In the second part of our series of articles on the global minimum tax, we present the proposed methodology of the legislation, focusing on the calculation of the income on which the minimum tax is based, and the taxes related to this income. The proposed regulation sets out the definition of the so-called covered taxes that are relevant for the calculation of the effective tax rate of the global minimum tax. By definition, covered taxes are those levied on income or profits as recorded in the accounting records, subject to a few exceptions.

Unlike many current tax systems, the minimum tax under the second pillar is determined, with some modifications, on the basis of the financial results reported in the consolidated financial statements of the company. In some cases, this can lead to very complex calculations which will require the introduction of new processes, rules and systems in the near future.  Among other considerations, the company will need to maintain separate books and records in accordance with the regulations of each jurisdiction, possibly for each consolidated group member, using the accounting framework of the group’s parent company.

As the effective tax rate will have to be calculated on a jurisdiction-by-jurisdiction basis, companies will have to prepare financial reports that were not previously required. Specifically, items that can be eliminated on consolidation, or that can only be accounted for on consolidation, but that are not currently “shifted down” to the books and records of each component unit, may affect both the ultimate tax payable and the jurisdiction in which such tax is payable. Examples of such items are intercompany sales, transfers of intellectual property, management fees, and transfer pricing fees.

Calculation of the additional tax

The proposal requires companies to have a minimum GloBE effective tax rate of 15% per jurisdiction. The second pillar effective tax rate (GloBE ETR) is the ratio of adjusted covered taxes to GloBE income or loss. If the GloBE ETR is less than 15%, then an additional tax is determined by applying the difference between the GloBE ETR and 15% to the second-pillar income, reduced by a materials-based deduction (“economic presence exclusion”). As a general rule, the rate of the economic presence allowance is equal to 5% of the group member’s employee wage bill or 5% of the tangible assets located in the group member’s State of residence.

GloBE income or loss

GloBE income is the financial result calculated on a stand-alone company basis under the accounting framework of the parent company, adjusted for items determined in accordance with the model rules. These adjusting items include (1) net tax expense (current and deferred income taxes), (2) dividends withdrawn, (3) gain or loss on certain revaluation methods, (4) gain or loss on disposal of assets and liabilities, (5) foreign exchange gain or loss resulting from exchange rate differences between the currencies used for accounting and local tax purposes.

A practical challenge for companies will be to determine the income reported in the financial statements at the level of each group member. Where group members’ accounts are kept in accordance with local accounting rules, companies should be aware of the differences between these rules and the accounting principles set out in IFRS or GAAP.

Adjusted covered taxes

Once the final GloBE income has been determined, the taxes associated with that income or loss are determined to arrive at the effective tax rate (ETR) at the level of the group member. These related taxes, referred to in the regulations as ‘covered taxes’, broadly refer to taxes levied on the income of group members, as well as specific taxes assessed at the same level as income taxes. Adjusted covered taxes start with the current tax liability, which is accrued at the separate corporate/jurisdictional level, and then adjusted by a number of items. Although the list of adjustments in the model rules is not exhaustive, the following list is included:

– Deferred taxes

– Tax effects related to uncertain tax positions (until the year until paid and only if such taxes are eventually paid to the tax authorities)

– Deferred taxes related to items of income or loss specifically excluded from the GloBE tax base

– Deferred tax assets related to any GloBE loss

– Qualified and non-qualified refundable tax credits

– Any amount of current tax expenditures not expected to be paid within three years of the last day of the tax year (reducing the covered taxes)

De minimis exception

The reporting group member may choose to benefit from one of the exemptions offered by the regulations. Notable among these exemptions is the so-called de minimisexception, which states that a multinational reporting group may treat as zero the additional tax for a group member in a jurisdiction where (1) the GloBE income for that jurisdiction is less than EUR 10 million and (2) the average GloBE profit for that jurisdiction is negative or less than EUR 1 million.

In the third part of our article series, we present the proposed Hungarian regime, which, in light of the current favourable corporate tax rate, is of great importance for the obligations of the relevant groups of companies with a Hungarian subsidiary.