By Fani Kaikiti
Manager, Tax Department
K. Treppides & Co Ltd
On 22 December 2021, the European Commission proposed a Directive on the introduction of a minimum effective corporate tax rate of 15% on large multinational enterprise (MNE) groups operating in the European Union (EU). The draft Directive follows the publication by the Organization for Economic Cooperation and Development (OECD) of the Pillar II Model Rules (also referred to as the Global Anti-Base Erosion (GloBE) rules) designed to ensure that large MNEs pay a minimum level of tax on the income arising in each jurisdiction where they operate.
The proposed rules will apply to any MNE group, both domestic and international, with a total annual consolidated group revenue above EUR750 million, with a parent company or subsidiary situated in an EU Member State.
The effective tax rate of the Group is established per jurisdiction by dividing the taxes paid by the entities in that jurisdiction by their income. If the effective tax rate as calculated for a particular jurisdiction is below the minimum rate of 15%, the Group must pay a top-up tax, known as the Income Inclusion Rule (IIR), to bring its effective tax rate to 15%. The IIR imposes a top-up tax on a parent entity in respect of the income of subsidiaries and permanent establishments that is taxed below the 15% minimum effective tax rate.
The IIR applies on a top-down basis, which means that it is applied by the entity that is at the top of the ownership chain in the MNE group. However, in case where the jurisdiction of the ultimate parent entity does not apply the IIR, one or more intermediate parent entities may have to apply the IIR to their low-taxed constituent entities.
To the extent that the low-tax income of a constituent entity of the MNE Group is not subject to tax under an IIR, Member States can apply the Undertaxed Payments Rule (UTPR), under which any residual amount of top-up tax will be allocated to group entities in the EU. The amount of top-up tax that a Member State will collect from Group entities in its territory will be determined by a formula based on employees and assets.
The draft Directive allows EU Member States the option to apply a domestic top-up tax to low taxed domestic subsidiaries, which will allow the top-up tax due from the subsidiaries to be taxed within the relevant EU country instead of the jurisdiction of the parent company.
In line with the OECD/G20 Inclusive Framework agreement, government entities, international or non-profit organisations, pension funds or investment funds that are parent entities of a multinational group will not fall within the scope of the Directive.
The rules also provide for an exclusion of minimal amounts of income (known as the de minimis exclusion) under which if the revenues and profits in a jurisdiction are under a certain minimum amount, no top-up tax will be charged on the profits earned in that jurisdiction irrespective if the effective tax rate is below 15%. Income earned in international shipping is also excluded from the scope of the rules.
In addition, the rules provide for a substance carve-out under which an amount of income that is at least 5% of the value of tangible assets and 5% of the payroll can be excluded from the top-up tax. For the first ten years, there is a transitional rule where in the first year those amounts will be 8% of the carrying value of tangible assets and 10% of payroll, with both percentages gradually declining to 5% over the ten-year period.
The Pillar II rules are intended to be brought into law by 31st December 2023 and be effective for fiscal years beginning from 31st December 2023, with the UTPR rules coming into effect for fiscal years beginning from 31st December 2024.
These rules shall not affect all MNEs but are targeted to large MNE groups with low effective tax rates. The rules are expected to increase compliance burdens on MNE groups and will require a global coordination between tax departments in the jurisdictions where the MNEs are located. Whilst the provisions of the Directive are not yet final and are still under consideration by EU Member States which are vexed by the complexity of the proposed rules, Cyprus Companies which are part of such large MNE groups should begin to evaluate how they may be impacted and plan accordingly. MNEs should make a calculation in line with the GloBE rules of the effective tax rate in each jurisdiction where they operate and identify low-tax jurisdictions which could potentially result in the imposition of a top-up tax.
Following the global tax reform for the imposition of a minimum global corporate tax rate of 15%, the Cyprus government is considering increasing the corporate tax rate in Cyprus from the current 12,5% to 15%. However, since the GloBE rules require a minimum effective tax rate of 15%, even if Cyprus proceeds with the increase of its corporate tax rate to 15% the effective tax rate could still be lower than 15% due to application of tax regimes like the Notional Interest Deduction and Intellectual Property regime.
As the draft Directive allows the imposition of a domestic top-up tax, and taking into consideration that various business associations are not in favor of an increase in the corporate tax rate, it is possible that Cyprus may finally decide to keep the corporate tax rate of 12,5% and instead apply the minimum effective tax rate to low-taxed MNE entities in order for the top-up tax to be collected in Cyprus instead of in other jurisdictions.
In addition to the increase of the corporate tax rate, the government is considering the following as part of the Cyprus tax reform:
- The reduction of the special defence contribution rate on actual dividend distribution from the current 17%;
- The abolition of the deemed dividend distribution provisions of the legislation;
- The reduction of the special defence contribution rate on interest from the current 30%;
- The reduction or abolition of the annual company levy of EUR350;
- The introduction of carbon taxation with the gradual increase of taxes on fossil fuels and the introduction of environmental levies, as part of the green taxation measures published by the European Commission.
K. Treppides & Co Ltd is the largest independent consulting company in Cyprus with an established international presence and offices in Great Britain and Malta. Today the company employs approximately 200 professionals. It offers a full range of consulting, tax, accounting services to groups, companies and investors operating internationally in a variety of financial and business sectors. The Company, which started its operations in 1985, has 36 years of expertise and an elite team of experienced executives who can guide and assist investors and businesses during the establishment process and subsequent investment activity in Cyprus and internationally.
Nicosia: Treppides Tower, Kafkasou 9, Aglantzia, CY 2112, Nicosia, Cyprus
Limassol: Andrea Kariolou 38, Ayios Athanasios, CY 4102, Limassol Cyprus
London:7 Milner Street, London SW3 2QA
Malta: Level 1, Somnium, Tower Road, Swatar, Birkirkara BKR 4012