Global Anti-Base Erosion Proposal (“GloBE”) - Pillar Two

Position

OECD-Consultation 8 November 2019 – 2 December 2019

Global Anti-Base Erosion Proposal (“GloBE”) under Pillar Two

Federation of German Industries e.V.

December 2019

OECD Consultation – Secretariat Proposal for a Global Anti-Base Erosion Proposal (“GloBE”) – Pillar Two

Content 1.

General Comments ...............................................................3

2.

Specific Comments...............................................................6 2.1. Income Inclusion Rule......................................................6 2.2. Switch-Over Rule ...........................................................12 2.3. Undertaxed Payments Rule ...........................................12 2.4. The Interaction of the “GloBE”-Proposal with other International and Domestic Tax Rules ..................................13

Appendix: Selected Potential Implications of the “GloBE”Proposal ..................................................................................18 About BDI ...................................................................................25 Imprint.........................................................................................25

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OECD Consultation – Secretariat Proposal for a Global Anti-Base Erosion Proposal (“GloBE”) – Pillar Two

1. General Comments The BDI, as the voice of the German industries, appreciates the opportunity to provide feedback on the Secretariat’s Global Anti-Base Erosion Proposal (“GloBE”) - Pillar Two. We regard our comments as constructive but would like to point out that the German industry is very critical of the measures proposed under “GloBE” in view of their complexity and significant risks.

Besides detailed comments on the Income Inclusion Rule and on the interaction of the “GloBE”-Proposal to other tax rules we provide preliminary comments to the other proposed measures under Pillar Two. Although we are deeply concerned about the current state of the "GloBE" proposal, we look forward to further opportunities to contribute once the proposal has been developed further and crucial details have been clarified.

Global Consensus is Essential We are convinced that it is in the interest of taxpayers and tax authorities alike to maintain a globally coherent, consistent and homogenous enforcement of the international tax order. Therefore, any reform should be done through a comprehensive and coordinated approach between jurisdictions and avoid further fragmentation through uncoordinated unilateral action.

Would the measures proposed under Pillar Two be implemented via recommendations, achieving a legally binding global consensus seems near impossible and further fragmentation will occur.

Clarify Policy Rationale The principles underlying “GloBE” are not clear. It is our understanding, that the tax policy rationale of the current consultation paper is to disincentive profit shifting and tax competition by imposing a minimum tax on all income, thereby comprehensively addressing the remaining BEPS challenges. We believe that this policy rationale is not yet met by the current design of the “GloBE”-Proposal as no distinction is made between genuine commercial transactions and wholly artificial arrangements.

Furthermore, it should be clearly articulated why the previous BEPS project is not given a chance to succeed. Many actions of the BEPS project already show significant effects, with even more significant ones to come as the MLI and the EU Anti-Tax Avoidance Directives (2016/1164/EU and 2017/952/EU) will be implemented in all EU Member States. The OECD has also been successful in improving international coordination and information exchange in tax matters and in combating tax systems designed to evade taxation. Hence, the OECD/Inclusive Framework (IF) should also consider whether some BEPS-rules could be improved, replaced or simplified rather than imposing an additional layer of rules.

In this regard the impact of the already implemented BEPS actions should be assessed prior to the implementation of the measures proposed under Pillar Two. In case the assessment finds that most of the harmful tax practices have been eliminated, Pillar Two should not be introduced.

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OECD Consultation – Secretariat Proposal for a Global Anti-Base Erosion Proposal (“GloBE”) – Pillar Two

Need for Targeted and Proportionate Rules In case the previous BEPS project is judged to be inadequate and further action is required, the “GloBE”-Proposal should be realigned with the stated policy rationale. Therefore, the rules should be targeted and proportionate and address artificial arrangements only. This would focus the “GloBE”Proposal and would mean that it could be simplified significantly. Proportionality would be even more important should the „GloBE“-Proposal target genuine commercial transactions as well.

“GloBE” Could Distort Market Competition We would like to highlight that the “GloBE” proposal’s effects on competition could violate the principle of capital import neutrality. Companies competing in a jurisdiction with taxation below the effective minimum tax rate would be burdened by additional taxation in their home jurisdiction while local competitors are taxed at the low local rate. This would distort competition and is contrary to the stated policy rationale of Pillar Two. Tax Sovereignty We expect that the “GloBE”-Proposal will affect the behaviour of both taxpayers and jurisdictions. We note with deep concern that the “GloBE”-Proposal may reduce fair tax competition between jurisdictions and violate the tax sovereignty of the jurisdictions. We fundamentally believe that countries should be able to set and conduct their own tax policy in such a way that it induces sustainable economic growth, promotes research, development and innovation. We urge the participating countries to not increase corporate taxes, given the weakening economic outlook on the horizon.

Legal Certainty as a Fundamental Condition It should be strongly emphasised that the aim of any reform must be to design an international taxation order which provides legal certainty for both taxpayers and tax authorities. For that a global coordinated implementation of the “GloBE” is crucial. We are concerned that the current proposal does not satisfy taxpayers’ need for legal certainty as it is still too broad and lacks crucial detail.

The measures introduced by the “GloBE”-Proposal would need to be implemented into domestic law by each of the individual states signing up to Pillar Two and by changes to the entire double taxation treaty network. It should be considered how the “GloBE”-Proposal would affect bilateral treaties to the extent that it infringes tax treaty allocation of taxing rights for business profits and the non-discrimination clause of Article 24(4) of the OECD Model Convention. Additionally, existing domestic and international antiabuse regulations should be repealed.

