INTERNATIONAL TAXATION • BEPS 2.0 The Chartered Accountant • January 2023 • Vol. 71 • pp. 59–63 (Journal pp. 771–775)

New Era of Taxation – GloBE Rules under Pillar 2

SG
CA. Sachin Goyal
Member of the Institute • Contacts: sachingoyal0805@gmail.com | eboard@icai.in

The Digital Tax Transformation & The Two-Pillar Architecture

Digitalisation of world economies has made it imperative for tax authorities to introduce new concepts of taxation so that taxes are paid where economic activities are carried out and value is created. Current prevailing principles of taxation based on physical presence or Permanent Establishment (PE) are no longer appropriate for businesses that carry out substantial economic activities in a country via digital technologies without physical presence.

Pillar 1 (Nexus & Profit Allocation):
Rewrites profit allocation and nexus rules so MNEs pay taxes where consumers are located, allocating 20% to 30% of non-routine/residual profit to market jurisdictions via a revenue-based allocation key without requiring a PE.
Pillar 2 (Global Minimum Tax / GloBE):
Establishes a global minimum tax rate of 15% (Top-up Tax) on the income of low-taxed constituent entities, ensuring MNE groups pay an agreed minimum level of tax across all operating jurisdictions.

1. Regulatory Architecture, Milestones & Scope of Application

Following the release of the Pillar 2 Blueprint in October 2020, the OECD/G20 Inclusive Framework on Base Erosion and Profit Shifting (BEPS) published the draft Global Anti-base Erosion (GloBE) Model Rules in December 2021, providing the fine print of Pillar 2. A comprehensive Commentary was subsequently released in March 2022 to provide detailed guidance and nuance on statutory interpretations.

Common Approach (Not Mandatory Harmonization)

GloBE rules do not compel any jurisdiction to adopt domestic minimum taxes. However, where a jurisdiction’s Effective Tax Rate (ETR) is below the 15% minimum agreed rate, the rules empower other jurisdictions in the ownership chain to levy and collect a Top-up Tax on the low-taxed income.

€750 Million Revenue Applicability Threshold

GloBE Rules apply strictly to MNE Groups having total consolidated group revenue of €750 million or above in at least two of the four fiscal years immediately preceding the tested fiscal year (aligned with CbCR thresholds).

The Two Core GloBE Interlocking Mechanisms:

1. Income Inclusion Rule (IIR) – Primary Mechanism
IIR brings the income of Low-Tax Constituent Entities (LTCE) up to the agreed 15% minimum rate by requiring the parent entity (predominantly the Ultimate Parent Entity (UPE)) to pay tax on its allocable share of the top-up tax of the LTCE.
2. Undertaxed Payment Rule (UTPR) – Backstop Mechanism
Operates as a secondary backstop rule where the IIR is not sufficient to recover top-up taxes (e.g., where the UPE is located in a non-implementing jurisdiction). Top-up tax is allocated to jurisdictions adopting UTPR through denial of deductions or equivalent domestic adjustments based on relative employee headcount and tangible asset values.

2. Operational Flowchart: The 7-Step IIR Computation Framework

The application of the Income Inclusion Rule follows a rigorous seven-stage sequential process as formulated in the GloBE Model Rules:

Step 1: Identification of Constituent Entities (CEs) of MNE Group SCOPING
  • Define MNE Group, Constituent Entities (CE), Ultimate Parent Entity (UPE), and Fiscal Year.
  • Determine whether entities qualify as Excluded Entities: Governmental Entities, International Organisations, Non-profit Organisations, Pension Funds, Investment Funds that are UPEs, or Real Estate Investment Vehicles that are UPEs.
  • Special Consideration for India: Under Article 10.1, Governmental Entities must not carry on trade or business; hence Indian Public Sector Undertakings (PSUs) engaged in commercial business must be carefully evaluated to ascertain eligibility.
Step 2: Computation of GloBE Income or GloBE Loss of CEs TAX BASE
  • Financial accounting net income/loss prepared under acceptable accounting standards, subject to specific GloBE adjustments (Article 3.2).
  • Mandatory adjustments include: Excluded Dividends, asymmetric foreign currency gains/losses, intragroup financing arrangements, and accrued pension costs.
  • Elections available: Election to spread capital gains over five years.
  • Exclusion: Complete carve-out for International Shipping Income (Article 3.3).
Step 3: Computation of Adjusted Covered Taxes of CEs TAXES BORNE
  • Determine Covered Taxes (Article 4.2): Income taxes recorded in financial accounts, withholding taxes on distributions, taxes in lieu of income taxes.
  • Calculate Adjusted Covered Taxes: Add/deduct deferred tax adjustments, temporary difference recaptures, uncertain tax positions, and post-filing adjustments.
Step 4: Calculate Effective Tax Rate (ETR) & Top-up Tax Percentage BLENDED RATE
ETR = Sum of Adjusted Covered Taxes of each CE in Jurisdiction / Net GloBE Income of Jurisdiction
Top-up Tax Percentage = Minimum Rate (15%) – Effective Tax Rate (ETR)
*Investment entities are excluded from jurisdictional ETR determination. Blending occurs on a jurisdictional basis across all CEs located in that country.
Step 5: Computation of Excess Profit for a Jurisdiction SUBSTANCE CARVE-OUT
Excess Profit = Net GloBE Income – Substance-Based Income Exclusion (SBIE)
Substance-Based Income Exclusion (SBIE): Sum of the payroll carve-out and the tangible asset carve-out (Article 5.3). This protects genuine, active business operations and permits countries to offer targeted tax incentives on normal routine returns from real economic substance without triggering GloBE top-up tax.
Step 6: Computation of Jurisdictional Top-up Tax & CE Allocation TOP-UP TAX
Jurisdictional Top-up Tax = (Top-up Tax % × Excess Profit) + Additional Current Top-up Tax – Qualified Domestic Minimum Top-up Tax (QDMTT)
Top-up Tax of a CE = Jurisdictional Top-up Tax × (GloBE Income of CE / Aggregate GloBE Income of all CEs)
De Minimis Safe Harbour: Where average revenue is less than €10 million and average profit is less than €1 million in a jurisdiction (over 3 fiscal years), the Top-up Tax shall be deemed ZERO.
Step 7: Allocation of Top-up Taxes in Parent Entities’ Inclusion Ratios TOP-DOWN ALLOCATION
  • Top-down implementation: Tax is allocated to the Ultimate Parent Entity (UPE). If UPE is in a non-IIR jurisdiction, tax drops to the next Intermediate Parent Entity (IPE) in the ownership chain.
  • Determine Parent Entity’s Inclusion Ratio based on pro-rata economic ownership interest.
  • Apply the IIR Offset Mechanism to eliminate multi-tier double taxation across parent tiers.

