Sweetening the deal?

In its recent Administrative Guidance, the OECD’s Pillar II team has clarified several technical issues, including applying qualified domestic minimum top-up taxes (QDMTTs), which various jurisdictions may incorporate in their respective domestic laws. The Guidance confirmed that such rules need to be designed in a manner similar to the GloBE rules. The GloBE rules mainly deal with the Income Inclusion Rule (IIR) and the Undertaxed Profit Rule (UTPR). However, it seems that the Guidance gives countries electing for QDMTT room to depart from the GloBE rules. Is adopting QDMTTs is more appealing than it was earlier for a country like India? This article should be read with our previous articles.

First, as for scope, the GloBE rules applied only to MNE Groups, or groups with cross-border operations. The Guidance confirms that implementing countries could choose to extend the QDMTT rules to purely domestic groups.

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Second, concerning the charging provisions, a question arose about whether QDMTT outcomes must be capped for those under the IIR. Assume that an Ultimate Parent Entity (UPE) in Country R owns 75% of a low-taxed entity in Country S and the other 25% is owned by third-party minority shareholders. The top-up tax of this entity is $100. If Country R had an IIR, it could collect only $75, i.e., the amount permitted as per the UPE’s inclusion ratio. However, if Country S enacts a QDMTT, then the Guidance seems to confirm that Country S can collect $100 and need not cap the QDMTT to match outcomes under the IIR. 

Third, regarding determining the GloBE income per country, the GloBE rules permit certain deductions. For instance, fines and penalties up to a certain amount are deductible. However, the Guidance confirms that if the QDMTT countries’ corporate income tax regime does not allow fines and penalties as a deduction, then this deduction need not be allowed for QDMTT calculation. This would thus increase the GloBE income per country, reduce the country’s effective tax rate (ETR), and thus increase the collection of top-up taxes. Fourth, concerning covered taxes, the GloBE rules provide that controlled foreign corporation (CFC) taxes levied on a parent are to be pushed down to the relevant constituent entity. In this regard, the Guidance also clarified that the US GILTI rules, which apply on a global blending basis, will be treated as a CFC rule for the GloBE rules. Of course, if such CFC taxes were pushed down for QDMTT calculation, then the collection of top-up taxes by QDMTT countries would go down. Thus, to ensure that developing countries come on board and to preserve the rule order, it was agreed that such taxes would not be pushed down. Of course, the issue remains whether the country enacting the CFC will provide credit for the overseas QDMTT.

Fifth, with respect to the computation of top-up taxes, the GloBE rules provide that these taxes are collected on excess profits, which are the GloBE profits as reduced by a substance-based income exclusion (SBIE) amount. However, the Guidance now provides that for QDMTT, a country need not provide for an SBIE carve-out or it could depart from the GloBE rules and provide a stricter carve-out. This could lead to the collection of more top-up taxes. Sixth, with respect to the tax rate, the GloBE rules provide that the minimum rate is 15%. Meanwhile, the Guidance now indicates that QDMTT countries could go beyond this rate and fix the minimum to be higher. Considering the above reasons, QDMTTs are stricter than the GloBE rules. Thus, many countries are now incentivised to enact QDMTTs, as they can possibly collect more top-up taxes. The Guidance also indicated that it could develop a QDMTT safe harbour soon. If an MNE is operating in a QDMTT country, it would be exempt from making further top-up tax calculations under the IIR or UTPR. Thus, considering the above benefits, India should consider the adoption of a QDMTT.

From a taxpayer’s perspective, a question of dispute resolution under the QDMTT remains. For instance, assume that a UPE from Country R has a low-tax subsidiary in India. India adopts a QDMTT. The local taxpayer files a QDMTT tax return and pays it locally (say $100). However, based on their interpretation, the local tax administration considers the QDMTT to be higher (say $150). So, what options are available to the local taxpayer to resolve this dispute? On the one hand, assuming a QDMTT safe harbour is adopted, it seems that the issue is a purely local issue. Thus, the most logical action to follow is the domestic dispute resolution path for the domestic QDMTT—the taxpayer could go before the local courts. On the other hand, if a QDMTT safe harbour is not adopted, the chances of such a dispute becoming bilateral or multilateral increase substantially. For instance, in the above example, the Country R tax administration could assert that the top-up tax linked to India is only $70 based on their interpretation of the GloBE rules and thus, they could impose an additional top-up tax charge of $30 on the UPE. The situation becomes worse if the UTPR applies and several tax administrations impose a top-up tax on the local entities of the MNE Group in their jurisdiction.

The OECD is currently considering two paths—multilateral convention and a domestic dispute-resolution mechanism based on reciprocity. Both paths have their pros and cons. In the interim, the OECD as well as the members of the Inclusive Framework, should prioritise the development of a QDMTT safe harbour. (Respectively, professor, University of Lausanne, and partner, BMR Legal)