Additional Administrative Burden Should Be Avoided We are deeply concerned about the administrative burden of the measures proposed under Pillar Two, since the “GloBE”-Proposal would increase the complexity of international taxation significantly. To minimise the administrative burden for both businesses and tax administrations, the new rules should be simple and easy to administer, taking into consideration differing administrative capacities. It is essential to reduce complexity, which is why we advocate the global blending approach based on financial accounts www.bdi.eu

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OECD Consultation – Secretariat Proposal for a Global Anti-Base Erosion Proposal (“GloBE”) – Pillar Two

applicable at the level of the ultimate parent company adjusted for temporary tax differences and multi-year effects, with only few uniform carve-outs.

Eliminate Double Taxation through Rule Coordination If the elements of Pillar Two are implemented without clear rules on the interaction between the proposals under Pillar One and under Pillar Two, between the different elements of Pillar Two as well as between the measures proposed under Pillar Two and existing international and domestic tax rules, severe double taxation risks would be inevitable. The German industry is deeply concerned that current dispute resolution mechanisms are fundamentally unfit to solve such an increase in disputes.

The risk of double taxation is particularly high if a group is organised in different jurisdictions worldwide and the “GloBE”-Proposal are applied by multiple jurisdictions in an uncoordinated way. Likewise, situations in which the profit-oriented and expenditure-oriented approach under Pillar Two would be applied in a combined manner would inevitably lead to severe double taxation. Both situations might result in taxation in excess of 100% which is not acceptable and could be prevented through rule coordination.

Binding Dispute Prevention and Resolution Is a Mandatory Condition It is a precondition that the administrative burden and legal uncertainty need to be limited and any double taxation risk has to be eliminated by agreeing on a binding dispute resolution mechanism implemented via a multilateral treaty which comes into effect simultaneously for all countries and without any additional options for the signatories. The procedure of the EU Directive (2017/1852/EU) on tax dispute resolution mechanisms could serve as an example. Such a binding dispute resolution measure should mandate that the taxpayer must take part in the process and should explore a “Single Point of Contact”-Approach.

Provide for Economic Impact Assessment As the creation of a worldwide minimum effective tax could be one of the most significant steps in taxation history, it is critical to make public an economic impact assessment on a country-by-country basis, covering the effects on national tax revenue, investment, growth, employment and business models to allow for transparent public discourse as well as informed decision making by G20/IF members.

Ensure Continuity and Consider an Extension of the Timetable The international taxation order should keep pace with the changing business world. If the structural features of the reformed system would not be durable, the OECD Proposals will not withstand the test of time.

We recognize that the G20 has called for a final report by the end of 2020.

Considering our general reservations, we feel the need to stress that the anticipated timeline is beyond ambitious, unrealistically tight and may result in serious long-term repercussions if rushed to achieve a political resolution. We hope the OECD/IF will work to extend the timeline for putting the technical architecture of a consensus-based solution together, even if it requires discussions beyond the end of 2020. www.bdi.eu

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OECD Consultation – Secretariat Proposal for a Global Anti-Base Erosion Proposal (“GloBE”) – Pillar Two

2. Specific Comments 2.1. Income Inclusion Rule The Income Inclusion Rule developed under Pillar Two should ideally prevent abusive practices but should not punish activities that are not subject to profit shifting. The introduction of such a rule bears the potential to set an overarching standard which simplifies international tax law to the benefit of taxpayers and tax authorities alike and to create a truly level playing field. However, the introduction of an Income Inclusion Rule without standardized escape rules and without testing for abusive practices could result in taxation where there is no economic profit as well as double taxation and could be incompatible with EU law.

Many fundamental questions about the Income Inclusion Rule have not been answered yet. Is it about all businesses having to pay a minimum level of tax around the world? Is it about ensuring the “right” tax is paid in the right countries? Is it about ensuring that tax is paid where value is created? There are many distortions and issues cited in the Consultation Document associated with applying an Income Inclusion Rule at either a country level or an entity level, e.g. timing differences, issues with allocating taxable attributes of transparent entities among taxing jurisdictions, and crediting taxes that arise in another jurisdiction. Hence, our comments on the proposed Income Inclusion Rule should not be viewed as an exhaustive list but may be complemented or modified when the discussion evolves further.

Tax Base Determination Use of Financial Accounts to Determine Income While the calculation of profit based on tax law is preferable, the use of consolidated financial statement data of the ultimate parent jurisdiction, prepared under internationally recognized rules applicable at ultimate parent level would best serve as a practical and proportionate proxy, but requires adjustments to reflect material differences between financial accounting and tax profit. Contrary, a bottom-up approach would require a large number of complex calculations to coordinate and adopt such an approach, which is likely difficult and costly to perform. However, any solution found should tax net profits once and never revenue.

We believe that calculation according to corporate income tax rules applicable at ultimate parent jurisdiction and allowing for segmentation would trigger significant compliance costs and administrative burden for taxpayers and tax authorities.1 While the approach to use accounting standards as a proxy for tax matters seems to be quite a comfortable approach, the interaction between local accounts and group accounts, as well as between accounting profits and taxable profits will pose significant challenges. Hence, we would like to refer to the following potential challenges and downsides of this method:

1

See Appendix, Example 1 for additional compliance costs and administrative burden that would be triggered by calculating the tax base according to CIT rules.

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OECD Consultation – Secretariat Proposal for a Global Anti-Base Erosion Proposal (“GloBE”) – Pillar Two

▪ ▪

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2 3

Many MNEs use different accounting standards (e.g. local GAAP and IFRS) in parallel, i.e. there is no uniform accounting standard which could be used for the purposes of “GloBE”.

