Pillar Two: The Future of Incentives 

By Willem Oberholzer, Director, KISCH Tax Advisory

On 20 December 2021, the Organisation for Economic Co-operation and Development (OECD) released the Pillar Two?Model Rules?as approved by the OECD/G20 Inclusive Framework on Base Erosion and Profit Shifting (BEPS). These Rules set out the approach for a Global Minimum Tax at 15% for multinational enterprises (“MNEs”) with a turnover of more than €750 million.?There are not many South African headquartered MNEs to which the rules will apply, but the rules do potentially apply to locally resident subsidiaries of MNEs within scope, wherever headquartered (e.g.: local subsidiaries of non-resident headquartered MNEs) of which there are many. 

On 25 April 2024, the IF released a Consolidated Commentary (incorporating all Agreed Administrative Guidance released from March 2022 to December 2023). On 17 June 2024, the IF published the fourth set of Administrative Guidance on the Global Anti-Base Erosion (“GloBE”) Model Rules (Pillar Two), clarifying their operation and covering guidance on deferred tax liability recapture, divergence between GloBE and accounting carrying values, allocation of cross-border current and deferred taxes, allocation of profits and taxes involving flow-through entities and treatment of securitisation vehicles. On 10 July 2024, the?OECD published its invitation to comment on a draft User Guide for the?GloBE?Information Return XML Schema - a tool created to facilitate domestic?GIR?filings and a technical format for exchanging GIR information between administrations (the deadline to submit comments on this was 19 August 2024). The EU and several other jurisdictions introduced Pillar Two from 2024, while other countries and territories have indicated they will introduce Pillar Two from 2025. 

Over the years, environmental, social and governance (“ESG”) tax incentives have become a major tool used to encourage sustainable business activities. Pillar Two may greatly reduce the effectiveness of incentives when countries adopt the global 15% minimum effective tax rate rules (the benefit of tax incentives could be heavily diluted by a top-up tax should a tax incentive take a MNE’s effective tax rate below 15% in any jurisdiction). Pillar Two’s GloBE Rules provide for a coordinated system of taxation that intends to ensure that large MNE groups pay a minimum level of tax on the income arising in each of the jurisdictions in which they operate. To calculate this effective tax rate (“ETR”) figure, companies must report on approximately 200 data points for each country, and much of this is information not usually/easily available in financial reporting systems. 

This creates challenges for jurisdictions and MNEs that have relied on cash and tax incentives to catalyse their ESG goals. The impact of Pillar Two will, however, vary across companies, sectors and jurisdictions, with some companies reconsidering where they locate their business activity. 

With a local corporate income tax rate is 27%, one may think South African resident subsidiaries of foreign headquartered MNEs will fall outside of any additional tax charge (as SA’s ETR is already higher than 15%), but that does not take into account the various tax incentives/incentive regimes that may lower the ETR to below 15% e.g.: the Special Economic Zones, the R&D incentive and the oil and gas taxation regime. 

Some examples of tax incentives affected by the GloBE rules are:

• Economic/free trade zones; 
• Low/zero-tax rates; 
• Tax holidays; 
• Offshore tax regimes; 
• Immediate/accelerated depreciation of assets for tax purposes; 
• IP box regimes;
• Expenditure-based incentives e.g.: payroll withholding tax incentives;
• Rulings exempting income; and 
• Refundable and non-refundable income tax credits e.g.: R&D income tax credits.

Pillar Two allows companies to adjust for (temporary) timing differences when calculating their ETR, so incentives affecting the timing of taxes paid, for example, accelerated depreciation, should remain unchanged. 

In conclusion, the introduction of the Pillar Two Model Rules represents a significant shift towards ensuring that large multinational enterprises contribute a fair share of taxes to the jurisdictions in which they operate. This trend aligns with the growing global emphasis on corporate responsibility, not only in terms of environmental, social, and governance (ESG) criteria but also in tax compliance. The coordinated system of taxation under Pillar Two, with its global minimum tax of 15%, aims to reduce the effectiveness of tax incentives that lower effective tax rates below this threshold, ensuring that profits are taxed in the jurisdictions where economic activities take place. 

While the implementation of these rules presents challenges for companies and jurisdictions, particularly those that have traditionally relied on tax incentives to drive ESG goals, it ultimately brings the payment of taxes in line with the broader social responsibility expected of multinationals. As more countries adopt these measures, the global tax landscape will continue to evolve, reinforcing the idea that contributing fairly to the tax systems in which businesses operate is an integral part of their corporate duties. 

If you have any queries on the above or require any tax advice, please contact: 

Willem Oberholzer 
Director
KISCH Tax Advisory 
+ 27 83 326 0500
Willemo@kisch-ip.com