The adoption by EU Member States of a global minimum tax Directive (“EU Directive”) last December failed to catch public attention but it was one of the most significant developments in recent times, said James Smyth, Partner, International Corporate Tax, Deloitte.

Broadly, the effect of enacting the EU Directive is that large EU groups, wherever headquartered, will now be subject to an effective tax rate of at least 15% on all their profits wherever arising.

“These global minimum tax rules, which are referred to interchangeably as Model Rules, Global Anti-Base Erosion” rules or Pillar Two rules (“Model Rules”), were originally formulated by the OECD and approved by almost 140 EU and non-EU countries in October 2021”, he said.

“The unanimous adoption by EU countries of the EU Directive will mean that all EU countries will need to incorporate the Model Rules into their domestic legislation this year”.

“Non-EU countries, while not being subject to the EU Directive, will likely also implement Model Rules into domestic legislation. Non-EU Countries that have implemented the Model Rules or indicated their intention to implement such rules include the UK, Japan, South Korea and Switzerland”.

Smyth said that one exception is the US, which already has its own version of the minimum tax rules, albeit such rules, while similar, are not identical to the Model Rules. A proposed modification of the US rules to accommodate Pillar Two failed to reach agreement late last year.

The origins of the Model Rules can be traced back to the great financial crisis in 2008, said Smyth. “In the aftermath of the crash, there was a level of public outrage associated with perceived tax avoidance by multinational groups (“MNEs”) at a time when governments were providing taxpayer bail outs for financial institutions and implementing austerity measures”.

“As such, it became politically imperative for governments to take action. In response, the Base Erosion and Profit Shifting (“BEPS”) project was initiated in 2013, with the OECD being tasked with the management of the project. The challenge of taxing the digital economy was identified as one of the key areas of focus of the BEPS project”.

After a period of consultation, the OECD issued 15 final BEPS reports in 2015 incorporating their recommendations on various areas. Action 1 of the October 2015 final BEPS reports did not come to any definite conclusion dealing with the taxation of the digital economy, he said.

“Subsequently, at the request of the G20, the Inclusive Framework (“IF”), a body made up of 140 countries, was asked to work on this unresolved issue. In January 2019, the IF proposed to split the work into two pillars, Pillar One and Pillar Two. Pillar One focused on the development of new nexus and profit allocation rules to assign more taxing rights to market countries. The work on Pillar One is still ongoing. Pillar Two focused primarily on a global minimum tax”.

Smyth said: “Following significant work and negotiation, on 8 October 2021, almost 140 countries, including Ireland, reached an agreement in principle as to the two pillar approach. Following that, on 20 December 2021, the IF published the Model Rules, which set out the workings of the minimum tax rules. Shortly thereafter, on 22 December 2021, the European Commission issued a draft directive dealing with the implementation of the Model Rules within the EU. As mentioned, on 14 December 2022, EU Member States unanimously adopted the EU Directive after much political to-ing and fro-ing.”

EU Member States now have until 31 December 2023 to transpose the EU Directive into national legislation, said Smyth.

“The Directive will apply for accounting periods commencing from 31 December 2023 to entities that are members of a group, where such group meets an annual revenue threshold of at least €750m in at least two of the four preceding years”.

“However, certain entities that are members of such large groups may be excluded from the scope of the Directive including government entities, charities, pension funds, real estate investment funds and certain investment funds”.

It should be noted that EU Member States where less than 12 in-scope groups are headquartered may elect to defer the application of the minimum tax rules for six years. Ireland will not be one of those countries, he said.

“Broadly, where a group is within scope, such group must determine whether in each jurisdiction in which it is located, if it’s tax payable is at least 15% of profits,” said Smyth. “If yes, then no further tax is payable under the minimum tax rules. If on the other hand the tax payable is less than 15% of profits, then a top-up tax will be payable equal to the difference between 15% of profits and the tax payable”.

“For example, if the tax payable on profits of 100 is 16, then no top-up tax is payable. If the tax payable on profits of 100 is 13, then top-up tax of 2 would be payable, which would then bring the effective tax rate up to 15%”.
Smyth said that it is worth noting that Ireland’s current corporate tax rate of 12.5% remains unchanged and will continue to be applicable to the trading profits of Irish tax resident companies and branches of non-resident companies.