Some MNEs would determine the relevant tax base by local GAAP as the leading standard, while others would apply IFRS/US-GAAP as the leading standard. We do not expect this to be acceptable for the tax authorities. Rather we expect the tax authorities to rely on their tax sovereignty to ensure uniform tax bases for all local taxpayers. The acceptance of different financial standards as a basis for the determination of the taxable income would not be a consistent approach and would require local tax authorities to also accept foreign local GAAP as a basis, e.g. in inbound cases (example: German subsidiary of a Japanese MNE with Japanese GAAP as leading standard). Such an approach would increase complexity, administrative burden both for taxpayers and tax authorities and risks of errors. This is also true if the leading standard would only be taken as a basis for the determination of the Effective Tax Rate under Pillar Two without being of relevance for the further taxation procedure. In future tax audits profound knowledge in international accounting standards would be required. Statute of limitations should be internationally harmonised to avoid double taxation triggered by tax audits/MAPs.2 Clear-cut definition of entities in scope should be made (e.g. fully consolidated, proportional consolidation, at equity consolidation, no consolidation). In cases where a domestic company does not have a 100% share in a foreign subsidiary, there should be precise information on the determination of the income to be considered pro rata by the parent company.

Subsidiaries draw up their statutory accounts according to local GAAP, which divers regarding to the jurisdictions. Few countries require the annual accounts of a single company to be prepared by using e.g. IFRS. According to our understanding, reports provided by subsidiaries to the parent company for consolidation purposes seldom contain a full set of data reflecting the accounting standard applied for the consolidated reports. Foreign affiliates not using the financial standards of the ultimate parent would be required to set up additional account according to the financial standards of the ultimate parent for “GloBE” purposes. Alternatively, market states should be obliged to accept the profit calculated by the parent company according to its countries´ rules.

It also needs to be considered that accounting standards – local GAAP vs.

IFRS/US-GAAP – differ in many aspects. If each leading standard would be accepted for determining tax bases, the taxpayers’ results would be incomparable and the individual tax liabilities would hence depend on the individually chosen standard. This consequence seems not in line with the principle of fair/equal taxation. Using local financial standards would lead to different treatment of the same economic case in different jurisdictions. This is highly problematic from the point of view of the German Federal Fiscal Court.3

See Appendix, Example 2.

See German federal fiscal court (Bundesfinanzhof – BFH), Decision as of 14.10.2015, ref.

I R 20/15, Federal Tax Gazette (Bundessteuerblatt – BStBl), Part II 2017, p. 1240.

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OECD Consultation – Secretariat Proposal for a Global Anti-Base Erosion Proposal (“GloBE”) – Pillar Two

Adjustments If financial accounting is adopted, permanent differences between financial and tax accounting would need to be eliminated (neutralized) and temporary differences would need to be considered to provide an approximation of taxable profit and taxes paid. Any approach that is adopted to cure timing differences should apply to global excess taxes and tax attributes, rather than to excess taxes or tax attributes at a country or entity level, given the complexity in accounting for these attributes for potentially hundreds of affiliates.

It will be essential that a multilateral, harmonised view is found on the issue of treatment of permanent & temporary differences through as many as possible simplifications to limit the administrative burden and legal uncertainty for businesses.

1. Permanent Differences Some important permanent differences common to many countries are the exclusions of dividends received, step-ups, business combinations, discontinued operations, extraordinary items, or impairments not recognised in a territory. These differences should be excluded from the viewpoint of eliminating double taxation.4 Capital gains and losses need to be considered carefully, as there is no consensus in whether they become subject to taxation or not.

Overall, exemption systems must not be discriminated as compared to credit systems. There are some jurisdictions which apply corporate taxation not until distribution (e.g. Estonia, Latvia). If not covered by differed taxes under the domestic law of that jurisdictions, the “suspended” taxation should be treated like the “normal” case for the purposes of the Income Inclusion Rule.

Though not being a permanent difference itself we would like to refer to some accounting options under IFRS/US-GAAP whereas certain amounts can be shown in OCI rather than being recorded to P&L. MNEs might have some accounting policies with different exercise of such options. In case of financial standards being the basis for the determination of the taxable income this might result to inequalities between taxpayers.

Furthermore, if financial accounts based on consolidated accounting standards applied at ultimate parent level are defined as starting point for the tax base calculation, reporting currency must be defined and any potential foreign exchange profits and losses must be eliminated in determining the Effective Tax Rate.

2. Temporary Differences By their nature, temporary differences relate solely to the timing of taxation rather than whether the item will be subject to tax. The temporary differences can be addressed by applying cumulatively deferred tax accounting5 and a multi-year average effective tax rate.

4 5

See Appendix, Examples 3 and 4 for exclusion of permanent differences.

See Appendix, Example 5 for certain exceptions, in particular tax rate changes.

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OECD Consultation – Secretariat Proposal for a Global Anti-Base Erosion Proposal (“GloBE”) – Pillar Two

Deferred tax accounting is a relatively simple and realistic approach from the viewpoint of using financial accounting as a starting point and simplification. However, careful consideration is required with regard to the valuation allowance for deferred tax assets and equity in earnings of affiliated companies.

We are concerned that the Income Inclusion Rule may also punish projects or activities that over the full life of the project carry a significant level of taxation, even though this may not occur year by year, e.g. due to long term lead in costs like large infrastructure projects. Pillar Two should allow for averaging (e.g. 5 years) in order to deal with timing differences between parent country and “foreign” to get a real minimum tax. Whilst such a multiyear averaging approach to measure the Effective Tax Rate could provide more stability (for example “smoothing out” the effect of one-off items), its adoption would add additional complexity and potentially increase opportunity for tax evasion.

Effective Tax Rate While the proposal is still under basic development, we would already welcome the public consultation’s recommendation of the use of an agreed minimum fixed top-up globally uniform rate at the ultimate parent level (as opposed to using a percentage of the parent jurisdiction’s CIT rate). This should lower the administrative burden to some extent. Setting the minimum tax rate as a percentage of the parent jurisdiction’s CIT rate would disadvantage groups headquartered in relatively high tax jurisdictions as their cross-border activity would face a high probability of being effectively taxed below the percentage minimum rate in comparison the those headquartered in relatively low tax jurisdictions.

