Background and mode of action of Pillar 2
Since the presentation of the Action Plan of the Organization for Economic Co-operation and Development (OECD) and the G20 countries in 2015, the international community has taken numerous measures to combat base erosion and profit shifting (BEPS). The final step was to address the specific tax challenges of the digital economy. In mid-2021, an agreement was reached on a two-pillar model, with global minimum taxation being the second pillar (Pillar 2). Pillar 2 is currently being implemented by law in many countries. The European Union, for example, has obliged its member states by directive to implement minimum taxation from 2024.
The regulations published by the Inclusive Framework on BEPS contain the Global Anti-Base Erosion (GloBE) measures, designed to ensure that large multinational groups pay a minimum level of tax on their respective profits regardless of which countries they operate in. The GloBE rules comprise a Priority Income Inclusion Rule (IIR), which operates similarly to CFC, and a Undertaxed Profits Rule (UTPR) to be applied downstream. Minimum taxation is ensured by levying a top-up tax on profits in countries where the effective tax rate (ETR) is below 15%.
So much data, so little time
The minimum tax applies to multinational companies with a consolidated turnover of more than EUR 750 million. Determining the ETR per jurisdiction poses significant challenges for companies, as there are numerous specific calculation rules for determining both adjusted covered taxes and GloBE income. Several hundred data points are required to follow these rules, and in the case of large multinational groups with many foreign subsidiaries, these data points can even exceed four digits. Some of this data is not yet collected or is scattered across different locations within a group of companies and in disparate IT systems that are often not fully integrated.
Ultimately, implementing Pillar 2 in companies primarily involves documenting, defining, and partially revising processes for data collection and evaluation. These processes take time, particularly in complex or decentralized multinational groups. To save time and meet the legal requirements by 2024, the need for simplification regulations was expressed early on, with this wish being partially complied with by the OECD and the European Union.
Transitional safe harbors
In a transition period of three years, companies can set the tax increase amount for a country at zero if one of three tests is met for that country. These are:
- the de minimis test
- the simplified ETR test
- the routine profits test
For these three tests, companies can use data from a qualified country-by-country report (CbCR), which they prepare annually and submit to the competent tax authority. The transitional arrangements are therefore also referred to as the CbCR Safe Harbor.
The de-minimis test is fulfilled if the qualified CbCR shows less than EUR 10 million in revenue and less than EUR 1 million in pre-tax profit or loss for the respective country.
The simplified ETR test is fulfilled if the simplified tax expense (income tax expense according to the consolidated financial statements) in relation to profit or loss before tax (according to qualified CbCR) is at least equal to the transitional tax rate. This is 15 percent in 2023 and 2024, 16 percent in 2025 and 17 percent in 2026.
The routine profits test is fulfilled if the pre-tax profit or loss (as defined in the qualified CbCR) is equal to or less than the substance-based allowance. The substance-based allowance is the sum of 5% of wage costs and 5% of tangible assets.
Permanent simplifications
In addition to the temporary simplifications, the OECD requirements include permanent simplifications. These simplifications closely resemble the temporary safe harbors but employ simplified GloBE calculations rather than CbCR data. The Inclusive Framework will issue separate administrative guidelines outlining these simplified calculation requirements.
Increased importance of the country-by-country report
The introduction of simplification and transitional provisions will massively enhance the value of the Country-by-Country Report. So far, it is only a tax reporting format that is distributed to the tax authorities of the countries concerned and serves as a starting point for them to assess the risk of transfer pricing and other tax aspects of a multinational group. As a result of the implementation of Pillar 2, the CbCR data is directly linked to material tax consequences, in particular the question of whether the tax increase amount for a country may be set to zero in a simplified manner. As a result, it is also expected that the basis of data collection for the CbCR will come into focus in future tax audits – as well as the criteria for a “qualified” CbCR.
In addition, from the 2025 financial year, there will be an obligation to publish the income tax information report within the EU, which also reflects key data from the CbCR and is therefore also referred to as the "Public Country-by-Country Report".
All of this should prompt companies to put their CbCR processes to the test and adapt them if necessary. This requires powerful, technically integrated solutions and appropriate documentation to ensure an audit-proof data basis and to create reports with the highest possible degree of automation.
