Global taxation has arrived. Australia’s draft legislation to implement the OECD’s Pillar Two Global Anti-Base Erosion (GloBE) rules will place a 15% floor on the tax that large multinationals will pay in any particular jurisdiction. This aims to level the playing field by eliminating the tax benefit of routing profits through low-tax jurisdictions.
Compared with more targeted rules that address profit shifting (such as the diverted profits tax or the transfer pricing rules), the Australian Pillar Two seeks to cover the field by ensuring the effective tax rate (ETR) is at least 15% in all jurisdictions.
The apparent simplicity of the concept is not reflected in the hundreds of pages of initial legislation, a bewildering range of interactions with existing rules and the already familiar practical challenges of ensuring a multinational’s separate units are all rowing in the same direction.
Who do the Australian rules apply to?
The new rules apply to a multinational enterprise group (MNE Group) if it:
- operates through entities or permanent establishments in more than one jurisdiction (being that of the ultimate parent entity (UPE) and other entities (the Constituent Entities) of the MNE Group); and
- had a consolidated annual revenue of at least EUR 750 million (circa AU 1.2 billion) in at least two of the preceding four fiscal years.
Exemptions are provided for investment funds and real estate investment vehicles that are UPEs, pension funds (which should include Australian complying superannuation funds), governmental entities, international organisations and not-for-profits.
The legislative package
On 21 March 2024, Treasury delivered on its promise in the 2023-24 Federal Budget and released exposure draft legislation to implement the OECD’s Pillar Two Global Anti-Base Erosion (GloBE) rules. The package includes primary and (detailed) subordinate legislation, supported by the incorporation of evolving OECD guidance and commentary.
The legislative package forms part of a coordinated approach across approximately 140 jurisdictions and implements in Australia a 15% global and domestic minimum tax. There are three charging rules (which are new taxes separate from income tax):
- GloBE Income Inclusion Rule (IIR) (or: Australian parent pays top-up tax re foreign <15% ETR entities)
The IIR applies a top-up tax liability on the Australian parent entity of an MNE Group in relation to foreign Low-Taxed Constituent Entities (LTCEs) with an ETR of below 15%. The tax is calculated proportionally to the Australian parent entity’s interest in the foreign LTCE and brings the ETR up to 15%. The ETR is based on accounting concepts but is calculated in a unique way under the rules.
The IIR does not apply if the tax is already collected by the local jurisdiction of the LTCE via their domestic Pillar Two tax (ie a QDMTT, discussed below).
The DMT and the UTPR, discussed below, are fundamentally similar to the IIR but act as secondary rules to ensure Australia can hold foreign MNE Groups to account. The IIR and the UTPR form the Australian GloBE rules, while the DMT is regarded as a separate regime (though based on similar calculations).
- Domestic Minimum Top-up Tax (DMT) (or: (Top-up tax for Australian entities with a <15% ETR (and shield against foreign GloBE rules))
The DMT imposes tax directly on Australian LTCEs of foreign MNE Groups where the LTCE has an ETR of below 15%. This is designed to satisfy the OECD requirements for a Qualified Domestic Minimum Top-up Tax (QDMTT), engaging the QDMTT Safe Harbour which ensures the top-up tax computation is performed only at the local level under the Australian DMT and not a second time under another jurisdiction’s parent entity IIR equivalent.
The IIR and the DMT apply for fiscal years beginning on or after 1 January 2024.
- GloBE Undertaxed Profits Rule (UTPR) (or: Australian subsidiary pays some top-up tax where foreign parent does not do so in relation to a foreign entity)
The UTPR serves as a backstop to the IIR. The UTPR should permit Australia to impose some top-up tax (by denying deductions or making an equivalent adjustment) on Australian Constituent Entities who make payments to foreign related entities, to the extent that these foreign LTCE recipients are not subject to tax under an IIR. While the draft legislation includes charging and framework provisions for the UTPR, the current draft rules lack computation provisions. There is therefore some uncertainty as to how this rule will operate.
In combination, the DMT, IIR and UTPR ensure that all entities in an MNE Group connected to Australia are caught by the minimum ETR. While the DMT applies to entities who generate taxable income in Australia, the IIR applies to the Australian entity (or entities) closest to the top of the ownership chain in an MNE Group, while the UTPR is applied by other Australian entities in the MNE Group when the income of LTCEs is not subject to tax under an IIR in the relevant foreign jurisdiction.
