702 - BEPS Pillar 2

The release of the highly anticipated discussion document for South Africa pertaining to the implementation of Pillar 2 has not disappointed. Apart from the administrative burden on South African multi-national entities (MNEs), South Africa was one of the more than 130 countries that agreed during October 2021 to implement a minimum 15% corporate tax rate for MNEs with a global turnover in excess of €750 million. This is part of the two-pillar approach that arose out of the Base Erosion and Profit Shifting (BEPS) project of the Organisation for Economic Co-operation and Development (OECD) that aims to end “the race to the bottom” on tax rates that has been published as part of the efforts to tax the digital economy framework.

Even though the implementation of Pillar 2 is not limited to the digital economy as such, it is aimed at implementing a minimum effective tax rate of 15% throughout all the entities.

As of January 2024, 37 countries have adopted legislation to implement Pillar 2. However, the OECD has agreed that the Under Taxed Profits Rule (UTPR) can only become effective in 2025. Ironically, however, the US Congress has not yet adopted any similar legislation. Even though the Biden Administration supports the agreement, the relevant amendments have been omitted from the relevant legislation.

The countries that have adopted legislation have decided to implement the legislation with effect from 1 January 2024. Amongst others, 18 EU members have adopted legislation to that effect, even though the EU announced infringement decisions against 9 other EU member states that have not implemented Pillar 2 yet. These countries have been given a two-month period to respond and finalise their legislation.

The starting point in determining the effective tax rate (ETR) of an MNE group is the financial statements. However, a very complex calculation needs to be done to adapt these numbers in order to ultimately determine the profits of an MNE. Adjustments to the financial accounts have been kept to a minimum and are mainly focused to address permanent differences, for instance to remove dividends and equity gains and to remove expenses that are disallowed for tax purposes. Rules have also been prescribed to address temporary differences.

The OECD released a working paper on 9 January 2024 that, amongst others, indicates that some of the results of the implementation of Pillar 2 will be:

- The reduction in profit shifting by approximately half from US$698 billion to US$356 billion;
- the reduction in low-taxed profits on a worldwide basis; and
- the boosting of corporate income tax revenues by an average of US$155 billion to US$192 billion annually.

It is noted that the Pillar 2 model rules do not apply to government entities, international organisations and non-profit organisations, nor do they apply to entities that meet the definition of a pension, investment or real estate fund.

Effectively MNEs must calculate their ETR for each jurisdiction where they operate, and pay a top-up tax for the difference between their ETR per jurisdiction and the minimum 15% rate. Any resulting top-up tax is generally charged in the jurisdiction of the ultimate parent of the MNE, for instance South Africa, if the holding company is located in South Africa.

The minimum ETR of 15% is achieved by two main interlocking measures and using a top-down approach, namely the:

- Income Inclusion Rule (IIR); and
- UTPR.

The IIR aims to impose a top-up tax on the parent entity of a low-taxed foreign subsidiary. Under the IIR, the minimum tax is paid at the level of the parent entity, in proportion to its ownership interests in those entities that have low-taxed income. Generally, the IIR is applied at the level of the ultimate parent entity, and works its way down the ownership chain.

The UTPR on the other hand serves as a backstop to ensure that the minimum tax is paid where the income of a subsidiary in a low-taxed jurisdiction does not result in the low-taxed income being brought into account under an IIR. In such case an adjustment is made to increase the tax at the level of a subsidiary.

However, in order to retain the taxes in the jurisdiction of the parent entity (South Africa), jurisdictions can choose to implement a so-called Domestic Minimum Tax (DMT). The DMT takes precedence over the IIR and UTPR in order to ensure that the taxes that would otherwise have been paid overseas are collected in the territory in which the profits are generated. South Africa has chosen for the tax to be levied in South Africa as opposed to the country where the ultimate holding company of the entity is located.

The draft Global Minimum Tax Bill, 2024, was released in February 2024. As expected, South Africa has adopted the general approach in relation to Pillar 2 on the basis that the UTPR is not immediately implemented for South Africa. The thrust is thus more for taxes to be collected at a South African level, and not in the low-taxed jurisdictions.

Emil Brincker

Cliffe Dekker Hofmeyr

Acts and Bills

· Draft Global Minimum Tax Bill, 2024 (released on 21 February 2024).