Episode Transcript
[00:00:00] Foreign.
[00:00:06] Hello everyone and welcome to our podcast series where we bring you insights into the latest developments in global tax policy and controversy space.
[00:00:15] My name is Bruno Nicerdo Silva and I'm a senior advisor at the Global Tax Policy and Controversy Group based out of Hong Kong.
[00:00:27] And today I bring you the just released side by side package. So it's a much weighted document just released by the BEPS Inclusive Framework and it's good to put it into context. We discussed this in prior episodes of this podcast. So you know, probably the background this is part of the G7 political statement that dates back from in June to to come up with a solution that allows for the US now net CFC tested income or former guilty rules to coexist with the globe rules at the time of the G7 statement you probably remember and this was reinstated later in the context of the G20 communiques of July, October and November. It was also agreed to revisit the treatment of tax incentives. And now we have the side by side package. And the side by side package brings four new safe harbors, the extension of one safe harbor and finally the update to the central record of GMT legislation.
[00:01:42] So and this is what we're going to be discussing throughout this podcast. So the side by side package first contains the side by side package introduction so fundamentally explains what the side by side package is about and what it contains. And what it contains are as I mentioned, four new safe harbors plus extension of an existing safe harbor safe hardware. And these four five safe harbors can be grouped into three fundamental one the side by side system that includes the side by side safe harbor and the UP safe harbor. Then we have the SBTI substance based tax incentive safe harbor. And then the third element is material simplifications in which you have a simplified effective tax rate, simplified ETR safe harbor plus a one year extension of the transitional CBCR safe harbor.
[00:02:48] Let's first look to the first element which is the side by side system that introduces two safe harbors. So the idea behind the side by side system is to provide for a side by side arrangement so allow that certain regimes that that meet certain requirements regarding the taxation of domestic and or foreign income can sit along with the pillar. 2. The global minimum Tax rules and I'll explain in a moment why I mentioned domestic and or foreign income. The side by side arrangement is applicable as from 1st January 2026. So the two safe harbors that I will mention in a moment will be applicable as from that date. And these two safe harbors are the side by side and the UPE safe harbor. So what is the idea? The idea is that when we have the ultimate parent entity of a group which is located in a jurisdiction with a qualified side by side regime or with a UPE regime, the top up tax will be deemed zero for both the Income Inclusion rule, the IIR and the Undertax Profits rule dutpr in case we have a qualified side by side regime and therefore the set by side safe harbor applies or otherwise the top up tax will be deemed zero just for DutyPR in case we are in a qualified UP jurisdiction with a qualified UP regime in which the UP safe harbor applies.
[00:04:24] In any case and in line what we were mentioning prior podcasts, the QDMTT takes precedence. So qualified domestic top up taxes take precedence, meaning that any of these safe harbors will not affect the QDMTT application and they will not affect the QDMTT application in any sense. So the QMTMT remains applicable and remains applicable as it is now. So the top up tax payable under the TIQDMTT will be payable without any push down from for CFC inclusions. So there is no cross border allocation of tax for the purposes of determining the QDMTT payable.
[00:05:13] The application of the side by side system and these two SIP fibers of course will depending on jurisdictions having qualified regimes either qualified side by side or qualified UP regimes and this will be subject to a peer review process by the BAPS Inclusive Framework and any jurisdiction which will be acknowledged as being qualified side by side IOP regime or having qualified side by side OUPD regime that will be listed in the OECD Central Record of GMT legislation which probably you're already familiar with because it contains the list of jurisdictions which have a qualified IIR or QDMTT rules.
[00:05:58] Just maybe to add that currently only the United States at this moment has a qualified side by side regime. And I will speak now a little bit more on these two safe harbors. So let's start first by the side by side safe harbor. The side by side safe harbor is of course the one that addresses the U.S. reality because it allows to effectively switch off the application of the IIR and UTPR for the M and E groups which are headquartered in meaning with the ultimate parent entity located in a jurisdiction with a qualified side by side regime.
