In a historical agreement signed on 1 July 2021, 130 nations endorsed a declaration outlining a framework for reforming international tax regulations. Hong Kong, as an international financial and commercial centre, announced to implement BEPS 2.0 (Base Erosion and Profit Shifting), which consists of two pillars. BEPS 2.0 primarily targets major MNEs (multinational enterprises) that fulfil the defined standards but will have no impact on Hong Kong's small and medium-sized firms.
The agreement's first pillar is a substantial shift from the conventional international tax regulations of the previous 100 years, which primarily required a physical presence in a country before a country had the right to demand tax. The second pillar achieves an unprecedented agreement on a worldwide minimum level of taxes, thereby establishing a floor for tax competitiveness among states.
BEPS 2.0 (Base Erosion and Profit Shifting) Implementation Expected in 2023
The OECD (Organization for Economic Cooperation and Development) intends to finish writing the BEPS 2.0 model regulations by the end of 2022 or 2023, allowing participating jurisdictions to carry out their domestic legislative exercises and implement the package in 2023.
"The agreement's first pillar is a substantial shift from the conventional international tax regulations of the previous 100 years, which primarily required a physical presence in a country before a country had the right to demand tax."
Applicable to MNEs with €20bn or More in Worldwide Revenue
Pillar One effectively ties taxation rights with local market involvement. It will apply to companies with more than €20 billion (HKD 174 billion) in worldwide revenue and a profit before tax margin of at least 10% calculated using an averaging process (the revenue level will be reduced to €10 billion (HKD 87 billion) after seven years, assuming effective implementation).
4 Key Points to Note
The reforms have a global reach and, although simplified in comparison to prior suggestions, remain technically challenging.
Under the agreement, Digital Services Taxes and other relevant measures are to be repealed. However, the identification and timeline remain unclear.
The scope of insured enterprises has shifted away from the initial goal of highly digitalised business models. Extractives and regulated financial services are excluded, but most other businesses can be included.
The guidelines are expected to be finalised in 2022 and to go into force in 2023.
Timeline for Pillar Two Implementation
Source: German Chamber of Commerce, Hong Kong (GCC)
Pillar Two Develops A Worldwide Minimum Taxation Framework
Through a set of interlocking principles, Pillar Two develops a worldwide minimum taxation framework. The Model Rules apply to MNE (multinational enterprise) groups having total consolidated group revenue of more than €750 million in at least two of the previous four years.
A revised statement was issued on 8 October 2021, outlining the important components for an agreement on a two-pillar approach to meet tax difficulties posed by the digital economy. To further the work on this statement, the Model Global Anti-Base Erosion (GloBE) guidelines (Model Rules) under Pillar Two were released on 20 December 2021. Pillar Two has three new regulations that provide authorities extra taxation authority, including:
Two interlocking domestic rules (the GloBE rules) are the subject of the Model Rules:
(1) An IIR (Income Inclusion Rule), which levies a top-up tax on a parent corporation in consideration of income taxed at less than a 15% minimum effective tax rate on subsidiaries and permanent establishments; and
(2) the supporting UTPR (Undertaxed Payment Rule), which rejects deduction or requires an equivalent adjustment if a parent company's allocable share of the top-up tax for a low-taxed constituent business is not subject to tax under an IIR.
A STTR (Subject to Tax Rule), which overrides treaty benefits for certain related-party payments (including interest and royalties) that are not subject to a 9% minimum rate of tax in the recipient jurisdiction. The STTR will be creditable as a covered tax under the IIR and UTPR, which means the STTR applies first.
"The Pillar Two rules are expected to be enacted in 2022 and to go into force in 2023."
In October 2021, a thorough implementation plan was issued. Model legislation for the GloBE rules were included and a multilateral convention announced. A STTR model provision, as well as an implementing international agreement and potential transitional provisions, will be included in the proposal (possibly a deferral of the UTPR). This means that, while there are still uncertainties, Pillar Two is likely to result in a significant shift in the tax environment.
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