3. Undertaxed Payment Rule (UTPR): Mechanics & Allocation Formula

The UTPR serves as the essential secondary backstop mechanism when low-taxed profits cannot be taxed under an IIR (e.g., where the UPE is situated in a low-tax jurisdiction that has not adopted IIR). The total top-up tax calculated under UTPR uses identical computational rules as IIR, but is apportioned among implementing UTPR jurisdictions based on substance:

UTPR Jurisdictional Allocation Factor:
UTPR Allocation % = [ 50% × (No. of Employees in Jurisdiction / Total Employees in all UTPR Jurisdictions) ]
                   + [ 50% × (Total Tangible Assets in Jurisdiction / Total Tangible Assets in all UTPR Jurisdictions) ]

Enforcement Method: Implementing jurisdictions give effect to this top-up allocation by either denying tax deductions for local group entities or requiring an equivalent balance-sheet adjustment under domestic laws.

4. Comprehensive Numerical Case Study: ABC Group

Corporate Structure & Jurisdictional Baseline:

  • Country A: A Co is the Ultimate Parent Entity (UPE). Country A has NOT implemented GloBE Rules.
  • Country B: A Co owns 100% of B Co 1 and 100% of B Co 2. Country B HAS implemented a Qualified IIR.
  • Country C: B Co 1 owns 100% of C Co 1, C Co 2, and C Co 3. Country C has NOT implemented GloBE Rules.
  • Country D: B Co 2 owns 100% of D Co 1, D Co 2, and D Co 3. Country D has NOT implemented GloBE Rules.
  • Assumptions: Tested fiscal year is Year 5. No Excluded Entities; no International Shipping income.

1. Consolidated Group Revenue Test (€ Million):

Year Year 1 Year 2 (≥ €750M) Year 3 Year 4 (≥ €750M) Year 5 (Tested)
Revenue (€M) 500 800 400 900 300
Scoping Result: In Year 2 (€800M) and Year 4 (€900M), consolidated group revenue exceeds €750 million in at least 2 of the 4 preceding fiscal years. Therefore, ABC Group is fully covered under the GloBE Rules for Year 5.

2. Country C Computation & Jurisdictional Blending:

Particulars C Co 1 C Co 2 C Co 3 Jurisdictional Total
Covered Taxes (A) [€M] 300 400 200 900
GloBE Income (B) [€M] 1,500 2,000 2,400 5,900
Effective Tax Rate (ETR %) 20.00% 20.00% 8.33% 15.25%
Analysis: The jurisdictional ETR for Country C is 15.25%, which exceeds the 15% minimum agreed rate. Consequently, Country C is not a low-taxed jurisdiction. Even though individual entity C Co 3 has an ETR of 8.33% (well below 15%), under GloBE rules, blending occurs at the jurisdictional level. Hence, Top-up Tax liability for Country C = Nil.

