Report on a session at the annual IBA ‘The New Era of Taxation Conference’ in Rio de Janeiro
Thursday 21 September 2023

Session Chairs
Antonietta Alfano, Maisto e Associati, Rome
Ana Carolina Monguilod, CSMV Advogados, São Paulo

Panellists
Ryan Rabinovich, Fasken, Montréal      
Ana Paula Saunders, Eletrobras, Rio de Janeiro        
Carolina Fuensalida, Fuensalida & Del Valle Abogados, Santiago
Juan Manuel Iglesias Mamone, Mitrani, Caballero & Ruiz Moreno, Buenos Aires

Reporter
Carolina Amorim Ribeiro, Machado Meyer Advogados, Rio de Janeiro

Introduction

The panel focused on defining corporate taxes and tax benefits, which is crucial for calculating the effective tax rate (ETR) within the Organisation for Economic Co-operation and Development’s (OECD) Pillar Two Model Rules framework. This framework is an initiative by the OECD to ensure that multinational enterprises (MNEs) pay a minimum global effective tax rate of 15 per cent. The session commenced with the panellists providing updates on the implementation of the Pillar Two Rules in their respective regions. Subsequently, they analysed the covered taxes and tax incentives within their jurisdictions. To conclude, the panel presented some practical examples to illustrate the impact of these elements on the ETR calculation in certain jurisdictions.

Pillar Two – objectives and structure

Antonietta Alfano began the session by introducing the panel and explaining the main objectives and structure of the Pillar Two system on global minimum tax rules, which provides for complementary taxation, known as the top-up tax, which is triggered when the ETR, calculated for each jurisdiction according to standard rules, is less than 15 per cent.

Alfano clarified that the top-up rate mechanism lies in two interconnected rules, referred to as the Globe Anti-Base Erosion Rules (GloBE): (1) the income inclusion rule (IIR), applied as a rule by the ultimate parent entity concerning its low-taxed constituent entities, and (2) the undertaxed profits rule (UTPR), applicable when the IIR is not applicable. Additionally, she highlighted two other important elements that may significantly mitigate the complementary taxation: the substance-based income exclusion (a carve-out rule for excluding income from substantial economic activities from the GloBE income) and the qualified refundable tax credit.

Overview of Pillar Two implementation status

Alfano provided an overview of the state-of-the-art in Europe, sharing that at the end of December 2022, the Council of the European Union formally adopted Council Directive 2022/2523 to implement the Pillar Two global minimum tax rules at the EU level.

The directive substantially mirrors the OECD rules, but with some deviations driven by the need to harmonise the directive with the EU’s fundamental freedoms and the Court of Justice of the European Union’s legal precedents. The main difference compared to the OECD framework is that the EU’s GloBE rules apply not just to international MNEs, but also to large-scale domestic corporate groups.

EU Member States are required to implement EU Council Directive 2022/2523 by the end of 2023, and several countries have already released draft legislative proposals (the Czech Republic, Denmark, Finland, Germany, Ireland, Italy, Luxembourg, the Netherlands, Sweden, etc), while others have already made official announcements regarding the incorporation of the Pillar Two Rules into their national legislation (Belgium, Bulgaria, Cyprus, Poland and Portugal, among others).

Juan Manuel Iglesias commented on the quite distinct situation in Latin American countries, noting that, to date, no nation has yet implemented the Pillar Two Rules, and there have been no officially published draft regulations or public announcements.

Iglesias remarked that, from the experience with the base erosion and profit shifting (BEPS) measures, Argentina might take a couple of years to implement the Pillar Two Rules, despite the country being a member of the OECD Inclusive Framework.

He also went through the current situation concerning the matter in other countries in the region, including:  

• Brazil: the implementation of Pillar Two is not a priority. The government is engaged in implementing new transfer pricing rules and has been discussing a value-added tax (VAT) reform;
• Chile: despite promoting different tax reforms, including one aimed at incorporating the principles of Pillar Two, the government has not issued any official statements or draft regulations on the subject;
• Colombia: although Congress referred to Pillar Two to justify the enforcement of a 15 per cent minimum effective tax rate since 1 January 2023, the country has not fully adopted Pillar Two and the rules for determining the minimum tax rate may not entirely align with Pillar Two Model Rules; and
• Mexico: representatives of the tax authorities have confirmed the country’s intention to implement Pillar Two in a new law during fiscal year 2024, rather than incorporating it into the income tax law.

