Australian Government finally releases draft Pillar 2 legislation

by Graeme Cooper, Toby Eggleston, James Pettigrew

Background

Treasury has released exposure drafts of the primary and secondary legislation, as well as explanatory materials, for the package of laws to implement part of the OECD's "Two-Pillar Solution" in Australian law. The exposure drafts are accompanied by a Consultation Paper on some other issues involving the interaction between this tax and other aspects of the Australian income tax system.  This part of the OECD’s Two-Pillar Solution aims to ensure large multinational enterprises (MNEs) pay tax of at least 15% on their profits in the jurisdictions where they operate.

The package of legislation and commentary already runs to more than 300 pages and will no doubt grow. The package of laws which will establish this part of Pillar Two include:

• Taxation (Multinational---Global and Domestic Minimum Tax) Imposition Bill 2024 (Imposition Bill). This Bill imposes the three kinds of tax assessed under the Assessment Bill: the top-up tax imposed under the Income Inclusion Rule (IIR), a domestic minimum top-up tax (DMT), and the tax payable under the Undertaxed Profits Rule (UTPR). The assessment and imposition of these taxes is deliberately separated from the income tax (the tax imposed under the Income Tax Act 1986).
• Taxation (Multinational---Global and Domestic Minimum Tax) Bill 2024 (Assessment Bill). This Bill contains some of the core concepts needed for calculating the amount of tax, the power for the Treasurer to make Rules and some key definitions.
• Taxation (Multinational---Global and Domestic Minimum Tax) Consequential Bill 2024 (Consequential Bill). This Bill amends a number of existing Acts such as the ITAA 97, the Administration Act and the International Agreements Act to accommodate the existence of the new tax.
• Taxation (Multinational—Global and Domestic Minimum Tax) Rules 2024 (Rules). The Rules contain the bulk of the detail needed for calculating the three types of tax.

The package of legislation follows closely the text of Model Rules for the GloBE tax released by the OECD in December 2021 – albeit broken up between the Assessment Bill and Rules – and users are instructed that the provisions of Australia’s Act and rules are to be interpreted “in a manner consistent with …” the OECD’s Model Rules, Commentary and other listed OECD documents. The close structural resemblance between the Australian and OECD rules and this directive to seek consistency, are no doubt intended to reassure other countries that Australia’s legislation conforms to the OECD Model (which has impacts on their domestic law).

While the provisions dealing with the IIR and UTPR resemble closely the Model Rules we have known about since 2021, the DMT rules were not in the Model Rules and so deserve close scrutiny. Treasury has adopted a minimalist approach to create this tax by tweaking some of the IIR rules (“Assume that the following provisions did not apply ...”) Whether that approach will work effectively remains to be seen.

When enacted, the legislation and rules will represent a significant component of Australia's tax framework. The bad news is, the measure will bring with it a significant compliance headache for all large Australian multinational groups; the good news is, it is most unlikely to result in much additional tax being paid in Australia, if any. And any domestic minimum top-up tax that is paid will create additional franking credits for the benefit of shareholders.

This briefing note summarises the key points on the policy context, objectives and operation of the proposed new laws.

Treasury is seeking comments on the exposure drafts by 31 May 2023 and on the issues in the consultation paper by 16 April 2024.

Objectives and Operation

The objective is to ensure certain MNEs, referred to as "in-scope MNEs", pay a minimum 15% effective tax rate (ETR) on profits arising in each jurisdiction they operate in, consistent with the OECD's GloBE Rules. This is achieved by:

• Imposing a DMT on the Australian profits of in-scope MNEs taxed below 15%. Where this tax is imposed, the profits of the Australian members of an MNE group should be rendered immune from being taxed in any other country.
• Applying an IIR to impose top-up tax in Australia on the profits of the foreign branches and subsidiaries of Australian-headquartered (and possibly foreign headquartered) MNEs taxed below 15%;
• Applying a UTPR to collect top-up tax from Australian entities which are members of an MNE group where neither a DMT nor IIR has been triggered.