The UTPR applies for fiscal years beginning on or after 1 January 2025.
As is the case for Australia’s transfer pricing and Common Reporting Standard (CRS) laws, the new rules are to be interpreted consistently with the OECD guidance, commentary and safe harbour rules. Expected amendments and additions to the OECD guidance will also be captured (subject to any inconsistency with the Australian legislation).
Treasury has also released a consultation paper seeking feedback on the interaction of the Australian GloBE rules and the DMT with Australia’s existing hybrid mismatch rules, foreign hybrid entity rules, foreign income tax offsets, and controlled foreign company rules.
Consultation closes on 16 April 2024 on the primary legislation and closes on 16 May 2024 for the subordinate legislation.
Safe harbours
There are three safe harbours that may apply to an MNE Group, deeming Australian top-up tax for a fiscal year to be nil:
- The Transitional CbCR Safe Harbour, which applies until FY2028 through reliance on information contained in ‘qualifying’ CbCR reports and where a de minimis test, a special ETR test or a routine profits test (broadly where the profit before tax is less than certain other amounts) is met.
- The Permanent Simplified Calculations Safe Harbour, which currently applies to non-material Constituent Entities but provides a framework to allow MNE Groups to avoid making complex GloBE calculations where the calculation could be simplified without undermining the integrity of the GloBE rules. This also relies on the application of a de minimis test, an ETR test or routine profits test (as above). This rule is likely to be extended to material Constituent Entities in some form in the future.
- The QDMTT Safe Harbour described above, which should relieve an Australian MNE Group from the obligation to compute a jurisdictional ETR under the GloBE rules by deeming the top-up payable under an IIR or UTPR to be nil. The practical benefit of this is that the Group will be required to compute only one ETR in accordance with the DMT.
Administration
Reporting and payment obligations
The draft legislation requires Australian Constituent Entities of an MNE Group to lodge three returns 15 months after the end of every fiscal year. Note, this is 18 months for the first applicable year. The returns are:
- A standardised GloBE Information Return, consistent with the OECD Model Rules, which does not give rise to an assessment and which may be satisfied through the MNE Group filing the return in a foreign jurisdiction which has the required information exchange protocols with Australia.
- A supplementary Australian GloBE Tax Return, which contains information for the purposes of assessing and collecting IIR top-up tax and UTPR top-up tax.
- A supplementary DMT Return, containing information for the purposes of assessing and collecting DMT, which must be filed by all Constituent Entities of an MNE Group in Australia.
A domestic top-up tax assessment will be deemed to have been made upon the lodgment of a DMT Return while a GloBE top-up tax assessment will be deemed to have been made upon the lodgment of a GloBE Tax Return.
Payment and interest
DMT, IIR and UTPR top-up tax is due and payable on the same date as the deadline for the lodgement of the returns specified above. Interest charges (general interest charge and shortfall interest charge) can apply.
Penalties
The Australian tax law’s existing penalty regime applies to GloBE and DMT top-up tax. In particular, the ‘failure to lodge’ penalty is aligned with the existing increased penalties for ‘significant global entities’ (SGEs), with the effect that the increased SGE penalties will also apply to Constituent Entities of MNE Groups for a failure to lodge any of the above returns.
Objections
Taxpayers may object to a GloBE or DMT top-up tax assessment within 60 days, while the Australian Taxation Office’s (ATO’s) period of review of GloBE top-up tax and DMT top-up tax assessments is four years.
Key implications
Will much tax actually be paid under the rules, or is this a paper tiger?
The DMT is not expected to be frequently applied to require Australian entities to pay top-up tax. This is because Australia’s corporate and other tax rates are already some of the highest in the world, and Australia has a very advanced and comprehensive tax system which leaves few places to hide. There are also exemptions for approved low tax sectors such as government, superannuation and not-for-profits, etc.
However, the IIR (and to a lesser extent the UTPR) do have scope to operate. Even today, certain Australian or foreign headquartered multinationals have some operations in low tax jurisdictions, or benefit from generous foreign tax concessions. It may be that Australia’s existing controlled foreign company (CFC), foreign hybrid and hybrid mismatch rules will already address some of the mischief that the GloBE rules are directed against. That said, given how suddenly the rules have come in, and the probable misalignment with other jurisdictions’ speed of implementation, it is possible the IIR (and possibly the UTPR) will have bite particularly in early years.