Iglesias pointed out that, given this scenario, ultimate parent entities in these countries may not have to apply top-up taxes. However, the MNEs worldwide will still need to calculate the GloBE income of the subsidiaries in Latin American countries to determine if the ETR in each jurisdiction is below 15 per cent.

Ryan Rabinovich presented an overview of the situation in North America. In Canada, a proposed legislation concerning IIR and a qualified domestic minimum top-up tax (QDMTT) was open for public consultation until 29 September 2023. He pointed out that there is a placeholder left in the legislation for the UTPR. The government’s next steps will involve addressing the issues arising from introducing these changes in alignment with the national tax incentives regime.

Regarding the United States, Rabinovich summarised the recent developments in the context of the Biden government’s efforts to implement Pillar Two through the Build Back Better Act (BBBA).

The BBBA intended to adjust the US Global Intangible Low-Taxed Income (GILTI) regime to align with Pillar Two standards and serve as an IIR. However, it did not get any closer to being a full Pillar Two regime because it turned the GILTI rate of 10.5 per cent into 13.125 per cent, which is less than 15 per cent, thus it does not achieve the objective of adopting a global minimum tax rate. Additionally, the tax is imposed on an overall basis rather than jurisdiction by jurisdiction, contrary to the Pillar Two methodology. Also, for the 2022/2023 budget, the Biden administration proposed to replace the base erosion and anti-abuse (BEAT tax) with a UTPR. Even with these efforts, President Biden could not garner congressional support for the BBBA, and the expectation is that there will be no further developments, until at least after the 2024 election.

The ETR calculation: formula, covered taxes and tax incentives

Ana Carolina Monguilod then explained the ETR calculation formula according to the GloBE rules. The ETR applicable to a group is calculated for each tax year and each jurisdiction. It is reached through the division of the adjusted covered taxes of all the constituent entities in the jurisdiction by the so-called GloBE income. The GloBE income is based on the company’s financial statements, and the calculation should consider the constituent entities in each jurisdiction.

Moving to the definition of covered taxes, Monguilod emphasised that the blueprints published by the OECD for Pillar Two provide a vast concept, encompassing any tax on an entity’s income or profits. She referred to the four categories of taxes set forth by the Pillar Two Model Rules released by OECD.

Due to this broad concept, Monguilod anticipates some controversies in determining the applicable taxes and the allocation methods, especially in cases involving controlled foreign corporations (CFCs), permanent establishments and withholding taxes, etc.

Rabinovich explained that Canada is already a highly taxed jurisdiction: the general federal corporate income tax (CIT) rate is 15 per cent, while the general provincial CIT rates vary from 8 per cent to 16 per cent, totalling a general combined rate of between 23 per cent and 31 per cent. Despite that, he pointed out that several implications are expected: the impact of Pillar Two Rules will mainly involve the corporations benefitting from specific Canadian tax incentives, while the Canadian controlled private corporation regime (subject to a combined tax rate of between 9 per cent and 12 per cent on their first CA$500,000 of income) will not be affected.

Regarding Brazil, Ana Paula Saunders explained that there is a high CIT rate in the country, and the ETR is almost below 34 per cent. Recent research over the past decade reveals that only a few Brazilian companies have been subject to a tax rate below 15 per cent, which is crucial for Pillar Two.

Saunders also discussed an interesting point: even though Brazilian domestic law widely allows for the taxation of profits earned abroad, Brazil may be unable to tax all earnings generated overseas by its foreign subsidiaries due to its double taxation treaties. In this scenario, the Pillar Two Rules may have an effect if the foreign subsidiary’s effective tax rate falls below 15 per cent. From a Brazilian perspective, two key aspects need examination: the impact of tax incentives on the ETR and the implications of double taxation treaties, particularly in cases where foreign subsidiaries may be subject to an ETR below 15 per cent.