In-scope MNEs are those with annual consolidated revenue of €750 million or more in at least 2 of the previous 4 years. Wholly domestic groups are not in-scope. Investment funds and real estate investment vehicles that are Ultimate Parent Entities (UPEs) of the group are also excluded. There is also a longish list of excluded entities.

Other key features of the new tax include:

• The DMT and IIR apply for income years starting on or after 1 Jan 2024. The UTPR applies for income years starting on or after 1 Jan 2025.
• Liability for DMT and IIR top-up tax is based on a self-assessment model.
• Top-up tax liabilities are determined based on information reported in a new "GloBE Information Return". In-scope MNEs must file this return annually within 15 months after year-end (or 18 months in the first years of the new regime). Entities liable for DMT or IIR top-up tax must lodge an annual Australian tax return.
• DMT payments generate franking credits (but IIR/UTPR payments do not). DMT and IIR/UTPR payments are non-deductible for income tax purposes.
• Special rules allow MNE group liabilities to be consolidated and paid by the head company of an Australian tax consolidated group.
• Increased penalties apply for false statements and failure to lodge GloBE-related returns and documents on time.

Imposition Bill

The Imposition Bill formally imposes the DMT, IIR top-up tax and UTPR top-up tax.

Assessment Bill

The Assessment Bill contains some of the rules for determining whether an MNE is in-scope and liable for top-up tax under the DMT, IIR or UTPR. Key concepts and defined terms in the Assessment Bill include:

• Constituent Entity - Entities that are part of an MNE Group, including permanent establishments, but excluding Investment Funds, Pension Funds, Governmental Entities, International Organisations, and Non-profit Organisations.
• Ultimate Parent Entity (UPE) - The entity at the top of an MNE Group that directly or indirectly owns a Controlling Interest in other entities but is not itself owned with a Controlling Interest by another entity.
• GloBE Information Return - A standardised annual return published by the OECD containing information on an MNE Group's structure, ETR calculation, top-up tax computation and allocation.
• Qualified IIR - An IIR in another country that is "qualified" based on certain equivalency criteria. Payments of top-up tax under a Qualified IIR in another country takes priority in the "top-down" IIR allocation approach.

The Assessment Bill also includes administrative provisions on record-keeping requirements and allows details of top-up tax calculations to be prescribed in a legislative instrument.

Consequential Bill

The Consequential Bill makes consequential amendments to support administration of the new top-up taxes, including:

• Requiring lodgement of three annual returns - a GloBE Information Return, Australian GloBE Tax Return (for IIR top-up tax) and DMT Return. Lodgement is generally due within 15 months after year-end (extended to 18 months in the first years of the new regime).
• Allowing returns to be lodged by a nominated "Designated Local Entity" in some cases. Where a return is lodged by a UPE or Designated Filing Entity overseas under a Qualifying Competent Authority Agreement, the local filing obligation is satisfied if lodged within the 15 month (or 18 month) period.
• Allowing the Commissioner to issue assessments (including default assessments) of top-up tax based on the returns lodged. Objection and appeal rights apply.
• Applying general interest charges on unpaid top-up tax and shortfall interest charges on amended assessments resulting in additional top-up tax.
• Modifying the tax secrecy rules to allow the ATO to disclose MNE Group information between Constituent Entities for purposes of administration.
• Clarifying the new laws take priority in the event of any inconsistency with Australia's bilateral tax treaties.

Rules

Most of the detail involved in determining the amount of tax payable will be set out in the Rules rather than an Act – the Assessment Bill is about 35 pages, while the Rules are over 120 pages. The Rules set out the computations of the top-up tax payable, and the items which lead to that figure: the items which form the tax base [“GloBE Income or Loss”], the relevant taxes paid and ayable [“Adjusted Covered Taxes”], and the calculation of the Effective Tax Rate.