The minimum tax rate should not require an effective tax charge, i.e., the use of deferred tax assets, tax credits, and exemption of income to avoid double taxation, should not trigger the application of the Income Inclusion Rule.

In multi-tier group structures CFC taxation abroad has to be taken into account, irrespective of the year of assessment/payment of the foreign CFC tax.6 Often, a company’s total direct tax contribution to a government consist of more than simply corporate income taxes paid, but also other taxes designed to tax corporate profits, such as sector specific levies, withholding taxes and government royalties (e.g. the German trade tax (Gewerbesteuer)).

The OECD should provide a list of relevant corporate taxes for each jurisdiction and keep that list up to date.

The reason for a global approach is that the operations of each company in each jurisdiction will vary due to regulatory, legal and business constraints.

In addition, highly integrated businesses would not be well served by a view that considers each country on a stand-alone basis. Also, a globally fixed topup rate would avoid arbitrary situations between jurisdictions and would create a level playing field.

6

See Appendix, Example 6 for the inclusion of potential CFC taxation at lower tiers.

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OECD Consultation – Secretariat Proposal for a Global Anti-Base Erosion Proposal (“GloBE”) – Pillar Two

Other Issues Further clarification on the incorporation of the proportionate share of income and the avoidance of double taxation is required. We would like to highlight that tax credit for foreign taxes should be introduced to domestic legislations.

If jurisdictional blending is implemented, double taxation can arise when a parent corporation must incorporate foreign income that is effectively low taxed but cannot credit the foreign tax as domestic tax is not due because of negative domestic income or specifics of the jurisdiction. Double taxation could be avoided by introducing a tax credit carry forward or allowing for deduction of the foreign tax. The latter option is feasible only when the jurisdiction recognizes loss carry forwards.

The Income Inclusion Rule should provide for the carry forward of losses on the level of the company on which the rule applies. The offset of losses should not be restricted to the country in which the losses originated.

Furthermore, for purposes of the Income Inclusion Rule tax credit for withholding taxes on dividends at ultimate parent level should be provided for jurisdictions applying participation exemption systems, whereas the dividends should be tax exempt. If an entity by entity approach or jurisdiction approach of blending is introduced, the tax credit should apply at the suitable level.

Other possible sources of double taxation arise from basic mismatches (e.g. timing differences associated with GAAP differences, or differences between the parent country tax legislation and local tax legislation) or mismatches in measuring foreign profits for purposes of income inclusion versus foreign tax credit relief. Hence, further clarifications on the calculation of the Effective Tax Rate are required.

Blending The scope of the blending should be as wide as possible to make the proposal workable, to mitigate complexity and to reduce risk of double taxation. If financial accounting is used as a starting point, a global blending has the lowest compliance cost. Hence, we would recommend a global blending approach at the ultimate parent level which meets the policy objectives of Pillar Two in a proportionate and focused way. Even though, the global blending will in some cases create adverse effects from both taxpayer’s and tax authority’s perspective, simplicity should be favoured over accuracy.

Logically and systematically, domestic subsidiaries should be included in the global blending. The blending should further be applied on a multi-year basis.

We want to point out that a global blending does not lower the need to address temporary differences within the tax base calculation. Systematically, the blending should apply only after amendments to the accountable income with respect to differed taxes have been already made.

Mandating an entity by entity approach or jurisdiction approach creates significant complexity and causes high compliance costs for both taxpayers and tax authorities. In particular, the entity blending approach should be ruled www.bdi.eu 10

OECD Consultation – Secretariat Proposal for a Global Anti-Base Erosion Proposal (“GloBE”) – Pillar Two

out on general principles because of its complexity, but also because many jurisdictions do not tax on an entity by entity basis (e.g. group relief). The proper application of jurisdictional or entity blending would require significant systems and administrative costs to taxpayers to ensure the proper allocation of expenses incurred at the ultimate parent jurisdiction for the benefit of affiliates are allocated to the appropriate jurisdiction or entity.

Carve-Outs Generally, carve-outs for certain industries, business sectors etc. should be avoided or limited to ensure an equal taxation of all taxpayers rather than a privileged treatment of some groups of taxpayers. Furthermore, an exclusion (“white-listing”) of certain domestic regimes appears challenging. It could be complex to keep a “White List” up to date. However, the OECD/IF should find the right balance in addressing countries’ concerns on artificial arrangements and countries’ right to initiate an incentive-driven tax framework, which attracts FDI, R&D, employment, etc. through transparent and fair tax competition. Any possible “White List” should not be subject to alteration without unanimous and globally coordinated consent.

In order to not burden smaller businesses with significantly complex rules, we would advocate for a fixed threshold, under which the “GloBE”-proposal would not apply. The proposal of the current document to put this in line with the Country-by-Country-Reporting revenue threshold of 750 Million Euro for the whole MNE group seems appropriate.

Furthermore, we advocate for a carve-out of those incentive schemes which have shown to be fully compliant with BEPS Action 5 (“Unharmful Tax Regimes”) and the EU Code of Conduct.

We would also like the OECD/IF to consider simple gateway tests for those businesses with a modestly higher consolidated Effective Tax Rate of an MNE group (that usually coincide with non-mobile activities), e.g. higher that a certain percentage point above the fixed absolute minimum Effective Tax Rate to be determined for the Income Inclusion Rule (e.g. 20% above the minimum Effective Tax Rate). In these instances, companies should not be obliged to calculate the applicable tax rate in order to minimize the additional administrative burden.

A MNE with a consolidated Effective Tax Rate more than the identified minimum tax rate is not running afoul of the policy objective which is to minimum tax MNE’s that have an average low-income tax rate due to shifting income to low-tax jurisdictions. In addition to accomplishing the policy goals of the Income Inclusion Rule, this carve-out is administratively simple for all parties. The carve-out is also reliable, given the data used to qualify for the carve-out is audited by an independent accounting firm.

