Kuwait takes bold step towards fairer global taxation
For years, the global tax system allowed multinational corporations to minimize their tax bills by shifting profits to countries with very low or no corporate taxes. This created an uneven playing field, making it harder for countries to fund public services and putting local businesses at a disadvantage. Pillar Two, developed by the OECD and agreed upon by over 160 countries, aims to change this.
What is Pillar Two, and who does it affect?
At its heart, Pillar Two introduces a global minimum corporate tax rate of 15%. This means that if an MNE operates in a country where its effective tax rate (the actual tax paid on its profits) falls below 15%, that company might have to pay, in its jurisdiction, an additional 'top-up tax' to bring its effective rate up to the minimum.
Crucially, this new rule is not for every business. It specifically targets large multinational enterprises. In Kuwait, as per Law 157/2024, the rules apply to MNEs with annual consolidated revenues of EUR 750 million or more (approximately KD 250 million) in at least two of the four preceding financial years. This threshold ensures that the focus remains on the biggest global players, leaving smaller local businesses unaffected. Certain entities, such as government bodies, non-profit organizations, and international organizations, are generally excluded from these rules.
The pillars of implementation:
How the top-up tax is collected
To achieve this 15 percent minimum tax, Pillar Two utilizes two main interlocking mechanisms:
1.Income Inclusion Rule (IIR): This is the primary mechanism. It essentially allows a parent company, usually the ultimate parent entity (UPE) of an MNE group, to impose a top-up tax on its low-taxed subsidiary located in another country. Think of it as the head office ensuring its branches around the world pay their fair share.
2.Undertaxed Profits Rule (UTPR): This acts as a backstop. If the IIR is not applied (for example, if the parent company's country has not implemented the IIR), the UTPR allows other countries where the MNE operates to deny deductions or impose an equivalent charge, effectively collecting the top-up tax that would otherwise have gone uncollected.
In addition to these international rules, many countries, including Kuwait, are also implementing a Qualified Domestic Minimum Top-up Tax (QDMTT). This allows Kuwait to collect any top-up tax due on the profits of MNE entities located within its borders, ensuring that the revenue stays in Kuwait rather than being collected by another jurisdiction under the IIR or UTPR.
Understanding the key numbers: GloBE income, covered taxes and effective tax rate
To figure out if an MNE owes top-up tax, we need to understand a few key concepts:
•GloBE Income or Loss: This is the starting point for calculating the MNE's profits in a particular country for Pillar Two purposes. It begins with the financial accounting net income or loss (FANIL) of the MNE's entities in that jurisdiction, and then undergoes specific adjustments outlined in the GloBE rules. These adjustments ensure a consistent and standardized measure of profit across different countries, regardless of their local accounting rules.
•Adjusted Covered Taxes: This refers to the taxes actually paid by an MNE in a particular country that are relevant for Pillar Two. It starts with the current and deferred tax expense as reported in the MNE's financial statements, and then specific adjustments are made. These adjustments are crucial to ensure that only the taxes directly related to the GloBE income are considered and that any temporary differences in tax recognition are properly accounted for.
•Effective Tax Rate (ETR): This is the most crucial calculation. For each country where an MNE operates, the ETR is determined by dividing the total Adjusted Covered Taxes by the total GloBE Income for that jurisdiction. If this calculated ETR falls below the 15 percent minimum rate, then a top-up tax will be due.
Calculating the top-up tax: Bridging the gap
Once the ETR for a jurisdiction is found to be below 15 percent, the 'top-up tax percentage' is calculated as the difference between the 15 percent minimum rate and the actual ETR. This percentage is then applied to the MNE's 'excess profits' in that jurisdiction. The GloBE rules also include a Substance-Based Income Exclusion (SBIE), which reduces the amount of profit subject to the top-up tax based on the MNE's tangible assets and payroll costs in that jurisdiction. This is designed to reward real economic activity and discourage purely artificial profit shifting. The final top-up tax amount is then determined, with any QDMTT collected by Kuwait reducing the amount that would otherwise be due under the IIR or UTPR.
What this means for Kuwait
The implementation of Pillar Two through Law 157/2024 and its executive regulations signifies Kuwait's commitment to international tax cooperation and fairness. For multinational enterprises operating in Kuwait, this means:
•Increased compliance: MNEs will need to gather and analyze significant amounts of financial data on a jurisdictional basis to comply with the new rules. This will require robust data management systems and close collaboration between tax, finance, and accounting departments.