“The top-up tax is a separate provision and should only apply to certain low taxed companies that are members of large groups exceeding the €750m revenue threshold mentioned earlier. There are complex rules known as Income Inclusion Rule (“IIR”), the Qualifying Domestic Minimum Top-Up Tax (“QDMTT”) rule and the Undertaxed Profits Rule (“UTPR”), the interaction of which will determine where the top up tax is payable”.

For a large group within the scope of the Model Rules and with an accounting year commencing on or after 1 January 2024, the first top up tax return will be due by 30 June 2026.

“As that is over three years away, it may be tempting for many groups to put dealing with the Model Rules on the long finger. However, businesses would be advised to start considering these rules as early as possible,” he said.

“It is proposed that there will be additional substantial disclosures in accounts as early as 2023 which really need to be assessed now. There may also be stock exchange disclosures which might be required in relation to future effective tax charges.”

Smyth said that the reality for large Irish listed Groups is that the more relevant deadline in a Pillar Two context is the date of the first accounting disclosures that will need to be made in the 2023 annual reports this time next year.

“It should be noted that these rules are complex and while there is some overlap with existing corporate tax rules, they nonetheless are separate standalone provisions. While there are certain safe-harbour rules provided that may streamline the process, it will still be the case that carrying out such calculations will be time consuming.”

Smyth said that significant information will be needed in order to fully assess and quantify the impact of the Model rules over the next 12 months, to complete all relevant accounting disclosures and, ultimately, to file the top-up tax returns in due course.

“This information may not be readily available and an early exercise should be performed to ensure that the group has access to such information in advance of the above mentioned work.”

“It will be imperative for impacted groups to have a technology enabled solution for dealing with the new rules which do introduce a significant compliance burden far beyond anything we have seen before. Other aspects that impacted Groups will need to consider include the level of additional resources required, that is, will training and up-skilling be required and how will systems be updated?”

So, what is the impact on Ireland? Smyth said that while there are many reasons other than tax for Ireland’s success including an English-speaking population, an educated workforce, membership of the EU and favourable business conditions, we cannot ignore the reality that the 15% minimum tax will to some degree level the playing field with other competitor countries in terms of attracting Foreign Direct Investment (“FDI”).

“Given the significant tax contributions made by multinationals (“MNEs”) in Ireland, Pillar Two may pose a risk to our public finances,” he said.

“Accordingly, other areas of the Irish tax system and our economy in general must be adequately served to ensure that Ireland remains a competitive location in which to invest and grow businesses both from the perspective of inward investment and also domestic indigenous growth.”

“Considerations such as high marginal personal tax rates in Ireland, the existing complexity of Irish tax legislation and incentives to drive innovation and growth in the knowledge economy are, in our view, crucial to securing our future competitiveness on the global stage.”

Our marginal personal tax rates of 52% - 55% are among the highest in the EU. In addition, we have a low entry point for the higher marginal rate of income tax to apply. As such the personal tax burden in Ireland is higher than many of our competitors.

Smyth said that Ireland’s high personal tax rate acts as a disincentive to businesses locating in Ireland and attracting skilled employees here. Also, people are increasingly mobile. Not only are high personal taxes a barrier to attracting talent, but such high personal taxes may also be a factor in people deciding to relocate from Ireland.

“We need to retain and attract talent to Ireland not only to sustain our income tax base but also our corporate tax base,” he said.

“In our view, to maintain Ireland’s competitiveness, consideration should be given to reducing the marginal rate of income tax from its current level of 52%-55% and the entry point to the higher rate of income tax should be increased.”

The 15% minimum tax may not result in existing MNEs leaving Ireland, but this is a key issue to be monitored going forward. Smyth said that a question that does arise is whether Ireland will be an MNE hub for the next new technology.

“In order to ensure Ireland’s tax base is sustainable, we need to build a first class productive and innovative SME sector which produces high value jobs (in addition to our continued efforts in the MNE sector). While Ireland has a significant number of reliefs aimed at SMEs, many need to be refreshed and streamlined and should be revisited.”

“Our current SME tax system needs to be reformed to not only facilitate start-ups but also to incentivise entrepreneurs to remain and scale up their businesses. The taxation of entrepreneurs in a broad context should be addressed both in the context of personal taxation, taxation of funding/financing returns, as well as capital events”.

“We need to ensure that our SMEs have access to capital and talent and that such companies receive the necessary support to drive research, development, and innovation,” he said.

Please note this article first featured in the Business Post on Sunday, 19 February 2023 and was re-published kindly with their permission on our website.