An overview of the OECD’s Base Erosion and Profit Shifting 2.0 Pillar Two blueprint

Jonathan Culver

OECD releases BEPS 2.0 Pillar Two blueprint on the implementation of the global minimum level of tax and invites public comments

On 12 October 2020, the Organization for Economic Cooperation and Development (OECD)/G20 Inclusive Framework on Base Erosion and Profit Shifting released two detailed “blueprints” in relation to its ongoing work to address the tax challenges arising from the digitalization of the economy. The OECD welcomes comments on the proposals by 14 December 2020, and will hold a virtual public consultation meeting in mid-January 2021.

This article considers the Pillar Two blueprint, proposing a set of interlocking international tax rules designed to ensure that large multinational businesses pay a minimum level of tax on all profits in all jurisdictions, and focuses on Hong Kong implications and policy responses to the blueprint. The blueprint includes the following key elements:

  • The Global Anti-Base Erosion income inclusion rule and the undertaxed payments rule: Connected rules that are intended to ensure large multinational groups pay tax at a minimum level in each jurisdiction in which they operate. These share common rules for scope, and for calculating effective tax rates (ETRs) and top-up amounts. Both rules only apply to multinational groups with consolidated global revenues of at least €750 million.

–  The principal rule is the income inclusion rule (IIR),  which would trigger additional “top-up tax” payable in a group’s parent company jurisdiction where the profits of group companies in any one jurisdiction are taxed at an ETR below a minimum. A switch-over rule would apply similarly to ensure branches are within scope.

–  An undertaxed payments rule (UTPR) acts as a backstop for low-taxed group companies not controlled by a parent company subject to the IIR.

  • The subject to tax rule (STTR): A separate rule that applies before the IIR and UTPR. Paying (source) jurisdictions would be able to charge a top-up tax in respect of specific types of intragroup payments made to other group companies, where the recipient jurisdiction has a nominal tax rate less than a minimum tax rate. The rule would be applied on a payment-by-payment basis, but could be calculated and administered by way of an annual return.

Implications of the GloBE rules for Hong Kong taxpayers

Groups with jurisdictional ETRs below the minimum

The Global Anti-Base Erosion (GloBE) rules would only apply where jurisdictional ETR falls below a certain minimum ETR at which point the IIR or UTPR would apply. Consensus has not been reached on the minimum ETR. However, examples in the blueprint use various tax rates between 10 percent and 12.5 percent. While these rates are lower than Hong Kong’s headline tax rate of 16.5 percent, the presence of offshore claims or exempt capital disposals and other adjustments may decrease a group’s ETR below the minimum.

Groups below the minimum ETR may be subject to top-up tax and may not be able to benefit from certain favourable aspects of Hong Kong’s tax system such as exemptions, reliefs and incentives.

Inbound versus Hong Kong headquartered groups

Under the proposed rules, there would be a difference between groups that are inbound into Hong Kong and those that are headquartered in Hong Kong. Generally, where a group that is headquartered outside Hong Kong has implemented an IIR, the Hong Kong based operation would be subject to an IIR, such that top-up tax may be collected in respect of Hong Kong entities.

However, absent a change in domestic law, the Hong Kong operation of a Hong Kong headquartered group would not be subject to the IIR of any jurisdiction, while the part of the group that operates outside Hong Kong may be subject to top-up tax from another jurisdiction’s IIR. In this instance, UTPR may be applied elsewhere in the group in respect of certain intragroup payments, and top-up tax may be paid in respect of the Hong Kong headquartered operation by those jurisdictions that have an ETR above the GloBE minimum and are therefore eligible to collect top-up tax under the UTPR.

As a result of limitations on the tax that can be collected under the UTPR, where intragroup payments are relatively low, groups may pay less tax overall through the application of the UTPR as compared to the IIR.

U.S. headquartered groups

While consensus has not been reached on treating the United States Global Intangible Low-Taxed Income (GILTI) regime as a valid IIR for the purposes of the GloBE rules, the blueprint specifically addresses the need to consider this issue further and outlines the rationale for treating GILTI as an IIR. If GILTI were to be treated as an IIR, this would effectively create a new category of taxpayers under GloBE – those with an ultimate, or in certain cases, intermediate, U.S. headquarters. While GILTI has certain similarities to the IIR proposed under GloBE, it also has significant differences, which may complicate jurisdictions’ policy responses to GloBE.


The Pillar Two blueprint specifically excludes investment funds on broad policy grounds. The exclusion applies where the ultimate parent entity of a group that would be subject to GloBE qualifies as an investment fund. Currently, investment funds owned by a group that undertakes a non-investment management business are not covered by the exclusion, however the consultation document will explore further whether this is necessary, and how the exclusion could be broadened to cover these scenarios.

There is significant overlap between the investment funds exclusion under the blueprint and the unified fund exemption under Hong Kong tax law. While each fund and its subsidiary entities would need to be considered on a case-by-case basis, a significant population of funds that are incorporated, established, or administered in or from Hong Kong should be excluded from these rules. Importantly, offshore funds that are exempt under section 20AC of the Inland Revenue Ordinance, and do not qualify under the unified funds exemption, may not fall within the Pillar Two blueprint exemption based on the current definition of “investment fund.”