Carolina Fuensalida stated that, in Chile, there are no ongoing discussions concerning the impact of Pillar Two, since the existing tax rates are already quite high. However, noteworthy Chilean covered taxes could be:

1. the CIT, with a 27 per cent rate or a 25 per cent rate for small to medium-sized companies;
2. the dividend withholding tax (WHT), with a 35 per cent tax rate;
3. a single tax on the capital gains on instruments with stock exchange presence sales, levied at a 10 per cent tax rate; and
4. a special tax regime for investment funds incorporated in Chile with foreign investors.

Fuensalida argued that considering the general CIT is above the OECD average, it is hard to grasp how Pillar Two will apply in Chile. In addition, since Chile is a tiny country that depends very much on mining and copper, Fuensalida does not expect the application of complementary taxation to the point of compromising some of its tax incentive regimes. Otherwise, the country will lose some of its attractiveness and competitiveness.

In the case of Argentina, Iglesias noted that the country has high statutory tax rates, and several taxes could be regarded as covered taxes for GloBE purposes. These would include the federal CIT (rates between 25 per cent and 35 per cent depending on the taxable gain), the extraordinary CIT on advance payments (15 per cent to 25 per cent rates), the withholding income tax on dividends (7 per cent rate) and the net equity tax (an annual 0.5 per cent tax rate). He further explained the main aspects of each of these taxes and highlighted that other significant Argentinian taxes would not be considered as covered taxes for GloBE purposes, such as the so-called turnover tax and the withholding income tax for non-residents on Argentina-source income.

Following the discussion about covered taxes, the speakers turned their attention to tax incentives.

Monguilod introduced the topic, emphasising that such incentives would include specific tax credits, known as qualified refundable tax credits (QRTCs), which are government incentives delivered via the tax system, whose domestic law provides for: (1) the possibility that they may be paid in cash or a cash-equivalent means, and; (2) their full repayment in the first four tax periods from the time the constituent entity meets the conditions under the laws of the jurisdiction granting the credit. Any amount of tax creditable or refundable under an imputation credit regime is not included.

Monguilod further clarified that, in view of the Pillar Two Rules, QRTCs should be treated as a GloBE income within the ETR formula. In contrast, non-qualified refundable tax credits (NQRTCs) shall not be included as part of the income calculation, but as a reduction of the covered taxes. Consequently, NQRTCs will substantially impact the ETR, while QRTCs will have a slighter impact on the ETR.

Next, each speaker provided an overview of the most relevant tax incentives in their respective countries, describing their unique characteristics, the challenges regarding the application of the GloBE rules and the possible impact of these tax incentives for the ETR calculation.

Iglesias, for instance, pointed out that although Argentina has high statutory rates that suggest it would not be regarded as a low-taxed jurisdiction for GloBE purposes, there are certain distortions (ie, complex foreign exchange issues, adjustment for inflation), regardless of the tax incentives, to address when calculating the tax basis under GloBE that may derive from an ETR lower than 15 per cent.

Fuensalida reiterated the high Chilean tax rates and the absence of substantial tax incentives. However, she indicated that, for some notable activities, such as mining, Chile grants a significant accelerated tax depreciation for fixed assets. She also mentioned some examples of other tax benefits, underscoring that they are not substantial and will not bring the ETR below 15 per cent.

Regarding Canada, Rabinovich commented on the accelerated tax depreciation for clean energy investments and the 7.5 per cent federal tax rate reduction for ‘zero-emissions technology manufacturing profits’, pointing out that they do not have any impact for GloBE purposes. On the other hand, he marked as problematic other tax incentives considered as NQRTCs, such as non-refundable investment tax credits (ITCs), to the extent that they reduce adjusted covered taxes, bringing the ETR below 15 per cent and triggering the top-up tax. Finally, he also discussed a major incentive recently introduced in Canada regarding refundable ITCs for clean energy investments, qualified as QRTCs, and the expected impacts on the GloBE income calculation.

Iglesias and Rabinovich then provided two practical and detailed examples of how the ETR and the potential top-up tax should be calculated in accordance with the GloBE rules. The first example considered two Argentine tax incentives related to promotional regimes for the knowledge economy and the manufacturers of capital goods, and the second one examined a hypothesis involving Canadian refundable ITCs for clean energy investments.

Lastly, to conclude the panel session, Fuensalida and Rabinovich discussed a third example, involving the particular situation of transparent entities and the different regulations in Canada and Chile, pointing out the challenges to implementing the Pillar Two Rules in this specific scenario.