What is the Global Minimum Tax?
Based on the agreement of 137 (OECD) countries, including Latvia, of October 8, 2021, international reform regarding the application of business income tax was supported. As a result of the discussions, an agreement was reached on two work directions (two pillars were considered), of which:
- the first pillar relates to new profit sharing rules, which aim to redistribute the surplus profits of large international groups to jurisdictions where consumers or users are located, regardless of whether the group companies are physically located in those jurisdictions. The first pillar is still under discussion;
- the second pillar envisages the introduction of a global minimum tax for large international business groups. It was adopted on December 15, 2022.
Both pillars aim to address different but related issues related to the ever-increasing globalization and digitization of the economy. The dual objectives of Pillar 1 and Pillar 2 policies are to address base erosion/profit shifting and to provide a basis for preventing excessive tax competition between jurisdictions.
On December 15, 2022, the Council of the European Union (EU) approved a directive on determining the global minimum tax level for international business groups in the Union.
The directive introduces international business tax reforms at the EU level in accordance with the second pillar, setting the conditions for the introduction and application of the global minimum tax in EU countries, mainly for the profits of large international groups operating in the internal market and beyond.
The aim of the reform is to establish a basis for preventing competition in corporate income tax (CIT) rates by establishing a global minimum tax level.
Based on the above, it can be concluded that the global minimum income tax is a second pillar solution developed by the OECD, which envisages the introduction of a minimum CIT rate in the EU member states and applicable to the companies of international business groups, so that they pay at least a minimum level of tax on income earned in each in the country where they carry out economic activity.
For example, multinational corporations pay reduced CIT because they are able to shift their profits to "lower tax countries", which in the first place creates unfair competition for small, domestic companies that pay taxes in their country of jurisdiction. Meanwhile, "rich corporations" probably use various tax optimization tricks to save tax payments amounting to billions of euros, and in such cases significant tax losses are caused to the state budget and market competition is distorted.
How will the global minimum tax work?
The global minimum income tax will apply to international business groups and large local groups whose consolidated group revenues in at least two of the previous four years amount to at least 750 million. euro.
The tax rate is set at 15% of the profit earned in any country in which the group company carries out economic activity, regardless of the place of jurisdiction.
By nature, the income generated by the companies of the international group, regardless of whether they are generated in the digital or traditional environment, will be subject to VAT in each country, applying at least a minimum VAT rate of 15% to the corresponding portion of the profit.
In determining the amount of tax payable, the effective tax rate in the particular jurisdiction on the income earned in the financial year is calculated. The effective tax rate for a certain period can be calculated according to the basic formula indicated below, namely, CIT and equivalent taxes attributable to this period for this jurisdiction (adjusted, covered taxes), divided by the adjusted income of the relevant international group for this jurisdiction (adjusted or qualified income).
In other words, the adjusted covered taxes are those paid on taxable profits under the relevant local tax regulations of each jurisdiction. Adjusted or qualified income, on the other hand, is the profit or loss before income tax indicated in the consolidated financial statements of the parent company of the group of companies with the adjustments made, determined in Articles 15, 16, 17 and 18 of the directive.
If the effective tax rate is calculated to be lower than 15% (the minimum tax rate), then the parent company of the international group must calculate additional excess tax on each of the entities within the group in that jurisdiction so that its tax rate corresponds to the minimum.
In addition, the directive provides for a de minimis income exception, that is, in the event that the profit obtained by the units of a group of companies in a certain jurisdiction is less than 1 million. EUR and revenues are less than 10 million. euro. Based on Article 29 of the directive, it is considered that the excess tax of the entities within the group in this jurisdiction is 0% for the purposes of the global minimum tax base.
Regarding those countries where CIT is paid according to the profit distribution regime, for example in Latvia and Estonia, special conditions are set in Chapter 7 of the directive, obliging the group company to maintain an account for the recovery of the assumed distribution tax for each fiscal year for the income earned in the specific country.
On the other hand, if the CIT minimum rate is not paid within four years, for such an assumed distribution, if the group company has not suffered any allowable losses, the excess tax is payable based on the balance of the recovery account for the relevant year.
