Implementation of the OECD/G20 global minimum tax: Swiss electorate said yes
As part of the well-known BEPS project (Base Erosion and Profit Shifting), which has led several member states to amend their domestic tax laws in accordance with the recommendations issued by international organizations, Action 1 specifically deals with the tax challenges raised by the digitalization of the economy.
On 8 October 2021, the Inclusive Framework on BEPS, which currently consists of 143 Member States, declaration on the future taxation of large MNEs which are internationally active. This declaration is signed by 139 member states, including all OECD, G20 and EU states, and envisages a two-pillar solution:
- Pillar One will ensure a fairer distribution of profits and taxing rights among countries with respect to the largest MNEs, including digital companies.
- Pillar Two seeks to put a floor on competition over corporate income tax, through the introduction of a global minimum corporate tax rate that countries can use to protect their tax bases.
1. Pillar One: Re-allocation of taxing rights
Under Pillar One, profits and taxing rights over MNEs will be distributed among countries and will be re-allocated from their home countries to the markets where they have business activities and earn profits, regardless of whether firms have a physical presence there. Unilateral "digital taxes" will be abolished.
The scope of Pillar One will cover international groups of companies that generate an annual turnover of more than EUR 20 billion and a profit margin of more than 10 per cent (pre-tax profit on turnover). According to the OECD and the G20, these are the approximately 100 largest and most profitable business groups worldwide.
In actual terms, states in which a group of companies generates an annual turnover of at least EUR 1 million will be able to tax a share of their profits. A lower threshold is envisaged for smaller countries. The share of a company's profit to be shared between the states is 25 per cent of the profit that exceeds the profit margin by 10 per cent (so-called amount A). In order to ensure that the profit allocated is not subject to double taxation, the states in which the units of the group of companies with above-average returns are resident will probably have to grant a corresponding relief.
With the view to providing the groups of companies with legal certainty, there is a special dispute avoidance procedure associated with the share of the amount A between the states involved and the identification of the states which must grant some corresponding relief. In addition, these groups of companies must benefit from a special dispute resolution procedure, even for matters which are only indirectly related to the amount A.
The implementation of the Pillar One requires a multilateral agreement, which will have to be ratified necessary by the participating states.
2. Pillar Two: Minimum taxation
Under Pillar Two, a minimum taxation of 15 per cent will be introduced, according to an internationally standardised calculation basis, for groups of companies with an annual turnover of at least EUR 750 million.
The standardised calculation basis will be determined according to recognised accounting standards, with some adjustments. If the aggregate tax burden of a state (so-called 'jurisdictional blending') does not reach the minimum level of 15 per cent stipulated by the OECD and the G20, the profit of all operating units in a state, taking into account a percentage rate on tangible investments and wage costs (so-called 'carve-out' or substance deduction), is subject to additional taxation equal to the difference between the actual tax burden and the required minimum taxation. Profits from certain assets can therefore still be taxed at less than 15 per cent. The additional taxation is levied in the state of residence of the parent company or possibly on an intermediate company of the group of companies in question (so-called "Income Inclusion Rule", IIR). If this state does not introduce the IIR, taxation will be applied subsidiarily in the states where the subsidiaries of the group of companies are resident, through denial of deductions or equivalent modifications (so-called "Undertaxed Payments Rule", UTPR). However, the OECD and the G20 also allow the source state to independently impose the difference to the minimum taxation (so-called "Qualified Domestic Minimum Top-Up Tax"). This domestic top-up tax has priority over the IIR and the UTPR.
Pillar Two is not a minimum standard, namely states are neither politically nor legally obliged to adopt this minimum tax rule. Should they decide to transpose it into national law, they would have to adhere to the OECD and G20 standards and guidelines in accordance with the official declaration of 8 October 2021 and accept the application of the standards by other states.
On 20 December 2021, the OECD published a report delineating the scope and setting out the operative provisions and definitions of Pillar Two. These rules are intended to be implemented as part of a common approach and to be brought into domestic legislation as from 2022.
On 14 March 2022, the first edition of the Commentary to the Pillar Two rules was published. It explains the intended outcomes under these rules, clarifies the meaning of certain terms, and illustrates the application of the rules to certain fact patterns.
On 2 February 2023, the OECD published the Agreed Administrative Guidance for the Pillar Two Globe Rules, which will ensure co-ordinated outcomes and greater certainty for businesses as they move to apply the global minimum corporate tax rules from the beginning of 2024. The Agreed Administrative Guidance will be incorporated into a revised version of the Commentary that will be released later in 2023 and replace the original version of the Commentary issued in March 2022. The Inclusive Framework will continue to release further Agreed Administrative Guidance on an ongoing basis, to ensure that the rules continue to be implemented and applied in a co-ordinated manner.
The OECD/G20 Pillar Two also contains a "Subject to Tax Rule" to be included in the double taxation agreements (DTAs) with developing countries. In future, these countries will be able to levy a reduced withholding tax on interest, royalties, and other selected payments if the payments in question are subject to less than 9 per cent nominal taxation. It is expected that the relevant DTAs will be amended and ratified bilaterally or by a multilateral instrument.
3. The implementation in Switzerland
Switzerland has been traditionally prioritizing long-term, consensus-based solutions at the multilateral level, rather than a fragmented approach of individual national measures.
In this regard, Switzerland is dedicated to establishing regulations that promote innovation and prosperity, with a global uniformity and a mechanism for resolving disputes. The goal is to provide legal certainty for businesses affected by these regulations.
Considering the challenges imposed upon Switzerland by the OECD/G20 project on taxation of the digital economy, in January 2022, the Swiss Federal Council announced its intention to implement the project in stages.