3. Country D Computation & Top-Down IIR Allocation:

Particulars D Co 1 D Co 2 D Co 3 Jurisdictional Total
Covered Taxes (A) [€M] 100 200 130 430
GloBE Income (B) [€M] 1,000 1,200 1,500 3,700
Effective Tax Rate (ETR %) 10.00% 16.67% 8.67% 11.62%
Jurisdictional ETR: 430 / 3,700 = 11.62% (less than the agreed 15% minimum rate). Country D is a low-taxed jurisdiction.
Top-up Tax Percentage: 15% – 11.62% = 3.38%.
Jurisdictional Top-up Tax Liability: 3.38% × €3,700 Million = €125.06 Million.
Critical Nuance: Top-up tax is payable even in respect of the income of D Co 2, despite its individual standalone ETR being 16.67%, because calculations are strictly performed on a blended jurisdictional basis.
Application of Top-Down Approach:
A Co (the UPE located in Country A) has not implemented IIR. Under the statutory top-down hierarchy, priority drops down to the next Intermediate Parent Entity in the ownership chain that is subject to a Qualified IIR. Here, B Co 2 located in Country B holds 100% completed ownership interests in D Co 1, D Co 2, and D Co 3. Therefore, B Co 2 is legally required to pay the entire €125.06 Million Top-up Tax liability to Country B.

5. Complementary Treaty Rules: Switch-Over Rule (SOR) & Subject to Tax Rule (STTR)

Switch-Over Rule (SOR)

Where a Parent Entity jurisdiction has entered into a Double Tax Avoidance Agreement (DTAA) adopting the exemption method (rather than the credit method) to eliminate double taxation on profits of a Permanent Establishment (PE), concerns arise that treaty obligations might block the domestic application of IIR.

Function: SOR acts as a treaty safeguard. It switches the treaty method from exemption to credit, permitting the residence state to tax low-tax profits of the foreign PE up to the agreed 15% minimum rate using the identical test as IIR.

Subject to Tax Rule (STTR)

A treaty-based rule specifically targeting base erosion risks in source countries arising from intragroup cross-border payments (such as interest, royalties, and service fees) that exploit low nominal tax rates in the payee’s jurisdiction.

Priority Mechanism: Allows source jurisdictions to impose additional withholding tax on covered payments up to the agreed minimum rate. STTR operates as a priority rule, applied before GloBE rules, with STTR taxes credited under GloBE.

6. Key Open Implementation Points & Concluding Remarks

1. Interaction with Controlled Foreign Corporation (CFC) Rules:

Countries with established CFC regimes (e.g., US GILTI, UK CFC) implementing Qualified Domestic Minimum Top-up Tax (QDMTT) rules face complex technical choices regarding whether domestic top-up rules should credit CFC taxes and vice versa.

2. Development of GloBE Safe Harbours:

To mitigate heavy compliance and administrative burdens on MNEs and revenue bodies, the GloBE Implementation Framework is formulating transitional and permanent Safe Harbours. These allow MNEs to avoid detailed ETR and Top-up Tax calculations where operations clearly meet or exceed 15% ETR thresholds.

3. Standardised GloBE Information Return (GIR):

A standardised reporting template under Article 8.1.4 is undergoing finalization to enable seamless exchange of information across inclusive framework revenue authorities.

4. India Domestic Legislative Outlook:

While no specific provisions on GloBE were enacted under Finance Act 2022, India is expected to introduce enabling legislation by way of an ordinance or upcoming budget provisions to align with global adoption timelines from 2023 onwards. Indian MNEs and outbound conglomerates must proactively model their corporate hierarchies and tax exposures.

Statutory Notes & Citations:
  1. Organisation for Economic Co-operation and Development (OECD).
  2. Pillar 1 residual profit allocation percentage: between 20% and 30%.
  3. Top-up tax is computed for the jurisdiction or Constituent Entity pursuant to Article 5.2 of the GloBE Rules.
  4. OECD (2021), Tax Challenges Arising from the Digitalisation of the Economy – Global Anti-Base Erosion Model Rules (Pillar Two): Inclusive Framework on BEPS, OECD, Paris.
  5. OECD (2022), Tax Challenges Arising from the Digitalisation of the Economy – Commentary to the Global Anti-Base Erosion Model Rules (Pillar Two), OECD, Paris.
  6. Low-Taxed Constituent Entity (LTCE) means a Constituent Entity of the MNE Group located in a Low-Tax Jurisdiction or a Stateless Constituent Entity that, in respect of a Fiscal Year, has GloBE Income and is subject to an ETR lower than the 15% Minimum Rate.
  7. Ultimate Parent Entity (UPE) is an entity that owns a controlling interest in any other entity and is not owned, with a controlling interest, by another entity (Article 1.4 of GloBE Rules).
  8. An MNE Group means any Group that includes at least one Entity or PE that is not located in the jurisdiction of the UPE.
  9. A Constituent Entity (CE) is any Entity included in a Group, and any PE of such Main Entity.
  10. Fiscal Year means an accounting period with respect to which the UPE prepares its Consolidated Financial Statements.
  11. Covered Taxes: Defined under Article 4.2 of the GloBE Model Rules.
  12. GloBE Implementation Framework provides guidance and processes agreed by the Inclusive Framework to facilitate coordinated implementation, including common allocation methodology for specific national tax regimes.
  13. GloBE Information Return (GIR) means the standardised return developed in accordance with the GloBE Implementation Framework containing information described in Article 8.1.4.