- Pillar One addresses the challenges of the digitalization of the economy and the allocation of taxing rights to market jurisdictions; and
- Pillar Two addresses the remaining concerns about potential BEPS activity and the tax rate competition between countries.
The planning and implementation of the BEPS 2.0 project have since gained significant momentum, especially with the increased involvement of the United States (US) in the consultation process. In July 2021, members of the OECD/G20 Inclusive Framework (IF)1 released a high-level statement reflecting their agreement to the two-pillar solution (Statement). The Statement was updated and agreed on in October 2021 and as of 4 November 2021, 137 out of the 141 IF members have joined the Statement, including Malaysia. Various rules, commentaries and exposure drafts have been released, particularly on Pillar Two.
Both Pillars are fairly complex in design and remain a work-in-progress, but they can be generally described as tax rules that intend to achieve the following objectives:
- Pillar One seeks to re-allocate the taxing rights over part of the profits of multinational groups with annual turnovers exceeding EUR20 billion and profits exceeding 10%, to the jurisdictions in which their customers are located, i.e., market jurisdictions. This is a fundamental change to international tax law. Currently, an entity would generally only pay income tax in a foreign jurisdiction if it has a taxable business presence (referred to in the tax world as a “permanent establishment”) in that jurisdiction. With the implementation of Pillar One, the world’s largest corporations will end up paying tax in jurisdictions where they do not have a physical presence, such as jurisdictions into which they are selling goods or services through electronic platforms. Generally, such multinationals will have a tax liability in jurisdictions in which they earn at least EUR1 million in revenue, with the threshold being lowered to EUR250,000 for certain countries. Whilst there are exclusions for taxpayers in the extractives and regulated financial services industries, the groups will need to check whether they qualify for such exclusions.
- Pillar Two seeks to implement a global minimum tax rate of 15% via two interlocking rules which will require changes to domestic tax laws (together, the Global Anti-Base Erosion (GloBE) rules). Pillar Two also proposes a tax treaty-based subject to tax rule (STTR), which would apply where certain intra-group cross-border payments are subject to low levels of tax. Details on the STTR have yet to be finalised.
The GloBE rules are optional and countries can choose whether or not they implement them. The 15% minimum tax under the GloBE rules is calculated on a jurisdiction-by-jurisdiction basis. Where the effective tax rate in a particular jurisdiction is below 15%, the Income Inclusion Rule (IIR) under GloBE provides that a top-up tax will be payable in the jurisdiction of the ultimate parent entity (UPE) in the group. So for example, if a US UPE of a group which is within the scope of Pillar Two owns several subsidiaries in Malaysia (including Labuan) and the blended effective tax rate in Malaysia is only 10% in a particular year, the UPE would need to pay a top-up tax of 5% to the US tax authorities. If for some reason the IIR is not applied in the US (e.g., because the US chooses not to implement the GloBE rules), then another parent entity further down the ownership chain between Malaysia and the US may collect the IIR. If the IIR is not collected anywhere, the top-up tax would be shared among other jurisdictions in which the group has a presence and which have implemented the GloBE Rules. This alternative collection mechanism is known as the “Undertaxed Payments Rule” (UTPR) and would result in taxing rights over the 5% tax shortfall being shared among the jurisdictions in which the Group has tangible assets and / or employees.
Pillar Two would apply to multinational groups with turnovers of more than EUR750 million in two out of the four years prior to the relevant year which is being tested. Certain exceptions and carve-outs apply. For example, income from international shipping operations is excluded from the minimum tax under Pillar 2. However, various conditions and rules must be complied with, for this exception to be applied.
Overall, the work and guidance on Pillar Two is more advanced than that on Pillar One. The OECD had originally expected BEPS 2.0 to be substantially implemented by 2023. As discussed further below, whilst significant work has gone into the BEPS 2.0 Project and it has strong support, the implementation of certain aspects may be delayed.