Banks, broker dealers, and other share traders 

Dividends received, and share trading gains and losses in respect of portfolio shareholdings would be included in the GloBE tax base of the recipient, whereas amounts in respect of non-portfolio shareholdings would not. The treatment of covered taxes would follow the inclusion or exclusion of income in order to provide symmetry. The conditions or thresholds to be met for a shareholding to be considered a portfolio holding are to be determined. However, portfolio shareholdings typically are shareholdings of a relatively low percentage, often less than 10 percent of the total ordinary shares issued.

Hong Kong does not tax dividends, or share trading gains in respect of transactions executed on an exchange outside of Hong Kong. Accordingly, groups engaged in share trading are likely to have relatively low ETRs, particularly where share trading represents one of their main activities and therefore may be significantly affected by GloBE.

Helpfully, covered taxes would be taken into account, and it appears that taxes in excess of the minimum ETR may be blended with those below the minimum ETR in order to reduce the top-up tax that an entity may be required to pay. Anti-avoidance rules would be introduced to prevent the intentional shifting of withholding tax to a jurisdiction in order to increase its ETR and thus reduce the amount of top-up tax payable. However, the focus of these rules is likely to be passive income and therefore commercial trading portfolio aggregation may be acceptable.

Life insurance companies

Several considerations are unique to insurance companies. Firstly, life insurance companies, particularly those taxed under the 5 percent net premium basis, are taxed in a manner that is entirely disconnected from the accounts. Applying the IIR or UTPR based on a minimum ETR in this instance could effectively change the basis of taxation for these insurance companies, and would likely lead to a significant increase in taxation. This will be further complicated by the implementation of International Financial Reporting Standard 17 Insurance Contracts.

The Pillar Two blueprint provides an exclusion for investment returns of life insurance policyholders where the policyholder is beneficially entitled to the investment return. However, for most investment-linked products written by life insurance companies in Hong Kong, the life insurer remains beneficially entitled to this income until it is paid to a policyholder. Accordingly, this exclusion would need to be broadened significantly in order to be useful.

Implications of the STTR for Hong Kong

The STTR would operate differently to the GloBE rules and reference a nominal minimum tax rate instead of a minimum ETR. The focus of the STTR is not on considering the jurisdictional ETR of the recipient, but on whether an individual payment would be subject to a minimum rate of tax under the tax law of the relevant jurisdiction.

Where a payment is not subject to a minimum nominal tax rate and a jurisdiction has ceded its taxing rights through a treaty, top-up tax may be applied in order to increase the applicable tax rate up to the minimum. The minimum nominal tax rate is yet to be determined, although it is likely to be below the minimum ETR used for the purposes of GloBE in order to reduce instances of over-taxation.

The STTR would apply before the GloBE rules and would be limited to certain payments between related parties.

The STTR could have significant implications for Hong Kong and due to its application to payments, could apply even where a group has a high jurisdictional ETR for purposes of the GloBE. Offshore claims and the use of incentives applying to related party payments such as the corporate treasury centre may be particularly affected.

Hong Kong policy response to Pillar Two

Groups with a Hong Kong jurisdictional ETR lower than the minimum are likely to be subject to top-up tax in respect of their Hong Kong operations, representing an overall increase in taxation for the group.

This is problematic for Hong Kong as its attractiveness may be eroded by the additional tax burden, particularly as the additional revenue would not be collected in Hong Kong, but by another jurisdiction. This additional tax burden may be interpreted as penalizing groups for operating in Hong Kong. Some may question the fairness of such a rule as limiting the fiscal policy options available to Hong Kong, which is a highly developed and fiscally responsible economy operating a low, yet robust, tax regime.

Given that top-up tax in respect of Hong Kong based operations likely would be collected by the tax authorities of other jurisdictions, Hong Kong may wish to consider introducing rules that would ensure that any such top-up tax must be paid in Hong Kong. Such rules could be tailored to align with the GloBE and STTR rules precisely so as to minimize the impact to groups that would not be affected by those rules. This should allow the jurisdictional ETR of the relevant multinational group to be raised to the minimum ETR through the payment of tax within Hong Kong. The additional revenue could then be used to further incentivize investment into Hong Kong.

As discussed above, Hong Kong headquartered groups would be affected differently than inbound multinationals. They could be subject to the UTPR, but should not be subject to the IIR of another jurisdiction. Accordingly, they may prefer not to pay a minimum tax in Hong Kong that is modelled on the GloBE and STTR. Consideration should be given to the policy approach towards these groups and whether differing rules are desirable in the context of fairness, harmful tax practices, revenue collection, and the general attractiveness of Hong Kong.

Overall, Hong Kong’s ability to pursue certain fiscal policy aims may be curtailed by Pillar Two and Hong Kong will need to be mindful of the implications of Pillar Two when making policy decisions. Beyond attempting to retain and improve existing fiscal policy measures, it may be necessary to adopt a more nuanced policy approach in the future, recognizing the importance of a group’s position under Pillar Two, and in particular its marginal tax rate, when making investment or rationalization decisions.

The article is contributed by Jonathan Culver, Tax Partner, Deloitte China

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