GloBE Pillar 2 rules to be implemented in South Africa
GloBE Pillar 2 rules to be implemented in South Africa
By Associate Professor David Warneke, Tax Director
An important recent development in tax in South Africa is the release by National Treasury of the Draft Global Minimum Tax Bill and the Draft Global Minimum Tax Administration Bill. These Draft Bills were released for public comment on 21 February 2024 and seek to give effect to the Pillar 2 proposals of the Organisation for Economic Co-operation and Development (‘OECD’) in South Africa.
Pillar 2 is known as the global minimum tax. Broadly stated, it aims to ensure that for large multinational enterprises (‘MNE’s’) within scope, a minimum effective corporate tax rate of 15% applies in each jurisdiction in which the MNE operates. The threshold size of MNE for the purpose of the rules is a consolidated turnover of at least €750 million in the consolidated annual financial statements, in at least two of the four immediately preceding financial years in relation to the tested year. Since this translates to roughly R15.3 billion at current exchange rates, there are not many South African headquartered MNEs to which the rules will apply. However, the rules will also potentially apply to locally resident subsidiaries of MNEs that are within scope, wherever headquartered – for instance, to local subsidiaries of a non-resident headquartered MNE which is within scope, of which there are many.
The Draft Global Minimum Tax Bill is short – at 11 pages- and essentially seeks to bring the Global Anti-Base Erosion (‘GloBE’) Model Rules, as set out in the document titled ‘Tax Challenges Arising from the Digitalisation of the Economy – Global Anti-Base Erosion Model Rules (Pillar Two): Inclusive Framework on BEPS’, together with its related Commentary, Administrative Guidance and Safe Harbours into South African tax law without modification, except that South Africa has chosen not to apply the Undertaxed Payments Rule, and the Bill contains various permitted elections and clarifications. It seeks to legislate a so-called ‘ambulatory’ as opposed to a ‘static’ approach as it is provides that changes in the GloBE Rules, Commentary, Administrative Guidance or Safe Harbours over time will automatically be brought into our law. The document containing the GloBE Model Rules was approved by the Inclusive Framework of the OECD on 14 December 2021 and was endorsed by more than 135 countries. While South Africa is not a full member of the OECD, it is a member of the Steering Group of the Inclusive Framework.
The rules are extremely complex and therefore reporting thereon will be a costly endeavour for any enterprises that are within scope. Because South Africa’s corporate income tax rate is 27%, at first blush it may appear that any locally resident subsidiaries of MNEs headquartered elsewhere will fall outside of any additional charge to tax, since they will already have been subject to tax in South African at an effective rate of more than 15%. However, South Africa has various tax incentives and incentive regimes that may conceivably lower the effective tax rate payable to lower than 15%. For example, the research and development (section 11D) incentive, the oil and gas taxation regime, the gold mining formula regime and the Special Economic Zones incentive regime. In any event, even if the effective tax paid in South Africa is more than 15%, a GloBE Information Return will need to be submitted to SARS annually in respect of Domestic Constituent Entities of MNE groups that are within scope.
The Draft Global Minimum Tax Bill is proposed to be effective for fiscal years commencing on or after 1 January 2024. However, an eighteen-month period is granted for the filing of the first required returns and payment. This therefore means that the fiscus would only start collecting any tax payable in terms of the rules, from 30 June 2026 onwards. The 2024 Budget included an estimated revenue take of R8 billion from the proposals in the 2026/27 fiscal year. This is a very difficult amount to estimate and no details of the calculation were supplied: however, it is likely to be an insignificant amount of revenue compared to the total Budget tax revenue.
The Draft Global Minimum Tax Bill seeks to impose tax at two possible levels: in terms of an income inclusion rule (‘IIR’) and a domestic minimum top-up tax (‘DMTT’). The IIR will, in essence, apply to those relatively few MNEs that are headquartered in South Africa and that are within scope. It will require tax to be topped up to an effective rate of 15 percent, in respect of jurisdictions in which the MNE operated and where the effective rate of tax payable in that jurisdiction was lower than 15 percent. This tax will be payable to SARS (not the jurisdiction in which the tax rate was lower than 15 percent). The DMTT will apply in situations where the effective tax rate payable by a MNE in respect of its South African profits is lower than 15 percent and makes all South African constituent entities of such an MNE jointly and severally liable for topping up such tax to an effective rate of 15 percent. If South Africa did not impose a DMTT, any top-up tax in respect of the South African profits would be lost to South Africa, as it would be imposed under the IIR in the jurisdiction in which the MNE is headquartered (and paid by the MNE to its headquarter jurisdiction).