Moreover, an MNE should be permitted to carry forward any “excess tax rate” for next period carve-out judgments. This would, in addition to adjustments of temporary differences, acknowledge that an MNE’s Effective Tax Rate may vary from year-to-year (e.g., exchange rate P&L) based solely on timing differences between financial accounting and tax or market conditions, and not based on shifting profits to low-tax jurisdictions. www.bdi.eu

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OECD Consultation – Secretariat Proposal for a Global Anti-Base Erosion Proposal (“GloBE”) – Pillar Two

2.2. Switch-Over Rule The Switch-over Rule covers foreign branches as well as immovable property and allows the state of residence to apply the credit method instead of the exemption method where the profits attributable to a permanent establishment or derived from immovable property are subject to tax at an effective rate below the minimum rate.

Switching from exemption to credit method incorporates the income of a branch into the corporation’s domestic taxation. Insofar, further clarification on the avoidance of double taxation is required. Given the parents domestic income is negative and remains so after the income of the foreign branch is incorporated, the foreign tax credit should be subject to a carry forward or be deductible from the domestic income. The latter option is feasible only when the jurisdiction allows loss-carry forwards.

The introduction of a switch-over rule in accordance with Pillar Two would require changes in every major tax treaty. Insofar, the implementation of the Switch-over Rule would require a multi-lateral instrument (MLI) or similar legal instrument.

Moreover, a globally uniform definition of permanent establishment is needed. Taxation of a permanent establishment below required minimum effective level may occur because of qualification conflicts (e.g., service permanent establishments). This would lead to double taxation. Hence, the OECD/IF should provide clear rules on definition of permanent establishments, which would be applicable uniformly.

2.3. Undertaxed Payments Rule The undertaxed payment rule would deny a deduction or impose sourcebased taxation for a payment to a related party if that payment was not subject to tax at a minimum rate.

The scope of the Undertaxed Payment Rule and the Subject to Tax Rule should be limited to payments related to “mobile” income (e.g. interest and royalties). it would be appropriate to apply a substance-based carve-out reflecting the principles stated in the BEPS Action 5 final report. Other payments (e.g. by distributors to acquire inventory which they on-sell) should be out of scope.

Although the Undertaxed payment rule is limited to payments to related parties, there is no such restriction in the Subject to Tax Rule. It should be clarified that the scope is limited to payments to related parties only. It is not practical for companies to be required to determine the Effective Tax Rate applied to payments received by third parties.

Again, we would like to stress the point that the German Industry is very critical towards the proposed Undertaxed Payments Rule. Due to lack of any economic reasoning the Undertaxed Payments Rule should under no circumstances apply to under treaty benefits beyond interests and royalties or to unrelated parties. Not only would such an extensive application increase the administrative and compliance cost massively but would often reach its limits due to the lack of information. Double taxation would arise when the www.bdi.eu

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OECD Consultation – Secretariat Proposal for a Global Anti-Base Erosion Proposal (“GloBE”) – Pillar Two

Undertaxed Payment Rule is applied in multiple jurisdictions due to multitier group structures.

The Undertaxed Payments Rule would require the receiving corporation to share sensible tax information with foreign tax authorities such as tax declaration and tax returns. This possess significant challenges and could violate the German fiscal secrecy rules. Therefore, the receiving company should be be able provide proof of being taxed at a sufficient level by a certified chartered accountant who verifies the effective tax rate of the receiving corporation. Alternatively, and in line with the “SPOC”-Approach, the home jurisdiction tax authority of the receiving corporation should audit and provide proof of sufficient effective taxation to the relevant foreign tax authorities.

2.4. The Interaction of the “GloBE”-Proposal with other International and Domestic Tax Rules Coordination between Pillar One and Pillar Two There will be significant interaction between Pillars One and Pillar Two for countries adopting both proposals, with a high likelihood of double taxation risks without proper coordination. Therefore, it is crucial that further work is taken to understand the interaction between these two pillars.

Clarification is required regarding the timing of the test for effective low taxation with regards to Pillar One. For instance, a profit allocation which was not subject to low taxation could be subsequently reallocated under Pillar One, creating a situation in which the income of the foreign company is effectively low taxed. This would trigger the Income Inclusion Rule and would not reflect the policy rationale of Pillar Two. We believe that Profit Reallocation under Pillar One must be considered by calculating the Effective Tax Rate for Pillar Two. At the current stage we cannot make proper comments on administrative burden and coordination challenges between jurisdictions. The OECD/IF, however, should provide with clear rules upon overlapping substantive and procedural elements of both pillars.

The OECD/IF should include considerations, to be determined, prior to any agreement on the “GloBE”, whether the forthcoming Pillar One would not already address countries’ concerns to a reasonable extend.

Coordination between Elements of the “GloBE” First, we feel the need to stress that globally unanimous rule coordination within the Pillar Two proposal is essential as a lack of rule coordination can easily lead to instances of double or multiple taxation.

A rule of precedence, whereby the Income Inclusion Rule would take priority, would prevent double taxation that results from the simultaneous application of both the Income Inclusion Rule and Undertaxed Payments Rule.

Insofar, further clarification on the communication between the national tax authorities should be explored. For example, in case, the Income Inclusion Rule is applied, this should trigger a notification process for other tax www.bdi.eu

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OECD Consultation – Secretariat Proposal for a Global Anti-Base Erosion Proposal (“GloBE”) – Pillar Two

authorities to avoid an application of the Undertaxed Payment Rule. The use of binding cross-border administrative acts should be explored.

The current proposal does not contain explanations on how globally uniform and coordinated implementation could be achieved to avoid massive legal uncertainty and instances of double taxation due to overlapping rules between two or more states. Triangular cases (and cases where more than one jurisdiction sought to apply “Globe”-rules to the same structure or arrangement) should be analysed with care and in exchange with tax experts to avoid uncoordinated actions and double taxation.