Regardless of the above, the rules certainly put the ‘paper’ in paper tiger. Even if no or little tax is collected, affected multinationals will still need to go through the laborious and practically challenging exercise to update systems, perform due diligence and annually file three sets of reports to Australian and foreign authorities.
It should also be recognised that while the EUR 750 million threshold is high, there are plenty of Australian multinationals and foreign multinationals operating in Australia that meet this consolidated revenue requirement. It is not true that this rule will only be relevant to a handful of the top players.
Considerable compliance burden for taxpayers
The proposed legislation and commentary are substantial in volume (and will continue to be revised and supplemented). This, combined with the implementation date being the 2024 fiscal year onwards, will mean substantial work for taxpayers in understanding and complying with the proposed legislation in a short period of time.
- Calculation difficulties: The ETR is an essential aspect of the top-up tax calculation. While tax balances per financial accounts are used as the starting point, these are subject to a number of adjustments to determine “Adjusted Covered Taxes” and net “GloBE Income”, which in turn are the critical inputs in the GloBE ETR calculation. This deviation from the accounting concept of an ETR adds additional complexity, particularly in the interaction with financial reporting rules, and could introduce anomalies, hybridity and potentially double taxation issues, in addition to substantial set-up costs.
- Filing requirements: As highlighted above, an Australian Constituent Entity is required to furnish to the ATO a GloBE Information Return, Australian GloBE Tax Return and a DMT Tax Return. This will require taxpayers to update their internal systems and processes quickly to enable them to obtain the relevant information to furnish these returns (and in addition to keep records for an almost unprecedented period: 8 years).
- Practical challenges: In order to ensure the relevant returns provided to the ATO are correct (and any liability has been correctly self-assessed) an MNE must assess:
- whether foreign jurisdictions have comparable laws;
- the interaction with Australian domestic laws; and
- the coordination of multiple entities within the MNE Group.
This can be a costly exercise. It is also essential for foreign units in an MNE Group (including any foreign head office) to ‘buy in’ and provide necessary support to their Australian unit. As has been seen with respect to the imported hybrid mismatch rule, this kind of cooperation and buy-in cannot necessarily be taken for granted.
It is possible, however, that the advent of more efficient and novel technology solutions may systematise and streamline some of the processes. It should also be recognised that, unlike their more legalistic counterparts such as the hybrid mismatch rules, the GloBE rules do broadly rely on financial reports and data, much of which should already be in place and can be leveraged.
How will the GloBE rules impact business activity?
It remains to be seen how the Australian GloBE framework, when combined with domestic implementation in other jurisdictions, will impact the multinational transactional landscape. For example, additional reps and warranties, and associated due diligence, will be required for sale agreements, and there are likely to be exclusions in W&I policies.
Lenders will also need to deal with the additional risk of leakage from the security net and there may be updates required for reps and tax indemnities in financing documents.
Interaction with existing rules: complexity upon complexity
As recognised in Treasury’s consultation paper, the most complex technical feature of these rules will be how they fit into the plethora of rules already designed to ensure that ‘multinationals pay their fair share of tax’. Given this complexity, it is unfortunate that there is only a three-week consultation period. Some (but by no means not all) of the interaction issues are discussed below.
- (Consolidation rules) It has yet to be seen how the new GloBE rules will interact with specific features of the consolidation regime (apart from the single entity rule), including in relation to entry and exit rules and resetting of tax bases. It is already becoming clear that tax sharing and funding arrangements will have to (yet again) be amended to cater for the new tax (although the machinery to facilitate protection from joint and several liability and clear exit has not been legislated).
- (Hybrids) The highest risk of double taxation appears to be in relation to the hybrid mismatch and foreign hybrid entity partnership and company rules. For example, Treasury’s proposal for the hybrid mismatch rules to apply before the GloBE rules can result in a deduction in one jurisdiction being neutralised (due to an amount prima facie not being assessable to the recipient under the hybrid mismatch rules), but the GloBE rules subsequently kicking-in to bring that receipt to tax. Unless the current proposal is modified, it will be more important than ever that hybrid mismatches are eliminated both in Australia and offshore. This is still a daunting task for multinationals which operate in a large number of jurisdictions, not made easier by the sweeping imported hybrid mismatch rules.