The OECD summarises the steps involved in the application of the GloBE rules as follows. Terms in capital letters have a defined meanings in the GloBE Rules:
Step 1: Identification of groups within scope and the location of each constituent entity within the group. This step consists of the following sub-steps:
The term ‘Constituent Entity’ comprises all entities included in a group and permanent establishments. The latter are treated as separate Constituent Entities from the Main Entity and of any other permanent establishment of the Main Entity. Governmental Entities, International Organisations, Non-profit Organisations, Pension Funds and Real Estate Investment Vehicles are excluded in that they are not subject to the operative provisions of the GloBE Rules. However, their revenue is taken into account for purposes of the €750 million revenue test and the exclusion does not extend to the ownership interests of the Excluded Entities in other Constituent Entities. Entities are regarded as being located in the jurisdiction in which they are tax resident.
Step 2: Determination of the income of each constituent entity under the GloBE rules. This consists of the following sub-steps:
The starting point for determining GloBE income is the net income or loss that is used for preparing consolidated financial statements of the ultimate parent entity prior to the elimination of intra-group items. Therefore ‘taxable income’ as defined in the Income Tax Act is not the starting point. This net income or loss is adjusted for various book to tax differences that are considered justified on policy grounds, for example, dividends are excluded where this would result in double counting of previously taxed income and illegal payments are disallowed as deductions. International Shipping Income is also excluded.
Step 3: Determination of the taxes attributable to the income of constituent entities. This consists of the following sub-steps:
Again, the starting point for determining Covered Taxes is the current tax expense accrued for financial accounting purposes, with various adjustments. An adjustment is made to Covered Taxes by way of the Total Deferred Tax Adjustment, to take temporary differences and prior year losses into account for GloBE purposes. Covered Taxes are allocated to other Constituent Entities in situations such as taxes levied on controlled foreign company net income, withholding taxes and tax in respect of a Permanent Establishment or Tax Transparent Entity. Special rules apply when there is an adjustment to tax liability for a prior year, for example as a result of a tax audit or the filing of an amended return to correct an error.
Step 4: Calculate the effective tax rate of all constituent entities located in the same jurisdiction and determine the resulting top-up tax. In cases where an MNE is subject to an effective tax rate below 15% in any jurisdiction, this step sets out the mechanism for calculating the top-up tax payable in respect of that low tax jurisdiction. Essentially, the Covered Taxes calculated on a jurisdictional basis are divided by the GloBE Income calculated on a jurisdictional basis to give the Jurisdictional Effective Tax Rate. A Substance Based Income Exclusion – an excluded routine return on tangible assets and payroll- is subtracted from the jurisdictional GloBE Income. The resulting amount is then multiplied by the 15 percent minimum rate less the Jurisdictional Effective Tax Rate. After subtracting any Qualified Domestic Minimum Top-up Tax that may be levied by the jurisdiction in terms of the Pillar 2 rules, the result is the Jurisdictional Top-up Tax. For example, where the Jurisdictional Effective Tax Rate for South Africa amounts to less than 15 percent, in terms of our DMTT rules, Top-up Tax would be payable in South Africa. The Jurisdictional Top-up Tax is allocated to the Constituent Entities in the Low Tax Jurisdiction that have GloBE Income for the fiscal year (and in proportion to such income), which determines which entities trigger a charge to Top-up Tax under step 5. A De Minimus Exclusion applies in cases where the MNE has an Average GloBE Revenue that is less than €10 million and an Average GloBE Income or Loss that is either a loss or less than €1 million, computed on a three-year average basis. An envisaged on-going development relates to safe-harbours, to limit the compliance and administrative burden for aspects of an MNE’s operations that are likely to be taxable at or above 15 percent on a jurisdictional basis.
Step 5: Impose the top-up tax under the IIR or undertaxed payments rule (‘UTPR’) in accordance with the agreed rule order. It is worth noting that South Africa has chosen not to apply the UTPR charging provisions. As mentioned earlier, the IIR will potentially apply to MNE’s that are headquartered in South Africa. In such cases, the Parent Entity that is liable for the Top-up Tax under the IIR must be determined as well as the amount of Top-up Tax to be paid by the Parent Entity.
It is evident that the GloBE rules are complex and that they will substantially increase the compliance costs of MNEs. However, it should be borne in mind that the majority of the MNEs operating in South Africa that are within scope of the rules will also become subject to the same reporting framework in other jurisdictions in which they operate, including their headquarter jurisdiction. Unfortunately, it is difficult to share National Treasury’s optimism, as expressed in the 2024 Budget Review, that the implementation of these rules in South Africa will ‘bolster’ the corporate tax base. Indeed, it seems unlikely that South Africa will collect a significant additional amount of fiscal revenue from this source, relative to its total corporate fiscal collections.
An important recent development in tax in South Africa is the release by National Treasury of the Draft Global Minimum Tax Bill and the Draft Global Minimum Tax Administration Bill. These Draft Bills were released for public comment on 21 February 2024 and seek to give effect to the Pillar 2 proposals of the Organisation for Economic Co-operation and Development (‘OECD’) in South Africa.