1The IF was established to ensure interested countries and jurisdictions, including developing economies, can participate on an equal footing in the development of standards on BEPS related issues, while reviewing and monitoring the implementation of the BEPS Project
On 3 June 2022, the Ministry of Finance issued the 2023 Pre-Budget Statement (Statement). The Statement indicates that the Government and the OECD are currently discussing the implementation of the taxation of the digital economy, under the two Pillar approach. The Statement concludes its BEPS 2.0 discussion to say that Malaysia is currently reviewing the technical details of the two Pillars, including the possibility of introducing the Qualified Domestic Minimum Top-Up Tax (QDMTT) under Pillar Two. The QDMTT would allow Malaysia to impose a 15% minimum tax, using Pillar Two principles, on in-scope groups which have an effective tax rate of below 15% in Malaysia. This would prevent Malaysia from ceding taxing rights (over profits earned in Malaysia) to other countries, meaning other countries would not be able to collect IIR or UTPR on profits earned in Malaysia. This would also simplify compliance.
As the OECD works towards finalizing the details of BEPS 2.0, countries have already started discussing and consulting on how they may implement the two Pillars, and the potential impact of implementation. Given that Pillar Two would impact many more companies than Pillar One, many of the country announcements have focused on Pillar Two.
Set out below are some of the BEPS 2.0 announcements around the world:
- Singapore’s Budget 2022 statement on 18 February 2022 indicated that Singapore will adjust its tax system in response to the Pillar 2 GloBE rules. This would be accomplished by exploring a Minimum Effective Tax Rate (METR) to top-up the effective tax rate of multinational enterprises which are within the scope of Pillar Two, to 15%. Singapore will seek to design the METR with the objectives of certainty and compliance simplicity, to help maintain Singapore’s reputation as a country with an open and business-friendly environment.
- Hong Kong’s 2022/23 Budget Speech delivered on 23 February 2022 indicated that a legislative proposal would be submitted in the second half of 2022 to implement the 15% global minimum tax rate under Pillar 2, as well as other relevant requirements under the BEPS 2.0 Project. These amendments will only apply to multinational enterprise groups with annual consolidated group revenues exceeding EUR750 million. To safeguard Hong Kong’s taxing rights, Hong Kong is also considering the introduction of a domestic minimum tax. This minimum tax will only apply from the year of assessment 2024 / 2025. Further, Hong Kong reiterated its commitment to maintain its simple and transparent tax system, including taxation based on territorial principles, and will take steps to minimize the compliance burden on multinationals when implementing BEPS 2.0 measures.
- The Government of Jersey released a policy paper on 12 April 2022 outlining its policy thinking on BEPS 2.0. According to the policy paper, Jersey commits to implement the minimum standards in Pillar One and the STTR. Jersey has not yet decided on its approach in relation to the GloBE Rules, but indicates that its analysis to-date suggests that the best policy could be to implement GloBE with a 15% domestic minimum tax applying alongside the existing corporate tax framework. If Jersey decides to implement GloBE, the implementation is likely to take place after 1 January 2024. The paper discusses that most companies operating in Jersey will be outside the scope of GloBE and the corporate tax position of such companies would remain unchanged. The Government of Jersey will work closely with Guernsey, the Isle of Man, the United Kingdom and other like-minded jurisdictions on the implementation of BEPS 2.0.
- The European Union (EU) will implement Pillar Two by way of an EU Council Directive (Directive), which will be adopted by all EU Member States. Once adopted, Member States shall transpose the provisions of the Directive into law by 31 December 2023 and then apply these provisions for the fiscal years starting on or after 31 December 2023 except the UTPR, which would apply for the fiscal years starting on or after 31 December 2024. The current wording of the draft Directive allows Member States with no more than 12 parented groups within scope of Pillar Two to choose not to adopt the IIR and UTPR for six fiscal years beginning from 31 December 2023. During an Economic and Financial Affairs Council (ECOFIN) meeting held on 17 June 2022 by the EU Council, Hungary, which had initially supported the draft Directive, changed its position and objected to its adoption. Hungary expressed concerns about the Directive, referring to undesirable delays of Pillar One and mentioning the Ukraine war and recent elections in Hungary as a new circumstance. The draft Directive requires a unanimous decision by all Member States for adoption. French Minister Bruno Le Maire said that he remains optimistic and he still hopes to reach agreement during the French Presidency of the EU Council, which ends on 30 June 2022. With 26 Member States committed to Pillar Two introduction, and one country blocking, the EU remains close to adopting the minimum tax rules. There may be further developments after an EU leaders meeting in Luxembourg on 21 June 2022.