Using rules appears to be a deliberate strategy based on the theory that rules can be made and updated by the Treasurer directly, without the need to bother the Parliament.

Just how Treasury decided what needs to be in an Act and what can be consigned to rules is not clear but clearly flexibility has been very important. For example, while the initial list of OECD documents relevant to interpreting our new tax will be hard-wired into our Assessment Act, we know the OECD is already planning to revise and supplement those documents, and so the Bill allows for new documents to be added through the Rules. However, the power for the Treasurer to make rules ceases after 31 December 2026.

Issues for joint ventures

The proposed rules extend the application of the GloBE Rules to certain joint venture (JV) entities, even where they may not be consolidated on a line-by-line basis under accounting standards.

A JV is within scope of the GloBE Rules if it meets two key criteria:

1. The UPE holds, directly or indirectly, at least 50% of the ownership interests in the JV entity; and
2. The UPE's interest in the JV is reported under the equity method in the UPE's consolidated financial statements.

Where these criteria are met, the JV entity and its subsidiaries (if any) are treated as a separate notional "MNE Group" for GloBE purposes, with the JV entity itself treated as the notional UPE.

This means that the income and taxes of the JV and its subsidiaries are not blended with the rest of the "real" MNE Group for purposes of the ETR and top-up tax calculations. Rather, separate calculations are performed to determine if the JV Group is taxed at below the 15% minimum rate in any jurisdiction.

If the JV Group has an ETR below 15% in a jurisdiction, top-up tax is calculated and allocated to the "real" MNE Group members under the IIR and UTPR in the same manner as for a standalone MNE Group. The IIR top-up tax is allocated based on each parent entity's proportionate share of ownership interests in the JV.

The JV rules do not apply where either the JV entity or a direct shareholder of the JV entity is an Excluded Entity (e.g. an Investment Fund). This carve-out is necessary as Excluded Entities themselves are not subject to the GloBE Rules.

The JV provisions are a key integrity measure to prevent MNEs fragmenting their operations into JVs to avoid the GloBE Rules. At the same time, they add significant complexity, as they essentially require a separate hypothetical "MNE Group" to be constructed and evaluated for each in-scope JV.

MNEs will need to work through the analysis carefully to determine which JVs (if any) trigger these rules. Where the rules are triggered, the ETR and top-up tax calculations will need to be undertaken at the JV Group level, separately from the main MNE Group calculations.

Particular questions that will require close analysis include:

• Are any special purpose vehicles or holding entities interposed between the UPE and the JV entity, and if so how does this impact the 50% ownership test?
• Do shareholder agreements or other documents confer additional rights relevant to assessing control?
• Is the accounting treatment of each JV interest clear and unambiguous under the applicable accounting standards?

Commencement, Transitional Rules and Safe Harbours

The amendments commence on the day after Royal Assent. The DMT and IIR apply for income years commencing on or after 1 Jan 2024. The UTPR applies for income years commencing on or after 1 Jan 2025.

Transitional rules apply for initial "short" reporting periods. Where a return or payment is due before 30 June 2026 under the normal rules, the deadline is extended to 30 June 2026.

In a similar vein, the package includes a number of “safe harbours” which operate for the first three years to ease compliance with the new system.

Outstanding Issues and Consultation Questions

The draft EM identifies some areas where stakeholder comments are particularly sought:

• Potential deferral of GloBE Return exchange between jurisdictions;
• DMT Return lodgement requirements;
• Application/timing for franking credits; and
• Interactions with existing tax laws including foreign tax offset and hybrid mismatch rules.

The EM also invites comments on any aspects of the new laws that would benefit from additional ATO guidance.

Next Steps

Stakeholders are encouraged to review the draft legislation and explanatory material in detail to assess the potential impact for their organisations. Any submissions on the exposure drafts should be made to Treasury by the 31 May 2023 deadline.