On 08.10.2021, Estonia joined the Statement on the Two-Pillar Solution to Address the Tax Challenges Arising from the Digitalisation of the Economy, prepared under the OECD/G20 Inclusive Framework on Base Erosion and Profit Shifting (IF). This international tax reform has provoked controversy in Estonia. This article discusses what is covered by the reform and how it affects Estonia and the e-Residents.
Pillar One aims to adapt the international rules on how the taxation of corporate profits of the largest and most profitable MNEs is shared amongst countries, to reflect the changing nature of business models, including the ability of companies to do business without a physical presence.
The companies affected by this reform are multinational enterprises (MNEs) with global turnover above 20 billion euros and profitability (PBT/revenue) above 10%.
The Pillar One mechanism envisages a redistribution of a share of excess profits of MNEs to market jurisdictions where consumers or users are located. According to the agreement, jurisdictions will receive a part of the reallocated profits if the MNEs involved derive at least EUR 1 million in revenue from that jurisdiction. For smaller jurisdictions, with a GDP lower than EUR 40 billion, the amount of revenue derived will be set at EUR 250,000. The share of profits to be reallocated to market jurisdictions will be between 20% and 30% of the ‘residual profits’ of companies in scope, which would be defined as profits above 10% return on sales.
Pillar Two aims to ensure that multinational businesses are subject to a minimum effective level of tax on all of their profits each year. The global minimum effective tax rate will be at least 15%.
Pillar Two would apply to all multinational groups exceeding a threshold of EUR 750 million of combined financial revenues. Countries are free to apply a top-up tax to a parent entity as a response to the low taxation of a constituent entity even if they do not meet the EUR 750 million threshold.
Where an MNE has a subsidiary in lower-taxed country, the parent entity of a MNE would be subject to a top-up tax (Income Inclusion Rule, IIR) to make up for the low taxation of such subsidiaries in another country. If MNE is headquartered in a country that does not impose top-up tax on the parent company, their low-taxed subsidiaries will still effectively lose their tax advantages due to the so-called Undertaxed Payments Rule (UTPR), which denies deductions or requires an equivalent adjustment to the extent the low tax income is not subject to a top-up tax.
Implementation of the agreement in Europe
The Statement includes an implementation plan that foresees measures such as development of a Multilateral Convention (Pillar One) and Multilateral Instrument (Pillar Two), removal of all Digital Service Taxes and necessary changes in the domestic legislation over the next couple of years.
In the EU, it will be important to ensure that the global agreement is implemented in a consistent way across the Member States. Therefore, the Commission will table a Directive for the implementation of Pillar 2 in the EU and consider a need for a Directive for the implementation of Pillar One.
Adoption of rules to Estonia
Estonian Ministry of Finance has prepared a factsheet on the Global Minimum Tax (Pillar Two), reflecting the foreseen implementation mechanism of the minimum effective tax rate of 15 % under the Estonian tax system. In Estonia, companies generally pay income tax only on the distribution of profits. Thus in years where the company does not distribute profits, or distributes little, the effective tax rate is likely to remain at below 15%. The effective tax rate results from the ratio between the tax paid and the profit calculated according to accounting rules. E.g. if a company had a profit of €100.000 and distributed 50 000 of this, the tax rate would be tax liability of €12.500 (20/80). The effective tax rate was therefore €12.500/€100.000 = 12.5%.
Estonia’s current income tax system will remain in place, i.e. the tax liability only arises upon distribution of the profits. As the taxpayer is not the Estonian subsidiary but the foreign parent company, the Estonian company does not need to file a tax return.
Estonia has negotiated a 4-year exception that gives the head office of an Estonian company the right to defer tax on Estonian profits for up to 4 years. For example, where a Germany headquartered group has an Estonian subsidiary with an annual profit of €2 million, without such exception the German head office would incur an annual tax liability on Estonian profits of €300.000. However, with the exception, the tax for 2023 would be due in 2027.
De minimis exception applies to companies with a profit of less than €1 million and annual sales of less than €10 million in a given country. For example, a foreign group of companies that has only one subsidiary in Estonia with figures below these limits does not have to calculate or pay a minimum tax on the profits of an Estonian company. If there are several subsidiaries and their aggregated economic performance exceeds the limits, the exception does not apply.
Effect on e-Residents and their companies
Provided the rules target the MNEs, incl. those with subsidiaries in Estonia, the e-Residents’ companies should not be affected by the reform.
For a deeper discussion of how this issue might affect your business, please contact:
Statement on a Two-Pillar Solution to Address the Tax Challenges Arising from the Digitalisation of the Economy, 08.10.2021 https://www.oecd.org/tax/beps/statement-on-a-two-pillar-solution-to-address-the-tax-challenges-arising-from-the-digitalisation-of-the-economy-october-2021.pdf
OECD. International community strikes a ground-breaking tax deal for the digital age, 08.10.2021 https://www.oecd.org/tax/international-community-strikes-a-ground-breaking-tax-deal-for-the-digital-age.htm
European Commission. Global Agreement on Corporate Taxation: Frequently asked questions, 10.07.2021 https://ec.europa.eu/commission/presscorner/detail/pt/qanda_21_3564
Estonian Ministry of Finance. News “The Ministry of Finance has produced information material on the global minimum tax”, 18.10.2021 https://www.rahandusministeerium.ee/et/uudised/rahandusministeerium-koostas-infomaterjali-uleilmse-miinimummaksu-kohta