If the Undertaxed Payment Rule applies to a series of payments of which the first ones are taxed at a sufficient level, but the consequent payments are considered being undertaxed, this could trigger a denial of deductions of such payments in more than one jurisdiction, further aggravating the double taxation which might already arise from the combined effects of the Income Inclusion Rule and the Undertaxed Payment Rule. Situations in which double taxation could arise due to the combination of the profit-oriented and expenditure-oriented approach are foreseeable. For instance, considering a proportion of foreign low-taxed income in the parent’s taxation (profit-oriented) while at the same time denying the parent to deduct expenses related to the foreign subsidiary (expenditure-oriented) would inevitably lead to severe double taxation. In extreme uncoordinated cases the Effective Tax Rate can exceed 100%7 which is not acceptable.

If such a rule of precedence cannot be agreed upon, the Undertaxed Payment Rule could alternatively be limited to those payments made to a company whose ultimate parent is not subject to an effective minimum tax in accordance with the Income Inclusion Rule of Pillar Two. To allow countries to operate the Undertaxed Payments Rule as a primary rule will dramatically increase complexity as well as disputes and double taxation and dramatically decrease tax certainty.

Hence, it is highly questionable whether the simultaneous introduction of both rules is advisable. In our understanding, the combined effects of the rules would result in gross taxation which does not allow for deduction and would disregard the “Ability-to-Pay”-Principle. Furthermore, the simultaneous application of both rules under Pillar Two would punish certain behaviour twofold without introducing incentives for preferable behaviour contrary to similar policy initiatives (e.g., US Tax Reform, “Carrots and Sticks”Approach). Therefore, we advocate for the implementation of an Income Inclusion Rule only which focuses on abusive practices.

Coordination between “GloBE” and BEPS Actions The elements of the “GloBE”-Proposal overlap with existing and already implemented tax regimes with similar objectives on national level as well as with measures implemented in the context of the BEPS project (e.g., Action Points 2 to 5). Therefore, the OECD/IF should clarify the relation of the “GloBE” to national and other similar regimes as a simultaneous application

7

Calculation can be provided upon request.

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OECD Consultation – Secretariat Proposal for a Global Anti-Base Erosion Proposal (“GloBE”) – Pillar Two

could result in severe double taxation and high administrative and bureaucratic burdens.

The legal consequences of the Income Inclusion Rule resemble so-called Controlled Foreign Corporation (CFC) regimes. While a parent corporation is generally not taxed for a subsidiary’s income, under certain circumstances CFC regimes apply to apportion income of a subsidiary to the parent company and subject the subsidiary’s income to taxation on parent level without profit distribution. Generally, CFC regimes intend to thwart practices which have no purpose other than to escape the tax due on the profits generated by certain harmful activities in the state of residence of the parent but artificially moved to a low taxed subsidiary. In this context, CFC regimes commonly stipulate a low tax rate threshold, consider the nature of the activities, contain a significant or controlling ownership criteria and contain some sort of carve-outs that include substance and motive tests as well as de minimis exemptions.

The parallel existence of measures with similar objectives would result in double taxation, high administrative costs and bind human as well as financial resources to comply with the parallel measures. Such ramifications become even more severe in multi-tier structures and in triangular cases when multiple CFC regimes apply. The same is true with Undertaxed Payments Rule and comparable national rules (e.g. Article 4j German Income Tax Act).

In our view, once the “GloBE” is introduced, existing national anti-abuse rules would need to be abolished and repealed rather than be supplemented by the new rules to avoid conflicting tax computations and double taxation.8 Since the mentioned national anti-abuse rules result from EU Directives and initially from the BEPS project, changes should first be made to EU Directives.

Compatibility with EU law Special emphasis should be placed on the compatibility with EU law. Regarding the implementation of the proposal, we are concerned, that the implementation via a Directive (Art. 288 TFEU) would not be feasible due to the limits set by Art. 115 TFEU and the principles of subsidiarity and proportionality. Given the proposals are implemented on national level, either implementing an EU Directive or without a secondary EU law basis, the measures must be in line with primary and secondary EU law and the relevant CJEU case law.

Income Inclusion Rule From a primary law perspective, the Freedom of Establishment (Art. 49 TFEU) and the Free Movement of Capital (Art. 63 TFEU) are particularly relevant. The fundamental freedoms prohibit discriminatory legislation by mandating equal treatment of residents and non-residents in cross-border cases. While the Freedom of Establishment is limited in its geographical scope to EU cases, the Free Movement of Capital can apply to intra-EU as well as non-EU cases. In this regard, the applicable fundamental freedom, and thereby the limitations set by it, can be influenced by an ownership 8

See Appendix, Example 6 for interaction of the “GloBE” with local anti-abuse rules.

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criterion. In case the Income Inclusion Rule requires a significant or controlling ownership, it is settled CJEU case law that the Freedom of Establishment would take precedence over the Free Movement of Capital,9 limiting the EU law implications to intra-EU/EEA cases.10 Generally, the imposition of a fixed top up rate in accordance with the Income Inclusion Rule could constitute a restriction of the mentioned fundamental freedoms as a difference in treatment is established between crossborder and domestic cases, creating a tax disadvantage for the cross-border cases. A restriction is permissible only if it is justified by overriding reasons of public interest and the legislation is proportionate. Therefore, it is important to ensure that the Income Inclusion Rule is justifiable and proportionate.

