Executive summary

On 20 December 2022, the Organisation for Economic Co-operation and Development (OECD) released guidance on safe harbors and penalty relief under the BEPS 2.0. Pillar Two Global Anti-Base Erosion (GloBE) rules (the document), as approved by the OECD/G20 Inclusive Framework on Base Erosion and Profit Shifting (BEPS). This guidance follows an earlier public consultation on the GloBE Implementation Framework where stakeholders raised concerns about the complexity of the GloBE rules and called for safe harbors and simplifications.

The document includes the agreed terms of a transitional Country-by-Country Reporting (CbCR) safe harbor that effectively removes the need to calculate the GloBE effective tax rate (ETR) based on the GloBE rules for a multinational enterprise’s (MNE) operations in certain lower-risk jurisdictions in the initial years. It also includes the framework for the development of permanent safe harbors based on simplified income and tax calculations. Finally, it includes a common understanding among the Inclusive Framework member jurisdictions as to a transitional penalty relief regime for the initial years of application of the GloBE rules, which requires that jurisdictions give careful consideration as to the appropriateness of applying penalties or sanctions where an MNE has taken reasonable measures to ensure the correct application of the GloBE rules.

The document also notes that the Inclusive Framework will continue to explore whether other safe harbors and simplifications can be developed at a future time, highlighting in particular the ongoing work on a qualified domestic minimum top-up tax (QDMTT) safe harbor that would provide compliance simplifications for MNEs operating in jurisdictions that have adopted a QDMTT.

On the same date, the OECD also released two public consultation documents related to the implementation package of Pillar Two: one covering the GloBE Information Return and another covering tax certainty of the GloBE rules.

Detailed discussion

Background

Following the release of the GloBE Model Rules on 20 December 2021¹ and Commentary on 14 March 2022,² the Inclusive Framework launched a public consultation in connection with the work to be undertaken on the GloBE Implementation Framework. Overall, stakeholders raised concerns about the complexity of the calculations and adjustments required under the GloBE rules and called for the introduction of safe harbors and simplifications to reduce compliance and administration costs and improve tax certainty for MNEs. The EY comment letter submitted to the OECD can be found here.

During the 25 April 2022 public consultation meeting, the OECD Secretariat provided an overview of the comments received on key topics.³ On safe harbors, the OECD Secretariat indicated that the common views expressed by stakeholders included the desire for a safe harbor based on CbCR data and a mechanism that would ensure that no GloBE ETR calculations would be required for jurisdictions that have a QDMTT.

Safe harbors and penalty relief

On 20 December 2022, the OECD released guidance on safe harbors and penalty relief under the GloBE rules, as approved by the Inclusive Framework. The document sets out:

The design of a transitional CbCR safe harbor that would effectively exclude an MNE’s operations in certain lower-risk jurisdictions from the scope of the GloBE Model Rules calculations in the initial years (Chapter 1)

The framework for the development of a potential permanent safe harbor based on simplified calculations that is to be further developed and will be included in the Administrative Guidance to be approved by the Inclusive Framework and released in the future (Chapter 2)

A transitional penalty relief regime that provides a “soft-landing” during the initial years of the application of the GloBE rules (Chapter 3)

The document also notes that the Inclusive Framework will continue to explore whether other safe harbors and simplifications can be developed at a future time, including ongoing work on a QDMTT safe harbor that would eliminate the need for an MNE to perform a GloBE calculation in addition to the QDMTT calculation required under local law for a jurisdiction. The document indicates that the Inclusive Framework will consider such a safe harbor as part of Administrative Guidance on the QDMTT.

Transitional CbCR safe harbor

The transitional CbCR safe harbor is a temporary measure that allows an MNE to avoid undertaking detailed GloBE rule calculations in respect of a jurisdiction where it has Constituent Entities if it can demonstrate, based on its Country-by-Country (CbC) report, that for such jurisdiction it has one of the following:

Revenue and income below the de minimis threshold. This test works in the same way as the de minimis exclusion included in the GloBE rules, except that it only considers Total Revenue and Profit (Loss) before Income Tax of the current year as reflected in the CbC report (as opposed to the average for the current and the two preceding years as provided in the GloBE rules).

