Chapter 28: Latest Developments in International Taxation (Pillar 1 & 2)
1. Architecture of the OECD/G20 Two-Pillar Solution
| Pillar | Primary Problem Addressed | Scope of Application | Core Economic Mechanism |
|---|---|---|---|
| Pillar One | Reallocation of taxing rights to market jurisdictions in digitalized economy. | MNEs with global turnover > € 20 Billion and profitability > 10%. | Amount A: Reallocates 25% of residual profits to market states. Amount B: Simplified wholesale distribution margins. |
| Pillar Two | Race to the bottom in corporate tax rates; profit shifting to low-tax havens. | MNE groups with consolidated annual revenue ≥ € 750 Million. | Global Minimum Corporate Tax of 15% via interlocking rules (QDMTT, IIR, UTPR). |
2. Pillar One: Amount A & Amount B Framework
Amount A Calculation Algorithm:
1. Scope Test: Global Turnover > € 20 Billion AND Profit Margin $( ext{PBT} / ext{Revenue}) > 10\%$.
2. Residual Profit: Profits exceeding the 10% routine baseline margin.
3. Reallocation: 25% of Residual Profit is allocated to eligible market jurisdictions based on local in-country sales revenues!
1. Scope Test: Global Turnover > € 20 Billion AND Profit Margin $( ext{PBT} / ext{Revenue}) > 10\%$.
2. Residual Profit: Profits exceeding the 10% routine baseline margin.
3. Reallocation: 25% of Residual Profit is allocated to eligible market jurisdictions based on local in-country sales revenues!
| Component | Description & Operation |
|---|---|
| Amount B | Provides a streamlined, standardized return for baseline wholesale marketing and distribution activities to reduce transfer pricing disputes in developing countries. |
| Removal of DSTs | All unilateral Digital Services Taxes (including Indian Equalisation Levy) must be permanently repealed upon entry into force of Amount A. |
3. Pillar Two: 15% GloBE Minimum Tax Interlocking Rules
| Rule Order | Name of Rule | Statutory Mechanism & Hierarchy |
|---|---|---|
| Priority 1 | Qualified Domestic Minimum Top-Up Tax (QDMTT) | Allows the Source State where the low-tax entity is located to collect the top-up tax up to 15% before any foreign jurisdiction can tax it. |
| Priority 2 | Income Inclusion Rule (IIR) | The Ultimate Parent Entity (UPE) jurisdiction levies a top-up tax on the parent company in respect of low-taxed income of foreign subsidiaries where Effective Tax Rate (ETR) < 15%. |
| Priority 3 (Backstop) | Undertaxed Profits Rule (UTPR) | Applies if the low-tax jurisdiction has no QDMTT and the parent jurisdiction has not implemented IIR. Other group countries deny deductions or make adjustments to collect the top-up tax. |
Effective Tax Rate (ETR) Formula:
$ ext{ETR in Jurisdiction} = rac{ ext{Adjusted Covered Taxes}}{ ext{GloBE Income}}$.
$ ext{Top-Up Tax Rate} = \maxig(0,\; 15\% - ext{ETR}ig)$.
$ ext{Top-Up Tax Payable} = ext{Top-Up Tax Rate} imes ig( ext{GloBE Income} - ext{Substance-Based Income Exclusion (SBIE)}ig)$.
$ ext{ETR in Jurisdiction} = rac{ ext{Adjusted Covered Taxes}}{ ext{GloBE Income}}$.
$ ext{Top-Up Tax Rate} = \maxig(0,\; 15\% - ext{ETR}ig)$.
$ ext{Top-Up Tax Payable} = ext{Top-Up Tax Rate} imes ig( ext{GloBE Income} - ext{Substance-Based Income Exclusion (SBIE)}ig)$.
4. Subject to Tax Rule (STTR @ 9%)
• Nature: Treaty-based rule designed to protect developing countries.
• Operation: Source country is permitted to levy a withholding tax of up to 9% on cross-border intra-group covered payments (interest, royalties, service fees) IF the recipient jurisdiction taxes such income at a nominal tax rate of less than 9%!
• Priority: STTR takes precedence over GloBE rules (taxes paid under STTR count as covered taxes for GloBE ETR).
• Operation: Source country is permitted to levy a withholding tax of up to 9% on cross-border intra-group covered payments (interest, royalties, service fees) IF the recipient jurisdiction taxes such income at a nominal tax rate of less than 9%!
• Priority: STTR takes precedence over GloBE rules (taxes paid under STTR count as covered taxes for GloBE ETR).
5. High-Frequency Exam Traps
Trap 1: Substance-Based Income Exclusion (SBIE) protects real economic activity!
Under Pillar Two, top-up tax is NOT charged on the entire GloBE income. A deduction is granted for SBIE based on eligible payroll costs (8% reducing to 5%) and eligible tangible assets (10% reducing to 5%)!
Under Pillar Two, top-up tax is NOT charged on the entire GloBE income. A deduction is granted for SBIE based on eligible payroll costs (8% reducing to 5%) and eligible tangible assets (10% reducing to 5%)!
Trap 2: QDMTT keeps the revenue in the host country!
If a developing country enacts a QDMTT, it collects the 15% top-up tax itself. The parent company's home jurisdiction cannot collect any IIR top-up tax on those profits!
If a developing country enacts a QDMTT, it collects the 15% top-up tax itself. The parent company's home jurisdiction cannot collect any IIR top-up tax on those profits!