As argued in the previous subsection, the legal consequences of the Income Inclusion Rule resemble CFC regimes. In this context, possible justifications of a restriction could be the need to prevent tax evasion and the balanced allocation of taxing rights between EU Member States. According to CJEU case law, the specific objective of a restricting measure must be to prevent conduct involving the creation of wholly artificial arrangements which do not reflect economic reality, with a view to escaping the tax normally due on the profits generated by activities carried in the parent’s resident state.11 A restriction by a parent company Member State cannot be justified by the intention to offset a tax advantage gained through low taxation in a source Members State or the intention to prevent a reduction of tax revenues.12 It must be stressed that the establishment of a subsidiary or a permanent establishment in another Member State does not constitute tax evasion or allow for a general presumption of such activities.13 In our understanding, a fixed top up rate in accordance with the Income Inclusion Rule could be triggered exclusively by low effective taxation, lacking concrete criteria relating to practices of tax evasion. Since this could constitute an unjustifiable restriction of the fundamental freedoms, the Income Inclusion Rule should include further criteria such as significant or controlling ownership, certain activities as well as de minimis thresholds to determine not only if income has been subject to tax at a minimum effective rate but also if the low taxation is the result of conduct involving the creation of wholly artificial arrangements which do not reflect economic reality.

It must further be determined whether the legislation is proportionate. A measure is not proportionate when it goes beyond what is necessary to achieve its purpose. The introduction of a standardised escape

9

See Case C-35/11 (Test Claimants), paragraphs 90 et seq.; case C-685/16 (EV), paragraphs 31 et seq.

10 In case a significant or controlling ownership threshold is not included in the Income Inclusion Rule, the following would generally also apply vis-à-vis so called third countries, see case C-135/17 (X), paragraphs 57 et seq.

11 Case C-196/04 (Cadbury Schweppes), paragraph 55.

12 Case C-196/04 (Cadbury Schweppes), paragraph 49; case C-294/97 (Eurowings), paragraph 44.

13 Case C-164/96 (ICI), paragraph 26; case C-478/98 (Commission/Belgium), paragraph 45; case C-334/02 (Commission/France), paragraph 27. www.bdi.eu

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possibility/carve-out can align the Income Inclusion Rule with the standards set by CJEU case-law. The parent company should be given an opportunity to produce evidence that the subsidiary is actually established and that its activities are genuine.14 The definition of such substance, activity and/or motive requirements could be based on a combination of various criteria (e.g., capital investments, education level of employees, etc.) as such activities are less likely to be part of profit shifting activities.

In light of this, it might appear tempting to design the Income Inclusion Rule in a non-discriminatory way. Would the Income Inclusion Rule apply to all domestic and foreign subsidiaries, it would likely not capture domestic German cases due to the high effective domestic tax rate. Even though treated legally equal, low taxed cross-border cases would be treated factually different to domestic cases, which would not be in line with the fundamental freedoms. We take the position that this approach does not establish compatibility with EU law because discrimination is assessed based on factual (and not legal) equal treatment.

Furthermore, we are convinced that the problems arising from EU law cannot be minimised by setting the minimum Effective Tax Rate at below the lowest EU Members State corporate tax rate. Although the Income Inclusion Rule would not apply to intra-EU/EEA cases, this would infringe the Members States’ tax sovereignty as their ability to set their tax rates would be severely limited and would not address discriminatory issues regarding the Free Movement of Capital.

Additionally, secondary EU law such as the Interest and Royalty Directive (2003/49/EC), Merger Directive (2009/133/EC), the Parent-Subsidiary Directive (2011/96/EU) or the Anti-Tax Avoidance Directive (2016/1164/EU and 2017/952/EU) should be considered for the evaluation of the Income Inclusion Rule from a EU law perspective. In recent judgements, the CJEU assessed the compatibility of a national measure on the basis of the anti-abuse definition included in the Anti-Tax Avoidance Directive,15 further highlighting the need to analyse the compatibility of the Income Inclusion Rule with secondary EU law.

Undertaxed Payments Rule From a primary law perspective, the above outlined arguments also hold true for the Undertaxed Payments Rule as it creates a difference in treatment for residents and non-residents in cross-border cases. A similar expenditureoriented regime which denies deduction of payments to foreign companies if they are not subject to a fixed minimum tax is submitted to the CJEU for a preliminary ruling in light of the Freedom of Establishment (Art. 49 TFEU).16 From a secondary EU law perspective (for a list of EU Directives see above), the issue concerning beneficial owners and payment recipients with regards to interest and royalties should be considered.

14

Case C-196/04 (Cadbury Schweppes), paragraphs 61 et seq.

Case C-116/16 (T Danmark); case C-117/16 (Y Denmark Aps).

16 Case C-484/19 (Lexel AB).

15

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Appendix:

Selected Potential Implications of the “GloBE”Proposal

Example 1: Calculation of the Tax Base Calculation according to CIT Rules would trigger significant compliance costs and administrative burden.

Ultimate Parent

Rest of World Subsidiaries Subsidiaries Subsidiaries Subsidiaries

> 400 Legal Entities

Subsidiaries

Facts ▪ ▪

Ultimate Parent with multiple foreign subsidiaries Reconciliation and calculation of tax base according to German Tax Law for over 400 foreign legal entities/branches

Potential “GloBE” Implications ▪ ▪

Roughly estimated annual compliance costs ~ 6 million EUR without significant additional tax revenue (assuming cost of ~ 15 000 EUR per legal entity) Significant administrative burden for tax authorities to check tax base

BDI Position ▪

Calculate tax base according to financial accounting standards applicable at ultimate parent level, e.g. IFRS/US-GAAP

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Example 2: Tax Audit/MAP Future tax audit/MAP adjustments should be considered in the “GloBE” proposal.