An ETR that equals or exceeds an agreed rate. The agreed rate is 15% for fiscal years beginning in 2023 or 2024, 16% for fiscal years beginning in 2025 and 17% in 2026. For the computation of the ETR, the MNE would need to divide the jurisdiction’s Simplified Covered Taxes by the jurisdiction’s Profit (Loss) before Income Tax as reported on the MNE’s CbC report. Simplified Covered Taxes is defined as a jurisdiction’s income tax expense as reported in the MNE’s financial statements after eliminating any taxes that are not Covered Taxes and any uncertain tax positions. The definition of Simplified Covered Taxes differs from the definition under the GloBE rules because it does not require adjustments such as the allocation of controlled foreign corporation taxes and taxes related to permanent establishments, elimination of valuation adjustments and accounting recognition adjustments, elimination of deferred tax expense with respect to generation and use of tax credits and the recasting of taxes at the minimum rate of 15%.

No excess profits after excluding routine profits. For this test, an MNE would calculate the routine profits by subtracting a jurisdiction’s Substance-based Income Exclusion in accordance with the GloBE rules from the Profit (Loss) before Income Tax as reported in its CbC report.

If one of these tests is met, the Top-up Tax in a jurisdiction for a fiscal year will be deemed to be zero. Furthermore, the transition period referred to in the transition rules in Articles 9.1.1, 9.1.2 and 9.1.3 of the GloBE Model Rules will be extended and the GloBE Loss Election can be delayed until the transitional CBCR safe harbor no longer applies for the jurisdiction.

The document provides a number of conditions for the application of this transitional safe harbor, including the following:

It is limited to a transitional period that applies to fiscal years beginning on or before 31 December 2026 (but not including a fiscal year that ends after 30 June 2028). For MNEs with the calendar year as their fiscal year, this implies application to fiscal years 2024, 2025 and 2026.

It applies only where the MNE Group prepares its CbC report using Qualified Financial Statements, which is defined as: (i) the accounts used to prepare the Consolidated Financial Statements of the Ultimate Parent Entity (mirroring the requirements in Article 3.1.1 of the GloBE Model Rules); (ii) the separate financial statements of each Constituent Entity provided they are prepared in accordance with either an Acceptable Financial Accounting Standard or another Authorized Financial Accounting Standard if the information contained in such statements is maintained based on that accounting standard and it is reliable; or (iii) in the case of a Constituent Entity that is not included in the MNE Group’s Consolidated Financial Statements on a line-by-line basis solely due to size or materiality, the financial accounts of such entity that are used for preparation of the MNE Group’s CbC report.

It follows a “once out, always out” approach, under which if an MNE Group has not applied the transitional CbCR safe harbor with respect to a jurisdiction in a fiscal year in which the MNE Group is subject to the GloBE rules, the MNE Group cannot qualify for this safe harbor for that jurisdiction in a subsequent year.

To access the safe harbor, the MNE Group would need to comply with the filing requirements in GloBE Information Return that are specific to the transitional CbCR safe harbor.

The document provides special rules for the treatment of certain entities and groups, including rules on Joint Ventures, Tax Neutral Ultimate Parent Entities and Investment Entities and their Constituent Entity-owners. Another special rule requires the exclusion of a Net Unrealized Fair Value Loss (i.e., changes in fair value in Ownership Interests other than Portfolio Shareholdings) exceeding €50 million that is reflected in the profit in the CbC report. The document excludes from the application of the transitional CbCR safe harbor:

Stateless Constituent Entities

Multi-parented MNE Groups where a single qualified CbC report does not include the information of the combined groups

Jurisdictions with Constituent Entities that have elected to be subject to Eligible Distribution Tax Systems

Permanent safe harbor

The document provides a framework for the development of a potential permanent safe harbor based on simplified calculations. This safe harbor would permit the MNE Group to rely on simplified income, revenue, and tax calculations in determining whether it meets the de minimis, routine profits or ETR test under the GloBE rules. The simplified calculations permitted would be set out in Administrative Guidance. To access the benefit of the simplified calculations safe harbor, the MNE Group would need to comply with the filing requirements that are to be agreed as part of the Administrative Guidance for that safe harbor.

The document provides an example of a simplified calculations safe harbor that would apply to the treatment of non-material constituent entities (NMCEs) (i.e., subsidiaries and their permanent establishments that are excluded from the scope of the consolidated financial statements in a given fiscal year solely on size or materiality grounds). The simplified calculations would be done, on a Constituent Entity-by-Constituent Entity basis, based on the financial accounts available for NMCEs using definitions provided in the relevant CbC Regulations. Because the OECD CbCR model rules are being reviewed as part of the ongoing 2020 Review, the document notes that the Inclusive Framework will monitor changes to such model rules to ensure that any changes do not give rise to issues that could cause the NMCE simplified calculations to undermine the integrity of the GloBE rules.