- On 5 May 2022, New Zealand published an “official’s issues paper” (Paper) discussing the potential adoption of the Pillar Two GloBE rules. The Paper outlines the New Zealand Inland Revenue Officials’ (Officials) views as to whether New Zealand should adopt the GLOBE rules, and if so, how and when the rules should apply. The document represents the views of the Officials and the New Zealand Government has yet to make a final decision on New Zealand’s adoption of the Pillar Two proposals. The Paper indicates that the Officials support the implementation of the GloBE rules in New Zealand, but that New Zealand may not need to implement a domestic minimum tax such as the QDMTT. With respect to the timing of implementation, the Officials’ view is that New Zealand should wait to ensure that a “critical mass” of other jurisdictions adopt the GLOBE rules before progressing further. As well as looking to the EU, the United Kingdom and the US, New Zealand will look to follow Australia’s lead given the close economic relationship between the two countries.
- On 26 May 2022 Ireland announced a public consultation on how the Pillar Two Framework will be implemented into domestic law. Ireland is supportive of implementing the GloBE rules as well as a domestic minimum tax of 15% (referred to in the Irish consultation paper as a “Qualified Domestic Top-Up Tax” or QDTUT). In any case, as part of the EU, Ireland will be required to comply with the EU Directive in respect of Pillar Two.
The OECD’s initial plans to have BEPS 2.0 substantially implemented by 2023 may be somewhat delayed, with significant work remaining to be done on Pillar One in particular and with this Pillar now expected to be implemented in 2024. With respect to Pillar Two, whilst the OECD has indicated that much of the technical work is complete, many countries will be awaiting further guidance, in particular the detailed Implementation Framework. Countries are committed to implementing Pillar Two but may do so later than the original OECD target dates of having the IIR implemented by 2023 and the UTPR by 2024. For example, on 14 June 2022 the United Kingdom (“UK”) indicated that it will delay implementation of Pillar Two to accounting periods beginning on or after 31 December 2023.
It does appear that Pillar Two will result in multinational groups with global revenues of over EUR750 million being subjected to higher corporate taxes than smaller groups, with the IIR, UTPR and QDMTT potentially impacting these larger groups. Taxpayers will need to ensure that boards of directors and senior management are aware of the potential financial impact and that systems are capable of generating the data and calculations needed to comply with Pillar Two requirements. Companies which have not yet begun assessing the impact which BEPS 2.0 will have on their businesses should commence work on this immediately, as the analysis can be complex, the implications to the tax position can be significant and changes to the systems to enable compliance can take a considerable amount of time. Tax authorities will need to ensure that the relevant changes are made to domestic tax law and that tax filing platforms can cater to Pillar 2.
Malaysia has sent a clear message in the 2023 Pre-Budget Statement that the technical elements of BEPS 2.0 are being studied and the QDMTT is being explored. The authorities will want to ensure that Malaysia’s tax system is in line with international best practices and that Malaysia protects its taxing rights over profits generated here, whilst ensuring that our country remains attractive to foreign investors. It is relevant to note that for the purposes of calculating the effective tax rate for Malaysian operations under Pillar Two, Labuan is part of Malaysia and hence due consideration will also need to be given to the BEPS 2.0 impact on the Labuan tax system. More details may become available in Budget 2023, which is expected to be tabled on 28 October 2022.
With a more level tax playing field, investors and businesses will place increased importance on non-tax advantages offered by jurisdictions, such as cost competitiveness, the ease of setting up and doing business, reduced administrative burden and the availability of a skilled workforce and good physical and digital infrastructures. Labuan, and Malaysia as a whole, will continue to have a lot to offer to investors in a BEPS 2.0 world.
Partner, International Tax and Transaction Services
Tel: +603 7495 8413
Email: [email protected]
Anil has over 20 years of tax compliance and consulting experience and leads EY Malaysia’s International Corporate Tax Advisory and Tax Technical teams. He has advised on the tax and regulatory issues of various cross border transactions (both inbound and outbound), including transactions and group structures involving Labuan entities. His experience includes advising on the impact of the OECD’s Base Erosion & Profit Shifting (“BEPS”) Action Plans and BEPS 2.0 Project on holding and transactional structures and group effective tax rates, regulatory approvals, withholding taxes, tax incentives, structuring of operations in a business-focused and tax efficient manner and exit strategies.
Anil has advised on a number of restructuring exercises, including pre-IPO restructuring and pre-divestment restructuring. He has also led various tax buy-side and sell-side due diligence projects, including multi-country projects, involving various industries such as retail, education, oil & gas and healthcare.
