Pillar 2 has arrived in South Africa

Even though the implementation of Pillar 2 is not limited to the digital economy as such, it is aimed to implement a minimum effective tax rate of 15% throughout the entities. 

As of January 2024, 37 countries have adopted legislation to implement Pillar 2. However, the OECD has agreed that the Under Taxed Profits Rule (UTPR) can only become effective in 2025. Ironically, however, the US Congress has not yet adopted any similar legislation. Even though the Biden Administration supports the agreement, the relevant amendments have been omitted from the relevant legislation.

Those countries that have effected legislation have decided to implement same with effect from 1 January 2024. Amongst others, 18 EU members have adopted legislation to that effect, even though the EU announced infringement decisions against 9 other EU member states that have not impacted domestic legislation yet to implement Pillar 2. These countries have been given a two-month period to respond and finalise their legislation.

The starting point in determining the effective tax rate (ETR) of an MNE group is the financial statements. However, a very complex calculation needs to be done to adapt these numbers in order to ultimately determine the profits of an MNE. Adjustments to the financial accounts have been kept to a minimum and are mainly focused to address permanent differences, for instance to remove dividends and equity gains and to remove expenses that are disallowed for tax purposes. Rules have also been prescribed to address temporary differences.

The OECD released a working paper on 9 January 2024 that, amongst others, indicates that the implementation of Pillar 2 will result in amongst others:

• the reduction in profit shifting by approximately half from US$698 billion to US$356 billion;
• the reduction in low-taxed profits on a worldwide basis; and
• the boosting of corporate income tax revenues by an average of US$155 billion to US$192 billion annually.

It is noted that the Pillar 2 model rules do not apply to government entities, international organisations and non-profit organisations, nor do they apply to entities that meet the definition of a pension, investment or real estate fund.

Effectively MNEs must calculate their ETR for each jurisdiction where they operate, and pay a top-up tax for the difference between their ETR per jurisdiction and the minimum 15% rate. Any resulting top-up tax is generally charged in the jurisdiction of the ultimate parent of the MNE, for instance South Africa, if the holding company is located in South Africa.

The minimum ETR of 15% is achieved by two main interlocking measures and using a top-down approach, namely the:

• Income Inclusion Rule (IIR); and
• UTPR.

The IIR aims to impose a top-up tax on the parent entity of a low taxed foreign subsidiary. Under the IIR, the minimum tax is paid at the level of the parent entity, in proportion to its ownership interests in those entities that have low taxed income. Generally, the IIR is applied at the level of the ultimate parent entity, and works its way down the ownership chain.

The UTPR on the other hand serves as a backstop to ensure the minimum tax is paid where the income of a subsidiary in a low taxed jurisdiction does not result in the low-taxed income being brought into account under an IIR. In such case an adjustment is made to increase the tax at the level of the subsidiary.

However, in order to retain the taxes in the jurisdiction of the parent entity (South Africa), jurisdictions can choose to implement a so-called Domestic Minimum Tax (DMT). The DMT takes precedence over the IIR and UTPR in order to ensure that the taxes that would otherwise have been paid overseas are collected in the territory in which the profits are generated. South Africa has chosen for the tax to be levied in South Africa as opposed to the tax being levied in the country of the companies that are effectively low taxed.

The draft Global Minimum Tax Bill was released earlier today. As expected South Africa has adopted the general approach in relation to Pillar 2 on the basis that the UTPR is not immediately implemented and for South Africa to be able to collect the tax instead of the foreign low taxed jurisdiction. The thrust is thus for the taxes to be paid in South Africa as opposed to in the low taxed jurisdiction. On this basis it is estimated that more taxes will be collected at a South African level.