Pillar 2 is known as the global minimum tax. Broadly stated, it aims to ensure that for large multinational enterprises (‘MNE’s’) within scope, a minimum effective corporate tax rate of 15% applies in each jurisdiction in which the MNE operates. The threshold size of MNE for the purpose of the rules is a consolidated turnover of at least €750 million in the consolidated annual financial statements, in at least two of the four immediately preceding financial years in relation to the tested year. Since this translates to roughly R15.3 billion at current exchange rates, there are not many South African headquartered MNEs to which the rules will apply. However, the rules will also potentially apply to locally resident subsidiaries of MNEs that are within scope, wherever headquartered – for instance, to local subsidiaries of a non-resident headquartered MNE which is within scope, of which there are many.
The Draft Global Minimum Tax Bill is short – at 11 pages- and essentially seeks to bring the Global Anti-Base Erosion (‘GloBE’) Model Rules, as set out in the document titled ‘Tax Challenges Arising from the Digitalisation of the Economy – Global Anti-Base Erosion Model Rules (Pillar Two): Inclusive Framework on BEPS’, together with its related Commentary, Administrative Guidance and Safe Harbours into South African tax law without modification, except that South Africa has chosen not to apply the Undertaxed Payments Rule, and the Bill contains various permitted elections and clarifications. It seeks to legislate a so-called ‘ambulatory’ as opposed to a ‘static’ approach as it is provides that changes in the GloBE Rules, Commentary, Administrative Guidance or Safe Harbours over time will automatically be brought into our law. The document containing the GloBE Model Rules was approved by the Inclusive Framework of the OECD on 14 December 2021 and was endorsed by more than 135 countries. While South Africa is not a full member of the OECD, it is a member of the Steering Group of the Inclusive Framework.
The rules are extremely complex and therefore reporting thereon will be a costly endeavour for any enterprises that are within scope. Because South Africa’s corporate income tax rate is 27%, at first blush it may appear that any locally resident subsidiaries of MNEs headquartered elsewhere will fall outside of any additional charge to tax, since they will already have been subject to tax in South African at an effective rate of more than 15%. However, South Africa has various tax incentives and incentive regimes that may conceivably lower the effective tax rate payable to lower than 15%. For example, the research and development (section 11D) incentive, the oil and gas taxation regime, the gold mining formula regime and the Special Economic Zones incentive regime. In any event, even if the effective tax paid in South Africa is more than 15%, a GloBE Information Return will need to be submitted to SARS annually in respect of Domestic Constituent Entities of MNE groups that are within scope.
The Draft Global Minimum Tax Bill is proposed to be effective for fiscal years commencing on or after 1 January 2024. However, an eighteen-month period is granted for the filing of the first required returns and payment. This therefore means that the fiscus would only start collecting any tax payable in terms of the rules, from 30 June 2026 onwards. The 2024 Budget included an estimated revenue take of R8 billion from the proposals in the 2026/27 fiscal year. This is a very difficult amount to estimate and no details of the calculation were supplied: however, it is likely to be an insignificant amount of revenue compared to the total Budget tax revenue.
The Draft Global Minimum Tax Bill seeks to impose tax at two possible levels: in terms of an income inclusion rule (‘IIR’) and a domestic minimum top-up tax (‘DMTT’). The IIR will, in essence, apply to those relatively few MNEs that are headquartered in South Africa and that are within scope. It will require tax to be topped up to an effective rate of 15 percent, in respect of jurisdictions in which the MNE operated and where the effective rate of tax payable in that jurisdiction was lower than 15 percent. This tax will be payable to SARS (not the jurisdiction in which the tax rate was lower than 15 percent). The DMTT will apply in situations where the effective tax rate payable by a MNE in respect of its South African profits is lower than 15 percent and makes all South African constituent entities of such an MNE jointly and severally liable for topping up such tax to an effective rate of 15 percent. If South Africa did not impose a DMTT, any top-up tax in respect of the South African profits would be lost to South Africa, as it would be imposed under the IIR in the jurisdiction in which the MNE is headquartered (and paid by the MNE to its headquarter jurisdiction).
The OECD summarises the steps involved in the application of the GloBE rules as follows. Terms in capital letters have a defined meanings in the GloBE Rules:
Step 1: Identification of groups within scope and the location of each constituent entity within the group. This step consists of the following sub-steps:
- Identification of MNE Groups that are within scope;
- Identification of Constituent Entities;
- Removal of Excluded Entities; and
- Identification of the location of each Constituent Entity.
