2023) clarified some technical issues that worried the stakeholders, a question remains to be answered: how will the global minimum corporate income tax rate co-exist with the traditional tax incentives granted by domestic legislations that can make the effective tax rate (ETR) lower than 15%? Will jurisdictions be prepared to give up their set of tax incentives and remain attractive to foreign investment?
Briefly, the ETR of an MNE Group will be equal to the sum of the adjusted covered taxes, which are essentially, taxes on corporate profits and other equivalent taxes, paid by each MNE group entity in a jurisdiction, divided by the net GloBE income earned by the MNE group in that jurisdiction. In coordination with the domestic corporate income taxes rules, the GloBE Rules will determine that MNE Groups pay at least an ETR of 15% on the excess profits in every jurisdiction in which their entities operate.
It is clear to us that the application of the GloBE Rules might have a detrimental effect, leading to situations where the income reduction due to domestic tax incentives is “recollected” in another jurisdiction in order to achieve the ETR of 15%, or the jurisdiction itself foregoes the tax incentive to the benefit of another country by introducing an additional tax ensuring that the minimum taxation will be recaptured by the same jurisdiction.
The GloBE Rules have introduced the concept of Qualifying and Non-Qualifying Refundable Tax Credits, depending on whether they result in a financial impact. They should therefore be added to the income of the beneficiary entity to determine the ETR, or, instead, result in a reduction of the tax liability, in which case they will be treated as an adjustment to the tax liability.
This distinction is quite important in the ETR calculation. While the Qualifying Refundable Tax Credits (QRTCs)2, are treated as income and are included in the numerator (adjusted covered taxes) for the ETR calculation, leading to a higher ETR, the Non-Qualifying Refundable Tax Credits consist in an additional tax deduction (e.g., tax expense), resulting, consequently, in a lower ETR. Although both have effects on the ETR, the tax incentives that do not result in a reduction of the ETR will be easily maintained in domestic legislations. In contrast, the others may see their effects neutralized or even excluded by the possible application of an additional tax that compensates for the lack of tax needed to achieve the minimum ETR.
In principle, no doubts will arise as to the qualification of financial incentives and government grants as QRTCs to the extent that they represent income that is materialized. However, the same will not be the case for (non-refundable) incentives that result in a direct reduction of the tax bill related, for instance, to certain activities (e.g., R&D), investment expenses deductible for tax purposes, as well as incentives to the capitalization of companies (e.g., notional interest deduction).
A point of discussion relates to exemption regimes that fully or partially exempt from tax income arising from some sectors of the economy, types of entities or locations (e.g., Special Economic Zones), in which it is anticipated that the GloBE Rules have a significant impact. These special regimes would always be affected by Pillar Two since we are dealing with generalized corporate income tax reductions with the main purpose of providing favourable tax regimes, which should result in a tax policy dilemma for the jurisdictions that offer them.
The same rationale seems applicable to Patent Box regimes. In general, these regimes grant a deduction of the income derived from contracts concerning the disposal or temporary use of certain industrial property rights (e.g., patents, industrial models, copyrights). Even if these incentives lead to an ETR below 15%, the effects of the GloBE Rules could be “diluted” if there are other substantial activities carried out, resulting in a total ETR in that jurisdiction above 15%. In this case, the GloBE Rules are not expected to entirely cancel out but rather to reduce the impact of IP box tax incentives, since the intensity of their impact will be dependent upon several factors, for example, percentage of tax deduction, activities performed, related costs with IP activities. Accordingly, it appears reasonable that Patent Box regimes are maintained in coordination with the minimum taxation requirement, and it is difficult to define a priori what the effect of Pillar Two on these regimes would be.
Given that QRTCs require a refund element or a cash pay-out, it seems reasonable to assume that developed economies such as those of the EU should rethink their tax incentive schemes to assess whether adjustments should be made and give preference to the integration of financial incentives into their benefit packages.
Although several uncertainties remain regarding this subject and the case-by-case analysis that that should be made, Pillar Two will lead to a drastic change in the current tax landscape as we know it today, leading to a paradigm shift. It is of the utmost importance to assess how domestic tax incentives will be impacted and create measures to avoid the neutralizing effect that could be created.
Isaque Ramos – Partner
Ana Raquel Magalhães – Associate
1 The Global Anti-Base Erosion Rules, approved and released on 20 December 2021, consist of a coordinated system of rules which are designed to be implemented into the domestic law of each jurisdiction to ensure large Multinational Enterprise (MNE) Groups with consolidated revenue below EUR 750 million are subject to a minimum effective tax rate of 15% on excess profits on a jurisdictional basis.
2 QRTCs are defined as refundable tax credits that it must be paid as cash or available as cash equivalents within four years from when an entity satisfies the conditions for receiving the credit under the laws of the jurisdiction granting the credit.