[00:06:38] So what does it mean with this statement? It means that the side by side safe harbor will not affect the application of the IIR or the UTPR with respect to an M and a group with UP located in a jurisdiction which does not have a qualified side by side regime even if there's an intermediate parent entity which is located in a jurisdiction with the qualified side by side regimes.
[00:07:05] So in other words, if we have for example and taking for now the only country that has a qualified side by side regime, if we have an M and E group which has DUP in the United States, means that the IIR and UTPR will not apply to any of the entities of the group, both U.S. entities and foreign entities of that group.
[00:07:32] However, if we have the UP of the group located in other jurisdiction which does not have a qualified side by side regime, even if there's an intermediate parent entity in the United States, in that case the IIR and UTPR remain applicable.
[00:07:51] Now the side by side safe harbor is applicable, as I mentioned, to all both domestic and foreign constituent entities of the group and it applies also to JVs joint ventures. So parent owned partially owned parent entities, popes and also minority owned constituent entities. With this I mean that there are no special rules contrary to what you find in the globe rules for these types of entities. So the safe harbor, the carve out of the IIR and UTPR applies also to Popes, JVs, etc. As long as they meet the side by side safe harbor requirements. In order to meet the side by side safe harbor requirements, as I mentioned, or to be entitled to elect for the side by side safe harbor, we need to have a qualified side by side regime and this requires certain features which is to have electronic eligible domestic tax system, an eligible worldwide tax system, plus as a third requirement, have a foreign tax credit for QDMTTS on the same terms as any other credible covered taxes. I will discuss very briefly in a moment what is eligible domestic and eligible worldwide tax systems for the UP safe harbor. The UP safe harbor I think the easiest way to explain is to say that the UP safe harbor effectively replaces the transitional UTPR safe harbor that effectively ended in 2025.
[00:09:21] So what does it mean? It means that under the UPE safe harbor, if we have the UPE of the group located in a qualified UPE jurisdiction, the UTPR will not apply to the constituent of the group which are located in the UPE jurisdiction.
[00:09:42] So it means that the UPE safe harbor will not affect the application of the IAR or TPR with respect to MNEs located outside Europe jurisdiction at all. So the only impact is for the purpose of the UTPR application and limited to the UPE jurisdiction. To have a qualified UPE regime, we will need to have eligible domestic tax system.
[00:10:12] And there is a fundamental difference in terms of possibility for jurisdictions to have a qualified side by side regime or a qualified UP regime.
[00:10:27] So the first thing taking into account is the fact that both these safe harbors, as a matter of principle, can apply to any jurisdiction that meets the conditions to have a qualified side by side regime or a qualified UP regime.
[00:10:43] Now, in the context of the UPE safe harbor, the side by side system provides that the requirements to have a qualified UP regime, which is, as I mentioned, to have an illegible domestic tax system, that illegible domestic tax system has to be enacted prior to the 1st of January 2026. So it's effectively a cutoff date. Meaning if a jurisdiction does not have the features of an eligible domestic tax System prior to 1st January 2026, then it will not be able to have a qualified UPE regime anymore by changing its domestic tax system to meet the conditions for a qualified PE regime. In the context of the side by side safe harbor is different.
[00:11:32] So the idea is that they can be enacted prior to 1 January 2026 or at a later stage, subject to obtaining the qualified status.
[00:11:45] So there is a difference here between the two.
[00:11:49] Now the eligibility criteria for the qualified side by side NUPE regimes. So when we're talking about these regimes, there is one feature which is common, which is have an eligible domestic tax system. So any of these safe harbors depends on having a qualified regime. And both these regimes require to have a legible domestic tax system. And the fundamental idea behind the eligible domestic tax system is to ensure that domestic profits are subject to a minimum taxation. And this is based on combined elements of a nominal rate of at least 20% plus a QDMTT or a corporate alternative minimum tax with a nominal rate of at least 15% plus the last requirement that no material risk that ETR in the jurisdiction is below 15%.
[00:12:43] In the context of a qualified side by side regime, and on top of the eligible domestic tax system, we need also an eligible worldwide tax system.