The document indicates that the permanent safe harbor would be applicable in addition to the transitional CbCR safe harbor.

Penalty relief

The penalty relief is designed to provide transitional relief for MNE Groups in the initial years in which the GloBE rules are in effect. It would apply for the same transitional period as the transitional CbCR Safe Harbor (i.e., for any fiscal year beginning on or before 31 December 2026 but not including a fiscal year that ends after 30 June 2028).

Under the common understanding on penalty relief, no penalties or sanctions should apply where a tax administration considers that an MNE has taken "reasonable measures" to ensure the correct application of the GloBE rules. The term "reasonable measure" is not defined in the document, and it should be understood in light of each jurisdiction’s existing rules and practice. Whether an MNE has met the standard of taking reasonable measures must be assessed by a tax administration based on the facts and circumstances of the case. The document also indicates that the transitional penalty relief would not apply to cases of avoidance, fraud, or abuse.

Next steps

It is expected that Administrative Guidance will be released on a rolling basis, with the first package potentially to be released in early 2023. A QDMTT safe harbor will be considered by the Inclusive Framework as part of the Administrative Guidance on QDMTT. The Inclusive Framework also will continue to explore whether other safe harbors and simplifications can be developed. In this regard, the public consultation document on the GloBE Information Return that was published on 20 December 2022 seeks stakeholder input on simplified income or tax calculations that could be developed as part of permanent safe harbors.

Implications

The safe harbors and common understanding on penalty relief described in the document are aimed at reducing complexity and reducing the compliance burden for companies in the initial years of application of the GloBE rules. The document provides information relevant to the operation of the GloBE rules, making it an essential component of the global minimum tax package that should be carefully reviewed. Moreover, the document identifies numerous areas that are being given additional consideration by the Inclusive Framework, including the potential development of further safe harbors, so it will be important to monitor activity in this area.

This document is intended to be used by governments when incorporating the global minimum tax rules into their domestic tax legislation. In the European Union, the Minimum Tax Directive, which was formally adopted on 15 December 2022,⁴ includes in the preamble specific reference to safe harbors. Because there may well be variation in how different jurisdictions reflect the rules, companies should pay close attention to how the rules are implemented in all relevant jurisdictions.

It is important for businesses to review their CbC reports and evaluate whether these satisfy the requirements to be used for the transitional CbCR safe harbor. At the same time, given the temporary nature of the CbCR safe harbor and its applicability only to jurisdictions where the agreed transition ETR is met, it continues to be crucial for businesses to evaluate the potential impact of the global minimum tax rules on their tax positions and on their data and compliance processes and systems. Businesses also may consider engaging with the OECD and policymakers at both national and multilateral levels, including participation in the public consultations that the OECD has launched on the GloBE Information Return and on tax certainty for GloBE.

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For additional information with respect to this Alert, please contact the following:

Ernst & Young Belastingadviseurs LLP

• Ronald van den Brekel | ronald.van.den.brekel@nl.ey.com
• Marlies de Ruiter | marlies.de.ruiter@nl.ey.com
• Maikel Evers | maikel.evers@nl.ey.com
• David Corredor-Velásquez | david.corredor.velasquez@nl.ey.com
• Max Velthoven | max.velthoven@nl.ey.com
• Konstantina Tsilimigka | konstantina.tsilimigka@nl.ey.com
• Andromachi Anastasiou | andromachi.anastasiou@nl.ey.com

Ernst & Young LLP (United Kingdom)

• Matthew Mealey | mmealey@uk.ey.com

Ernst & Young LLP (United States)

• Barbara M. Angus | barbara.angus@ey.com
• Joana Dermendjieva | joana.dermendjieva@ey.com
• Jose A Bustos | joseantonio.bustos@ey.com

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Endnotes

See EY Global Tax Alert, OECD releases Model Rules on Pillar Two Global Minimum Tax: Detailed review, dated 22 December 2021.

See EY Global Tax Alert, OECD releases Commentary and illustrative examples on Pillar Two Model Rules, dated 21 March 2022.

See EY Global Tax Alert, OECD holds public consultation meeting on Implementation Framework for Pillar Two GloBE Rules, dated 29 April 2022.

See EY Global Tax Alert, EU Member States unanimously adopt Directive implementing Pillar Two Global Minimum Tax rules, dated 15 December 2022.