- (Jurisdictional blending) Under the jurisdictional blending approach taken by the GloBE rules, a GloBE tax liability will arise when the ETR of a particular jurisdiction in which the MNE Group operates is below 15%. This is in contrast to a global blending approach (adopted, for example, by Australia’s CFC rules), which would require an MNE Group to aggregate their total foreign income and the total foreign tax on that income for the purposes of determining an ETR.
- (Franking) It is unsurprising that Treasury did not have a readymade solution for the issue of franking credits and is consulting on the issue. As one of the few jurisdictions to operate a full imputation system, Australia requires bespoke rules to manage this interaction. It is currently proposed that no franking credits will be generated by the IIR and the UTPR but the DMT will generate franking credits. The rationale appears to be that the DMT tops up an Australian tax deficit, whereas the IIR and UTPR top up foreign tax deficits. However, this logic is not entirely sound as the IIR and UTPR tax will be paid and collected by the Australian Government. It is unclear why investors should not obtain a credit for these taxes.
- (Constitutional law) Section 51(ii) of the Constitution grants the Commonwealth the power to impose taxes, and to impose laws regarding the collection and administration of taxes. However, in Waterhouse v Deputy Commissioner of Land Tax (Cth) (1914) 17 CLR 665 the High Court held that a law which operates not to impose tax but to impose a liability upon one entity to pay another’s debt falls outside the ambit of section 51(ii) and is thus beyond the Commonwealth’s power. Insofar as Australia’s investment treaty obligations are often subject to exceptions for ‘taxation measures’, to the extent the GloBE rules do not meet this definition, potential breaches of Australian investment treaties also arise.
How will the Australian GloBE rules interact with the international GloBE framework?
While the GloBE rules are intended to operate uniformly around the world, this may not necessarily be the reality. Experience tells us that the interpretation of OECD guidelines will differ from country to country, and given the Pillar Two framework is under constant development, this may cause further divergences in approach. What’s more, the rules are being implemented domestically in different jurisdictions without perfect harmonisation. Varying rules, interpretative approaches and start dates will not only create significant compliance burdens for qualifying MNE Groups, but may also create the potential for double taxation.
As currently drafted, there does not appear to be a suitable mechanism for dealing with instances of double taxation caused by differing approaches to GloBE in different jurisdictions. In this regard, while Treasury has released a Discussion Paper seeking consultation as to how Australia’s foreign income tax offset (FITO) regime in Division 770 of the 1997 Act should interact with the new rules, it has also expressed the view that taxes imposed offshore under a foreign jurisdiction’s IIR or UTPR should not give rise to a FITO in Australia.
Further, there does not appear to be a clear international dispute framework for instances of double taxation arising under the GloBE rules. The rules are said to apply in the event of any inconsistency with an Australian bilateral tax treaty unless expressed otherwise. Treasury sees this as consistent with the OECD’s intention for both the IIR and UTPR to be ‘compatible’ with international tax agreements, based on the OECD Model Tax Convention.
If the new rules do operate outside of the existing bilateral treaty framework and/or do not constitute taxes covered under Article 2 of Australia’s Double Taxation Agreements, would taxpayers in the future be able to access international dispute mechanisms like a mutual agreement procedure (MAP) or arbitration via tax treaties, in circumstances of double taxation pursuant to GloBE?
Future expansion: Multilateral instruments
While the IIR and the UTPR are the key operative GloBE rules, the OECD framework also includes, as optional for jurisdictions to adopt, the Switch-over Rule (SOR). The SOR applies to any entity in an MNE Group that may be tax exempt in a jurisdiction where it has a PE.
There is also a Subject to Tax Rule (STTR). This is a model treaty provision that allows jurisdictions to impose limited additional taxation on certain cross-border payments between related entities, where the recipient is subject to a nominal corporate income tax rate below 9%.
The Australian Government has yet to adopt the SOR and the STTR. However, Australia has indicated it intends to sign the Multilateral Convention to Facilitate the Implementation of the Pillar Two Subject to Tax Rule (STTR MLI) (though no date for this is confirmed).
This will be one of the many additional issues that are likely to arise incrementally as the rules are developed over the next several years.