[00:12:51] And here what is at stake is at stake that I not only require minimum taxation on domestic income, but also minimum taxation on foreign income, even undistributed income, which means of course, that I need to have a CFC regime or alike again, no material risk that foreign income is taxed at an effective tax rate below 15% and that there are mechanisms to address.
[00:13:18] This is as further explained in the Rules side by side package and we can address this in later podcasts in terms of the filing obligations.
[00:13:27] So the election of One of these safe harbors will be made through the Globe Information Return. But this, the Globe information return filing will be simplified for M and E groups that can elect the application of these safe harbors.
[00:13:43] In any case, the safe harbors will not affect the reporting obligation for fiscal years commencing before 1st of January 2026. And this is particularly the case of course, when we are talking about the side by side safe harbor. Now let's look to the other important safe harbor which is the substance based tax incentives safe harbor. So again, picking what I mentioned earlier in terms of the rationale behind this is that if you remember, part of the political statement in which there was agreed to come up with this side by side approach was also to revisit tax incentives.
[00:14:23] So let's look what we have today. Today we have two types of incentives which have more beneficial treatment under the GMT or the Globe rules which are the qualified refundable tax credits QRTCs plus the marketable transport tax credits or MTTCs. So the preferential tax treatment is that the effective tax rate adjustment in case of these two types of incentives they are treated as subsidies or government grants and the global rules follow financial accounting treatment. And since for financial accounting purposes this is treated as income, the qualified refundable tax credits and the marketable transferable tax credits are as well treated as global income and therefore they have a significant less impact on the effective tax rate.
[00:15:16] Now the QRTCs and MTTCs, the treatment will remain the same with one difference which I'll mention in a moment. But we have a new type of tax incentives and this new type is the qualified tax incentives or the QTIs.
[00:15:32] And again this comes in the form of safe harbor. So again the language is identical to other safe harbors that you know, top up tax deemed zero for the amount of QTIs used in the jurisdiction and QTIs we are talking about expenditure based and certain production based tax incentives.
[00:15:52] So incentives which are linked to expenditure being for instance tax credits but also super deductions and even income exemptions, provided that the amount of the incentive is calculated by reference to the expenditure, they are all treated as expenditure based tax incentives and they will get this beneficial treatment which I explain in a moment.
[00:16:18] The tax allowances for capital expenditure that only give rise to timing differences, they will not fall in the definition of QTIs because there's already the deferred tax mechanisms used in the global rules which already address the timing differences. Then we also together with expenditure based we have production based tax incentives.
[00:16:38] Why production based tax incentives and why did I mention certain production based tax incentives? Because they need to meet certain requirements.
[00:16:46] The incentive needs to be calculated based on the volume of the production and based on production of tangible property jurisdiction and based on the units produced in the jurisdiction providing the incentive.
[00:17:02] So what is the ETR adjustment in the case of the qualified tax incentives or qti?
[00:17:08] So the ATR adjustment is not by increasing little globe income but is looking to the other elements of the ETR formula which is the numerator. So we're going to increase the amount of COVID taxes so no impact on globe income. But the impact comes on at the level of increasing cover taxes.
[00:17:27] And the amount of the increase will be the amount of those QTIs used in the fiscal year but subject to a substance cap.
[00:17:38] And the substance cap can be based on two methods. We have the default method which is the greater of 5.5% of the payroll costs or the depreciation in respect of eligible tangible assets.
[00:17:56] There's a second method which is 1% of the carrying value on eligible tangible assets excluding land, debt and other non depreciable assets.
[00:18:07] The second method only applies upon election of the M and E group and this election is going to be for a five year period.
[00:18:17] I mentioned earlier that the QRTCs and MTTCs remain the same treatment with the difference and what is the difference is that QRTCs and MTTCs that meet the definition of QTIs, meaning that they are either expenditure based or production based and meet the production based or meet the production based requirements. Then there is the possibility to elect to treat these QRTCs or MTTCs totally or partially as a QTY, meaning that they can be totally or partially generate an increase to the adjusted cover taxes rather than low income. So you can choose just one of those incentives and even just part of that incentive to be treated as a qti.
