The new international tax environment

The background

The aims of the OECD’s base erosion and profit shifting project include bringing the international tax system up to date and achieving greater tax fairness between traditional and digital companies. BEPS 2.0 is based on a two-pillar approach. Pillar 1 mainly involves shifting taxing rights for multinationals with an annual turnover of over EUR 20 billion to market jurisdictions, i.e., the countries where they have business activities. Pillar 2 introduces a global minimum tax rate of 15% for enterprises with an annual turnover over EUR 750 million, although countries can opt to set a lower threshold. For Switzerland, it can be assumed that the turnover threshold of EUR 750 million will be taken over.

According to recent estimates by the federal government, only a small number of multinational enterprises in Switzerland will be affected by Pillar 1. Pillar 2, on the other hand, will affect around 200 enterprises headquartered in Switzerland along with around 2,000 – 3,000 Swiss-based subsidiaries of foreign companies. Due its greater practical relevance, we will concentrate on Pillar 2 in this article.
 

Overview of Pillar 2

By setting a global minimum tax rate of 15%, Pillar 2 is designed to limit tax competition and thus the incentive to avoid tax by shifting profits within a multinational group. This framework for global minimum taxation is also known as the GloBE (Global anti-Base Erosion) rules. A deadline of 1 January 2023 has been agreed for Pillar 2 to enter into force. Each country is therefore expected to make the necessary changes in its domestic legislation in 2022. The OECD has thus set a very ambitious target.

15% of what?

The GloBE rules are not just about the domestic tax rate. Instead, they introduce a complex new mechanism to determine the tax base for the minimum tax rate. The GloBE rules use two parameters for this: a GloBE-specific definition of an entity’s income or loss and a GloBE-specific definition of its covered taxes. Covered taxes include corporate income and capital taxes. Determining GloBE income (i.e., the tax base) is more complex. It is based on the financial accounting net profit of each constituent entity under IFRS or US GAAP. Other accounting standards such as Swiss FER may also be used, provided the consolidated net income does not differ significantly from the net income determined under IFRS. Specific OECD corrections must be made to adjust the standards before they are aggregated by country.

Local taxable income often differs from both IFRS/Swiss GAAP FER income and the GloBE income computation proposed by the OECD. This is also the case in Switzerland:
(see Figure 1).
 

Figure 1: Procedure for determining GloBE income

After determining GloBE income further steps are needed, such as an analysis of whether an enterprise may be able to benefit from certain deductions. Ensuring the lowest possible taxation of high-margin business is at the heart of Pillar 2. The computation methods mean that the GloBE minimum tax rate cannot be compared directly with Swiss corporate income taxes. Companies in cantons with total federal and cantonal income tax rates of over 15% may still be affected by GloBE.

Consequences of low taxation

If the effective tax rate in a country is below the minimum rate, the differential, known as a top-up amount, may be taxed by other jurisdictions. This involves the country where the ultimate parent entity or intermediate holding company is located or jurisdictions from which payments are made to the company. The OECD has a detailed set of rules to determine which country or countries have taxation rights over the top-up amount. Thus, countries have an interest in not allowing a top-up amount to arise that can be taxed by other countries, but to tax this tax base themselves. This is the case in Switzerland too.

What does it mean for Switzerland?

Implementing Pillar 2 in Switzerland will be challenging. Firstly, the GloBE-compliant computation of covered taxes for the companies concerned has be transferred into domestic law. Secondly there is the question of what other steps may be needed to ensure multinationals continue to view Switzerland as an attractive place to do business in spite of very sharp increases in income tax rates in some cases.

The authorities are currently working urgently on Switzerland’s response to the global initiative. Nonetheless, the earliest realistic date for implementation in Switzerland is 1 January 2024. This may be challenging for multinational companies, as many countries will implement Pillar 2 earlier than this. A temporal divergence results in additional administrative work and planning uncertainties for the companies concerned.