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BEPS Pillar 2 rules need attention beyond the tax function

James Smyth, Partner, Corporate & International Tax.

While the financial services industry is not the main target of the incoming Pillar 2 rules, a particular focus of attention will be asset finance, where the tax benefits may accrue to the lessee rather than the lessor. James Smyth analyses the development of the rules to date and actions that should be taken without delay ahead of the 2024 implementation date.

Many readers will recall the febrile days of late 2021 when US Treasury Secretary Janet Yellen came to Dublin to cajole Paschal Donohue into signing up to the minimum tax rate initiative – the meaning of the words ‘at least’ being key to those discussions. Some would now see this as ironic in that while countries such as South Korea, the Netherlands, Japan and the UK have published draft Pillar 2 laws, there is no near-term expectation that the US will actually implement Pillar 2.

The time is nigh, however, with Ireland and other EU member states mandated to introduce legislation during 2023 with a 1 January 2024 start date for calendar year entities. This is often referred to as the Global Minimum Tax Rate Directive and this is more indicative of its contents than ‘Pillar 2’. The objective is to ensure that a minimum 15% tax is effectively borne on the profits of large MNEs irrespective of where they are recognised thereby reducing tax competition between nations (‘profit shifting’).

Does this mean Ireland will simply replace the 12.5% corporation tax rate with 15%? In short, no.

Outwardly, the rules are simple in concept but unsurprisingly complex in implementation.

Corporate income taxes worldwide are based on a patchwork of rules many of which start with ‘Net Income before Tax’ from financial statements. However, there is no coherent global approach to the computation of taxable profits with the result that formal tax rates often do not reflect effective tax rates. (This discussion could become even more complex if we addressed the issue of cash tax rates but none of that for now.)

The OECD solution to this is to create a new system for computing profits against which the actual tax charges of an entity are compared (on a country-by-country basis). Once this comparison is done, if the effective tax rate is less than 15%, a Top-Up Tax is imposed and this can be collected using many multi-letter mechanisms; IIR (Income Inclusion Rule), UTPR (Under Taxed Profits Rule) and QDMTT (Qualified Domestic Minimum Top-up Tax). In essence, the country where the profits are recognised gets an opportunity to collect any tax necessary to bring the rate up to 15% (QDMTT), followed by the IIR which is applied by a parent or intermediate parent entity with a fallback that all countries implementing Pillar 2 can collect any necessary residual tax from affiliates or parents based in territories which have not implemented the rules effectively (UTPR).

Even skilled tax ninjas will be tuning out by now and wondering when they can retire. Worry not, change is good and to be embraced. For groups which are in scope, an early impact assessment will be required.

The impact on Ireland’s financial services industry

For Irish operations in the FDI space, it is the QDMTT which is likely to be most relevant. Where there are substantial cohorts of employees/contractors and significant tangible assets in Ireland, it might very well be that little Top-up Tax is payable. This is because these factors are treated more favourably under Pillar 2 than financial assets and intangibles (effectively boosting the effective tax rate). A particular focus of attention will be asset finance where the tax benefits of those tangible assets may accrue to the lessee rather than the lessor for Pillar 2 purposes with the result that cash tax might be accelerated.

The financial services industry is not a particular focus of Pillar 2 and express exclusions for regulated investment and real estate funds are included together with special rules for insurance companies. Companies which are formed to hold assets for investment and real estate funds may also fall outside the scope of Pillar 2 but this is very much dependent on the facts and circumstances of each case. This will be particularly relevant for companies to which Section 110 treatment applies.

What action to take now?

While the new rules will not come into effect until 2024, companies will be expected to report on the potential impact in their 2023 accounts. An early-stage impact assessment should be undertaken to understand whether the group as whole is in scope and which entities might be affected. Simplified rules in the form of safe harbours have been designed to limit the impact over the initial 3 years. Where the safe harbours do not apply, Pillar 2 imposes a significant burden in terms of data and will likely require systems changes to streamline the compliance burden. Groups undergoing a finance transformation will want to build this into their plans. Compliance with the full rules will require close cooperation between finance and tax functions as much of the data that will be required would not usually be sought for existing tax compliance purposes.

And the Exchequer impact…

In the short term, it is to be expected that the Irish Exchequer will benefit from increased tax revenues with the threat of if or when Pillar 1 (which was initially designed to counteract the tax effects of digital disruptors) is implemented as that would likely reallocate profits to the jurisdictions where customers are based. That initiative is so stuck in the multinational mire that Pillar 2 might be the only pillar – whether Pillar 2 will turn out to be a gleaming Spire reaching to the skies or truncated (Nelson’s) Pillar will depend on the viewpoint of the observer and/or the success of the implementation process.

Please note this article first featured in the Irish Tax Monitor in April 2023 and was re-published kindly with their permission on our website.

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