[00:19:14] Finally, let's look to the material simplifications. One is very simple to explain which is the one year extension of transitional side country by country reporting safe harbor. The transitional CBCR safe harbor and so it's extended for the fiscal year of 2027 with the same 17% transition rate which was already applicable for 2026 and the ideas that support the transition to the simplified ETR safe harbor. And the simplified ETR safe harbor brings several new elements.
[00:19:58] First element is that of course is a new safe harbor and the top up tax is deemed zero once again when the simplified ETR is of at least 15%. So first of all, first element is the fact that there is no buffer rate.
[00:20:14] So for the purposes of the simplified ETR safe hardware, the reference is the same as the minimum rate, 15%.
[00:20:22] For the purpose of the simplified ETR safe harbor, the calculation is not going to be entity by entity, but it's going to be jurisdiction per jurisdiction is going to be determined based on simplified income and simplified taxes. So the idea is to minimize the amount of the adjustments so that we're going to have basically basic adjustments and then potentially industry or some conditional or even optional adjustments to be made.
[00:20:50] The simplified ETR is calculated based on financial accounting data used by the MNEs to prepare the consolidated financial statements and as a matter of principle will be generally available from any fiscal year commencing on or after 31st of December 2026. But in certain cases, for jurisdictions which are able to implement it, restoration retrospectively possible to apply it on or after 31st of December 2025, provided certain conditions are met.
[00:21:28] And these conditions, essentially I want to stress, is only for the first potential year of application. So for the fiscal year of 2026 is that a certain group of conditions need to be met in order for the immediate application of the simplified ETR safe harbor. And it's fundamentally that the QDMTT safe harbor applies with respect to the tested jurisdiction, or only one jurisdiction has taxing rights with respect to the tested jurisdiction, or all jurisdictions that have taxing rights with respect to the jurisdiction have adopted the earlier application of the simplified ETR safe harbor. Fundamentally, it means that all jurisdictions that have taxing rights will be applying the simplified ETR safe harbor already. So this is the requirement to apply already from fiscal year of 2026. Otherwise, without these three conditions that I mentioned, it will be applicable for the fiscal year of 2027. So you can see here that there is the potential overlap of one or two years in which MNEs may have the option to choose between the transitional CBCR safe harbor or the simplified DTR safe harbor. So for sure, for the fiscal year of 2027, both is going to be in place for the fiscal year of 2026, depending on the jurisdictions and the conditions that I just mentioned. The final element that I want to talk about is that the simplified DTR safe harbor, as a matter of principle, can be applied on a year, year after year basis. There are entry and reentry requirements. But there's a fundamental distinction from the transitional CBCR safe harbor, which had the rule once out, always out, in the context of the simplified ETR safe harbor that does not apply anymore. There is the need to meet certain re entry requirements or entry requirements, but it will be possible to enter or re enter for the purpose of these rules.
[00:23:32] And this is well, fundamentally all I had to say for now as our first moment of unveiling the side by side package, a lot to be considered. You can see that there's a significant impact in terms of possible perimeter of the globe rules, possible recalculation taking into account the simplified DTR safe harbor and and potential exposure to the GMT rules, the very important element of impact on tax incentives.
[00:24:07] So there's a lot of digest, there's a lot of impact and there's a lot of to rethink in terms of impact of the rules.
[00:24:16] So I just want to finalize by thank you for joining us today and stay with us as we continue this journey in our upcoming podcast.
[00:24:24] Please also check our monthly newsletter, our Tax Alerts that will bring you the latest key updates around selected editorial pieces from our global tax Network. We will be discussing much more in the coming weeks on more specific elements of the side by Side package, so if you haven't subscribed yet, use the link in the description to receive the newsletter directly in your inbox. And don't forget to follow this channel. There will be regular insights and updates to all podcast coming your way. Thank you.
