After the OECD published more detailed rules on the proposed global minimum tax in December, multinational enterprises are now in a better position to start addressing how to respond.
While several key points remain to be addressed in the more detailed commentary due shortly, and taxpayers will also need to see how different governments around the world respond, the ambitious timeframe that the OECD has set for implementation means that it is important to start assessing impacts and formulating strategies now.
What's new?
The latest rules include several important changes from earlier versions.
The most significant change probably concerns the Undertaxed Payments Rule (UTPR – the backstop rule which enables subsidiary and sister companies within the group to collect underpaid tax where a parent company does not do so). The previous mechanism for this only applied to intra-group payments and gave rise to the possibility that groups who were headquartered in Hong Kong, whose profits mainly arose in Hong Kong and who had relatively low amounts of intra-group payments, may potentially have been able to navigate through the rules without suffering significant amounts of top-up tax.
The revised rules effectively block off this option by dispensing with the need for intra-group payments to exist before top-up tax can be applied and instead allocating top-up rights based on a combination of employee numbers and fixed asset value.
The new rules include provision for jurisdictions to introduce a domestic top-up tax, effectively giving them the right to impose top-up tax on their own profits in priority to other jurisdictions within the group. This will be important for businesses in Hong Kong because, as noted below, this seems to be a route the Hong Kong Government is keen to follow. Indeed, it seems quite likely to be a common response across the world.
The latest rules provide more details on the calculation of the effective tax rates, including what adjustments to accounting profit are required and how to deal with deferred tax and losses. One of the key effects for a jurisdiction like Hong Kong, where the notional tax rate is very close to the GloBE (Global Anti-Base Erosion) minimum, is that the rules effectively set out a limited number of acceptable book-to-tax adjustments, such as depreciation of capital assets and non-taxation of substantial shareholdings. Timing differences not on the approved list are only acceptable where they reverse in five years, whereas unapproved permanent differences are very likely to be subject to top-up tax.
A number of elections are included within the proposed rules, including electing for revaluation gains and losses to be excluded from taxable profits and elections on the use of losses. Affected taxpayers will need to model the impact of the new rules on their businesses and understand which elections are appropriate for them.
Losses in particular are a complex area under the new rules, and groups should work to identify which losses are available for reducing top-up taxes and ensure they are used effectively. Similarly, the rules appear to allow a top-up tax to be raised in respect of permanent differences arising in a loss-making entity, even where it is in an otherwise high-tax jurisdiction. Tax managers will need to review their loss entities and make sure they understand the impact of the losses on their overall tax position.
Potential Hong Kong SAR Government response
It is likely that the Hong Kong SAR Government will amend domestic legislation as a result of the global minimum tax. In particular, it seems unlikely that it will want to continue to offer incentives the benefit of which is counteracted by a top-up tax overseas. On the other hand, there appears to be a preference to leave the existing low and simple tax system in place for smaller taxpayers who are not affected by the minimum tax rules.
One option being considered is a minimum tax based on accounting profits, which would mean that incentives or other exempt items were effectively negated for taxpayers within large multinational groups. This type of tax is considered by the proposed rules and will be deducted from any top-up tax otherwise due in a jurisdiction, effectively giving each jurisdiction the chance to levy its own top-up tax before the formal mechanisms of the Income Inclusion Rule (IIR) and UTPR kick in.
The imposition of a minimum tax in Hong Kong would have significant effects on many companies operating here and consideration may need to be given to whether existing arrangements remain tax effective.
Particular considerations for Hong Kong businesses
The introduction of the global minimum tax is likely to come at about the same time as changes to Hong Kong tax law resulting from the E.U.'s concerns regarding Hong Kong's source-based system of taxation. This means that businesses need to be prepared for significant changes to the Hong Kong tax system over the course of the next year. It is important for them to understand the potential impact of these changes and what impact this may have on their current business models.
Groups currently treating a significant proportion of their income as offshore sourced, whether that arises from external trading profits, or from internal arrangements like intra-group financing that are eliminated on consolidation, will need to assess whether that position remains viable. While we understand that the Government intends to retain existing incentives and preferential regimes, the value of some of these to large groups may be significantly diminished unless there is other income or available GloBE losses within the jurisdiction to help offset the low rate.
Groups may want to look at their intra-group charging arrangements to ensure these remain efficient once the new rules come in.
Many Hong Kong groups are quite complex, both in terms of undertaking a wide range of activities and in legal structure. These create complexities under the GloBE rules as the requirement to calculate jurisdictionally blended effective tax rates across the group can lead to unexpected results for minority interests and the impacts of businesses such as shipping or investments, for which special rules can apply, needs to be considered in the context of the wider group.
Hong Kong taxpayers also need to be aware that the minimum tax rules do not contain a general exemption for capital gains, although gains on substantial shareholdings are exempt. While elections are available to exclude unrealised gains on revaluations from the tax base, gains on disposal of fixed assets potentially become taxable, and the deferred tax implications of this would need to be considered. Groups may want to consider using SPVs for holding certain assets, although the full implications of this will need to be carefully considered.
Conclusion
The new rules will have a significant effect on how large businesses are taxed in Hong Kong. While many details are still to be confirmed, the speed with which they are being introduced means that it is important for businesses to address what impact the changes will have.
Ivor Morris, Partner, KPMG China