Ultimate Parent

Country A Subsidiary A Royalty Payment Country B Subsidiary B

Tax Audit Adjustment

Facts ▪ ▪ ▪ ▪

Subsidiary A grants license to subsidiary B Royalty income of subsidiary A not subject to tax in Country A due to preferential regime Royalty expense of subsidiary B not tax deductible due to anti-abuse rule in Country B Future Tax Audit result in A: royalty income subject to CIT at 25%

Potential “GloBE” Implications ▪ ▪

Subsidiary A income subject to Income Inclusion Rule at ultimate parent and non-deductible in Country B Future Tax Audit result in A: Subsidiary A income subject to CIT

BDI Position ▪

Future Tax Audit Adjustments need to be considered in “GloBE” to mitigate risk of double taxation

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Example 3: Permanent Differences (1) Permanent differences triggered by participation exemption gimes should be excluded.

re-

Ultimate Parent

Country A Participation exemption

Subsidiary A Subsidiary A

Country B Dividend Subsidiary BB Subsidiary

Income taxed < minimum tax

Facts ▪ ▪ ▪

Income at Subsidiary B taxed below required minimum effective tax rate Subsidiary A generates only dividend income received from Subsidiary B Dividends received by Subsidiary A are fully exempt from taxation based on the participation exemption regime in Country A

Potential “GloBE” Implications ▪ ▪

Subsidiary B income subject to Income Inclusion Rule at ultimate parent Subsidiary A dividend income subject to Income Inclusion Rule at ultimate parent level

BDI Position ▪

Permanent differences triggered by participation exemption regimes (e.g. dividends, capital gains) to be excluded to mitigate the risk of double taxation

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Example 4: Permanent Differences (2) Permanent differences triggered by tax neutral reorganizations should be excluded.

Ultimate Parent

Country A Contribution BU 1

Subsidiary A Subsidiary A BU1

BU2

Subsidiary BB Subsidiary

Facts ▪ ▪

Subsidiary A contributes Business Unit 1 (BU) into Subsidiary B on a carry-over basis for tax purposes Contribution carried out at fair market value for accounting purposes resulting in a goodwill step-up in Subsidiary B and a corresponding step-up in basis in Subsidiary A

Potential “GloBE” Implications ▪ ▪

Goodwill step-up and step-up in basis might trigger effective tax to fall below minimum effective tax rate Respective income subject to Income Inclusion Rule at ultimate parent level

BDI Position ▪

Permanent differences triggered by Tax neutral Reorganizations to be excluded to mitigate the Risk of Double Taxation

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Example 5: Deferred Taxes and Tax Rate Changes Impact of tax rate changes on deferred taxes should be excluded.

Ultimate Parent

Country A Subsidiary AA Subsidiary

Deferred tax asset

Facts ▪ ▪ ▪

Corporate income tax rate in Country A in year 1: 10%17 Due to a tax reform the corporate income tax rate increases to 20% effective in year 2 Subsidiary A deferred tax asset (DTA) prior to Tax Reform: 10 EUR/$

Potential “GloBE” Implications ▪ ▪

DTA after tax reform: 20 EUR/$ → reduction of effective tax in year 1 by 10 EUR/$ Subsidiary A income subject to Income Inclusion Rule at ultimate parent

BDI Position ▪

17

Impacts of Tax Rate Changes on DTA/DTL to be excluded

Assumption: minimum Effective Tax Rate rate according to “GloBE“.

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Example 6: Deferred Taxes and Tax Rate Changes Potential CFC tax at lower tiers should be included in the calculation of the effective tax rate.

UltimateParent Parent Ultimate

Country A Subsidiary AA Subsidiary

Country B Subsidiary BB Subsidiary

Low taxed under Country A CFC Rules Low taxed under “GloBE” Ultimate Parent

Facts ▪ ▪

Subsidiary B qualifies as CFC under local tax law in Country A Subsidiary B’s income is low taxed under “GloBE”

Potential “GloBE” Implications ▪

Subsidiary B income subject to CFC tax at Subsidiary A and subject to Income Inclusion Rule at ultimate parent

BDI Position ▪ ▪

CFC tax at lower tiers to be included in effective tax calculation/CFC income to be excluded under “GloBE” to mitigate double taxation risk Global blending reduces double taxation risk

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Example 7: Local Anti-Abuse Rules Interaction with local anti-abuse Rules to be observed; global blending would reduce double taxation risk

Ultimate Parent

Country A Subsidiary AA Subsidiary

Country B Royalty payment

Subsidiary Subsidiary BB

Deduction limitation on royalty payment

Facts ▪ ▪ ▪

Subsidiary A grants license to Subsidiary B Royalty income of Subsidiary A not subject to tax in Country A due to preferential regime Royalty expense of Subsidiary B not tax deductible due to antiabuse rule in Country B

Potential “GloBE” Implications ▪

Subsidiary A income subject to Income Inclusion Rule at ultimate parent level and non-deductible in Country B

BDI Position ▪ ▪

Interaction between local anti-abuse rules and Income Inclusion Rule to be observed to mitigate the risk of double taxation Global blending reduces double taxation risks

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About BDI The Federation of German Industries (BDI) communicates German industries’ interests to the political authorities concerned. She offers strong support for companies in global competition. The BDI has access to a wide-spread network both within Germany and Europe, to all the important markets and to international organizations. The BDI accompanies the capturing of international markets politically. Also, she offers information and politico-economic guidance on all issues relevant to industries. The BDI is the leading organization of German industries and related service providers. She represents 36 inter-trade organizations and more than 100.000 companies with their approximately 8 million employees. Membership is optional. 15 federal representations are advocating industries’ interests on a regional level.

Imprint Federation of German Industries e.V. (BDI) Breite Straße 29, 10178 Berlin www.bdi.eu T: +49 30 2028-0

Contact Dr. Monika Wünnemann Head of Department Tax and Finance T:+49 30 2028-1507 M.Wuennemann@bdi.eu Satenik Melkonyan Senior Manager Tax and Finance T: +49 30 2028-1585 S.Melkonyan@bdi.eu

BDI document number: D 1113

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