Such a decision was confirmed on 11 March 2022.
Considering, on the one hand, that the minimum taxation envisaged by the OECD and the G20 results in a different tax treatment between companies affected and those not affected by the project, in breach of the constitutional principle of equal treatment, and considering, on the other hand, that these new rules must urgently enter into force as of 1 January 2024, the Federal Council proposed to amend the Federal Constitution and to be authorised to regulate the minimum tax by means of a temporary ordinance, which will be replaced by a federal law approved by the parliament as soon as there is sufficient clarity on the application of international standards.
On 22 June 2022, the Federal Council issued a Message concerning the Federal Decree on special taxation of large groups of companies, in which it specified the content of the project as follows.
Concerning Pillar One, the work at the OECD and G20 level is continuing. Given the necessity to agree upon a multilateral agreement, which will then have to be ratified by the participating states, the Federal Council will decide on its implementation at the due time.
Concerning Pillar Two, the Federal Council is of the opinion that many states, including those in the EU, will incorporate minimum taxation rules into their national laws. As a result, if a group of companies is not subject to this minimum tax in another state like Switzerland, these countries will be allowed to impose higher taxes on the group entities operating in their territory. Thus, if Switzerland does not introduce such a minimum tax, other states will charge the difference up to the 15 percent tax rate. This would have a significant impact on Switzerland's attractiveness as a business location, as MNEs based in higher tax countries will be exposed to increased administrative costs and tax burdens and will have less incentives to operate or invest in Switzerland.
The new minimum taxation rules will also directly impact most Swiss cantons, even those with statutory tax rates above 15 percent. In fact, cantonal special tax rules granting a reduced taxation of corporate profits deriving from a patent or similar rights (patent box), could result in an effective tax rate between 10 and 12 percent. This does not meet the minimum taxation level. In addition, taxable profits under Pillar Two are calculated according to common rules at the international level, which significantly differ from those existing in domestic tax laws of states, including Switzerland.
Switzerland cannot prevent MNEs operating on its territory from being subject to higher taxation in other states. However, with a view to protecting its economic and tax policy interests, it must adapt its tax system to the new reality, by ensuring that groups of companies based on its territory are subject to the minimum taxation level. Failure to implement the minimum taxation would result for Switzerland in a loss of competitiveness and in a significant reduction of tax revenues. In fact, MNEs operating in Switzerland would still be taxed, but the additional tax revenue would be collected by other countries.
On 16 December 2022, the Swiss Federal Parliament issued the Federal Decree concerning the special taxation of large group of companies to implement the OECD/G20 project. This decree provides for the introduction of a new Article 129a in the Federal Constitution, which is the basis for the implementation of both pillars of the OECD/G20 project in Swiss national law. It constitutes the foundations for the transitional provisions contained in paragraph 15 of Article 197 and the legal basis for the temporary ordinance on minimum taxation to be enacted by the Federal Council.
Regarding Pillar One, Switzerland will thus have the legal ground to introduce taxation in the market jurisdiction. However, neither the Federal Council nor the Federal Parliament have yet decided whether Switzerland will join a future international agreement and implement such taxation.
Regarding Pillar Two, Switzerland will be able to introduce the minimum tax starting from 2024. Such a minimum tax is conceived as a direct tax, but the Federal Constitution defers to the legislator the choice of structuring it as a federal or cantonal tax. Within the transitional provision, the Federal Council proposed the introduction of a federal tax.
On 18 June 2023, the Swiss people voted on the implementation of the OECD/G20 project and approved it with a majority of 78,45 percent.
In compliance with the OECD standards, the Federal Council can now proceed with the introduction of a top-up tax comprising the "Qualified Domestic Minimum Top-Up Tax", the IIR and the UTPR, according to the Pillar Two rules.
Despite the approval at large majority mentioned above, it is important to note that political debates preceding the vote mainly focused on the necessity for Switzerland not to lose its attractiveness, and on the correct allocation of the resulting additional tax revenue between the Confederation and the Cantons (25 and 75 percent, respectively). Little attention was indeed paid to the fact that these new rules are established at the international level and outside national parliaments, they are imposed through international political pressure, and undermine fair tax competition and the freedom of countries to democratically chose their own tax system.
To comply with the OECD standards, the wording of the newly approved Article 129a of the Federal Constitution allows the Federal legislator to enact legislative provisions which can also derogate several constitutional principles, which cannot be disregarded.
In particular, the Confederation is allowed to deviate from the principles of generality and uniformity of taxation, as well as from the principle of taxation according to economic capacity laid down in Article 127 paragraph 2 of the Federal Constitution. These principles are not merely constitutional provisions, but fundamental rights, which in tax matters implement the principle of equal treatment under Article 8 of the Federal Constitution.
The minimum threshold of EUR 750 million of total annual turnover, which delimits the scope of application of the minimum tax, and which is de facto intended to penalize specific MNEs from a tax perspective, subjects these latter to some additional taxation, which does not apply to other companies. This different treatment cannot be justified on the fact that the OECD/G20 Project provides for different taxation of groups of companies and their units depending on their turnover and profitability.
Furthermore, it is permitted to derogate from Article 128 paragraph 1 of the Federal Constitution, which sets the direct federal tax rate of corporate entities at a maximum of 8.5 percent. It is also allowed to deviate from the second sentence of Article 129 paragraph 2 of the Federal Constitution, which, in the context of the competence assigned to the Confederation regarding the harmonization of direct federal, cantonal and municipal taxes, expressly excludes from such harmonization tax rates and tax-exempt amounts. These are reserved matters of sovereignty of each canton and remain outside any interference of the Federal legislator.