The term ‘Constituent Entity’ comprises all entities included in a group and permanent establishments. The latter are treated as separate Constituent Entities from the Main Entity and of any other permanent establishment of the Main Entity. Governmental Entities, International Organisations, Non-profit Organisations, Pension Funds and Real Estate Investment Vehicles are excluded in that they are not subject to the operative provisions of the GloBE Rules. However, their revenue is taken into account for purposes of the €750 million revenue test and the exclusion does not extend to the ownership interests of the Excluded Entities in other Constituent Entities. Entities are regarded as being located in the jurisdiction in which they are tax resident.
Step 2: Determination of the income of each constituent entity under the GloBE rules. This consists of the following sub-steps:
- Determination of Financial Accounting Net Income;
- Adjustment of Financial Accounting Net Income or Loss to GloBE base; and
- Allocation of GloBE Income or Loss to Permanent Establishments or Flow-through Entities, if necessary.
The starting point for determining GloBE income is the net income or loss that is used for preparing consolidated financial statements of the ultimate parent entity prior to the elimination of intra-group items. Therefore ‘taxable income’ as defined in the Income Tax Act is not the starting point. This net income or loss is adjusted for various book to tax differences that are considered justified on policy grounds, for example, dividends are excluded where this would result in double counting of previously taxed income and illegal payments are disallowed as deductions. International Shipping Income is also excluded.
Step 3: Determination of the taxes attributable to the income of constituent entities. This consists of the following sub-steps:
- Identification of Covered Taxes;
- Adjustment of Covered Taxes for temporary differences and prior year losses;
- Allocation of Covered Taxes as necessary; and
- Accounting for post-filing adjustments.
Again, the starting point for determining Covered Taxes is the current tax expense accrued for financial accounting purposes, with various adjustments. An adjustment is made to Covered Taxes by way of the Total Deferred Tax Adjustment, to take temporary differences and prior year losses into account for GloBE purposes. Covered Taxes are allocated to other Constituent Entities in situations such as taxes levied on controlled foreign company net income, withholding taxes and tax in respect of a Permanent Establishment or Tax Transparent Entity. Special rules apply when there is an adjustment to tax liability for a prior year, for example as a result of a tax audit or the filing of an amended return to correct an error.
Step 4: Calculate the effective tax rate of all constituent entities located in the same jurisdiction and determine the resulting top-up tax. In cases where an MNE is subject to an effective tax rate below 15% in any jurisdiction, this step sets out the mechanism for calculating the top-up tax payable in respect of that low tax jurisdiction. Essentially, the Covered Taxes calculated on a jurisdictional basis are divided by the GloBE Income calculated on a jurisdictional basis to give the Jurisdictional Effective Tax Rate. A Substance Based Income Exclusion – an excluded routine return on tangible assets and payroll- is subtracted from the jurisdictional GloBE Income. The resulting amount is then multiplied by the 15 percent minimum rate less the Jurisdictional Effective Tax Rate. After subtracting any Qualified Domestic Minimum Top-up Tax that may be levied by the jurisdiction in terms of the Pillar 2 rules, the result is the Jurisdictional Top-up Tax. For example, where the Jurisdictional Effective Tax Rate for South Africa amounts to less than 15 percent, in terms of our DMTT rules, Top-up Tax would be payable in South Africa. The Jurisdictional Top-up Tax is allocated to the Constituent Entities in the Low Tax Jurisdiction that have GloBE Income for the fiscal year (and in proportion to such income), which determines which entities trigger a charge to Top-up Tax under step 5. A De Minimus Exclusion applies in cases where the MNE has an Average GloBE Revenue that is less than €10 million and an Average GloBE Income or Loss that is either a loss or less than €1 million, computed on a three-year average basis. An envisaged on-going development relates to safe-harbours, to limit the compliance and administrative burden for aspects of an MNE’s operations that are likely to be taxable at or above 15 percent on a jurisdictional basis.
Step 5: Impose the top-up tax under the IIR or undertaxed payments rule (‘UTPR’) in accordance with the agreed rule order. It is worth noting that South Africa has chosen not to apply the UTPR charging provisions. As mentioned earlier, the IIR will potentially apply to MNE’s that are headquartered in South Africa. In such cases, the Parent Entity that is liable for the Top-up Tax under the IIR must be determined as well as the amount of Top-up Tax to be paid by the Parent Entity.
It is evident that the GloBE rules are complex and that they will substantially increase the compliance costs of MNEs. However, it should be borne in mind that the majority of the MNEs operating in South Africa that are within scope of the rules will also become subject to the same reporting framework in other jurisdictions in which they operate, including their headquarter jurisdiction. Unfortunately, it is difficult to share National Treasury’s optimism, as expressed in the 2024 Budget Review, that the implementation of these rules in South Africa will ‘bolster’ the corporate tax base. Indeed, it seems unlikely that South Africa will collect a significant additional amount of fiscal revenue from this source, relative to its total corporate fiscal collections.