According to the administrative provisions contained in Chapter 8 of the Directive, group companies located in a member state are obliged to submit a declaration of excess tax information to the tax administration, unless it is submitted by a group company in another jurisdiction with which the member states have agreed on the exchange of information.
On the other hand, if the group company is not obliged to submit such a declaration, for example, if one of the group companies submitted the declaration in its own country, then the company must notify the tax administration about the identity of the unit that is part of the group of companies and provide information about the country in which this company submitted the declaration for international group of companies.
Under the terms of the directive, returns will have to be submitted within 15 months of the end of the fiscal year to which they relate. On the other hand, for failure to submit declarations within the deadline or for providing false information, an administrative fine of 5% of the turnover of the group company in the relevant fiscal year is provided.
In order for the member states to benefit from the surplus tax revenues, Article 10 of the directive provides options for the application of the local surplus tax system in the specific country. For example, if a member state has chosen to apply a qualified local surtax, then the company of the group that carried out specific economic activities in that country will be the payer of CIT. On the other hand, if the member state has chosen not to introduce a local surcharge, then it will be paid by the parent company of the international group in its country of jurisdiction, that is, in this case, the surcharge goes to the country where the parent company is registered.
Taking into account the publicly available information of the Ministry of Finance (FM), including the report of September 8, 2021 published by the FM on the general principles of the State Tax Policy Guidelines, tax reforms are also planned in Latvia regarding the implementation of the global minimum tax, thereby increasing the income of the Latvian state budget from international economic activities of enterprise groups in the territory of Latvia.
How will the tax affect Latvian companies?
The directive will apply to any large Latvian company group or subsidiary company of an international company group in Latvia, whose annual group turnover will exceed 750 million. euro.
According to the provisions of the directive, any group company operating in Latvia will have to make a CIT payment in the amount of at least 15% of the earned income in Latvia.
According to the information published on the website of the Saeima, the minimum international CIT could apply to a small number of parent companies of groups registered in Latvia and approximately 300 parent and subsidiary companies or branches of other countries. These corporate groups are headquartered in the United States, the Netherlands, Finland, Sweden, Germany, Lithuania and elsewhere.
Taking into account the current VAT payment model established in Latvia (VAT is payable at the time of profit distribution – deferred tax), the special conditions set out in Chapter 7 of the directive on the procedure for paying the global minimum tax will be applicable to business units located in Latvia, as in the general case it is payable for fiscal year.
According to the special conditions of the directive, which are mentioned in Article 38 of the directive, it is determined that, regardless of whether the group company made a profit distribution in a given year, it is obliged to maintain an assumed distribution tax recovery account for each fiscal year for the income earned in Latvia.
On the other hand, if the profit is not distributed within four years and the tax at the minimum rate of 15% is not paid into the Latvian budget, then for such supposed distribution (if the group company has not incurred losses), the additional tax is payable based on the balance of the recovery account for the relevant year.
Analyzing the requirements of the directive and the norms of the Latvian CIT law, several questions arise about how the changes will affect the current CIT payment model in Latvia (tax rates, payment procedures, submission of declarations, etc.) and when the process of integrating the directive's conditions into Latvian regulatory acts will be started.
The global minimum tax must enter into force from January 1, 2024, so the integration process in Latvian regulatory acts must be started immediately, as the expected changes are extensive and very technical. They raise fundamental issues of tax policy and administration, so not only international business groups, but also investors will have questions about how their tax regime will change and how to react to it. It is known from publicly available information that the Estonian state authorities and the EU Economic and Financial Council have reached an agreement that will allow Estonia to postpone the deadline for the introduction of the global minimum tax.
Based on the information published on the website of the FM, the FM plans to organize discussions with cooperation partners and business organizations in order to find the most optimal solution for the new regulation. However, at the time of writing, there is no information about specific dates, nor is there any information about amendments to any binding bills or the extension of the deadline for the implementation of the global minimum tax.
Source: iBizness