•Potential for Higher Tax Bills: Companies that have historically paid very low effective tax rates in Kuwait or other jurisdictions may see an increase in their overall tax burden.
•Leveling the Playing Field: For local Kuwaiti businesses and smaller enterprises not subject to Pillar Two, this initiative helps to create a fairer competitive environment by ensuring large MNEs contribute their share.
•Enhanced Revenue for Kuwait: More importantly, by implementing a QDMTT, Kuwait ensures that any top-up tax generated from low-taxed profits within its borders is collected locally, contributing to the national economy and supporting public services.
This new tax era is a complex but necessary step towards a more equitable and stable global tax system. While the intricacies of Pillar Two can be challenging, Kuwait's proactive approach in implementing these rules demonstrates its commitment to responsible global citizenship and a more prosperous future for all.
Note: Hassan M Abdulrahim is a Senior Instructor (Business) at Canadian College Kuwait and CEO & Co-founder of Visionary Consulting Company
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The importance of GloBE income for Kuwait
Beyond the balance sheet: Cornerstone of global minimum tax calculation KUWAIT: Kuwait's financial landscape is evolving rapidly with the recent implementation of the BEPS Pillar Two initiative, as enshrined in Law 157/2024. While the headline figure of a 15 percent global minimum corporate tax rate often captures attention, the mechanics behind this calculation are equally important. At the very core of determining whether a large multinational enterprise (MNE) owes additional tax under these new rules is a concept called 'GloBE income or loss'. This is not simply the profit you see on a company's financial statements or its taxable income under local Kuwaiti tax laws. GloBE income or loss is a specially defined and adjusted measure, designed to create a consistent and comparable tax base across all jurisdictions where an MNE operates. Understanding this foundational concept is crucial for grasping how the Pillar Two system truly works. The starting point: Financial accounting net income or loss The journey to calculating GloBE income or loss begins with the familiar: the financial accounting net income or loss (FANIL) of each individual 'Constituent Entity', ie, a company or branch that is part of the MNE group, in a particular jurisdiction. This is the 'bottom-line' profit or loss figure that companies prepare for their consolidated financial statements, typically in accordance with recognized accounting standards like International Financial Reporting Standards (IFRS) or US Generally Accepted Accounting Principles (GAAP). This starting point makes sense because financial statements are already widely prepared by MNEs and provide a comprehensive view of their economic performance. However, different accounting standards and national tax laws can lead to significant variations in how profits are reported or taxed. This is where the necessary adjustments come in. 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While the details can be highly technical, we can group them into several common categories to understand their intent: Tax-related adjustments: • Net tax expense: A crucial adjustment is to exclude the income tax expense itself from the accounting profit. This is because we are calculating the effective tax rate, so we need to start with profit before taxes to correctly determine the tax burden. Non-income taxes, like property taxes or payroll taxes, are generally not adjusted out, as they are considered operating expenses. • Certain tax credits: Qualified refundable tax credits (QRTCs) – which are tax credits that are refundable in cash even if the company has no tax liability – are treated as income for GloBE purposes, not as a reduction in tax. This prevents them from artificially lowering the ETR. Non-refundable tax credits, however, are treated as a reduction in covered taxes. Exclusions for specific types of income or gain: • Excluded dividends: Dividends received from ownership interests, especially those where the MNE holds a significant stake, are generally excluded from GloBE Income. This prevents the same profits from being taxed multiple times as they flow up an MNE's ownership chain, ensuring that profits are taxed once at the operating entity level. • Excluded equity gains or losses: Gains or losses arising from the revaluation or disposal of certain equity investments, eg, holdings in other companies that are not part of the MNE group's core business, are often excluded. This aims to focus the GloBE calculation on the MNE's core operating profits. • Revaluation gains and losses: Gains or losses from the revaluation of property, plant, and equipment, if recognized in Other Comprehensive Income rather than the main profit and loss statement, are typically excluded unless they relate to certain types of financial instruments. Adjustments for policy reasons and distortions: • Illegal payments, fines and penalties: Expenses related to illegal payments, bribes, or fines and penalties that are not deductible for tax purposes in most jurisdictions are generally added back to profit for GloBE purposes. This ensures that a company cannot reduce its effective tax rate through illicit activities. • Asymmetric foreign currency gains/losses: Certain foreign exchange gains or losses that are treated differently for accounting and tax purposes, leading to asymmetric outcomes, are adjusted to ensure consistency. • Prior period errors and changes in accounting principles: Adjustments are made to ensure that the impact of correcting errors or changing accounting policies in the current year does not distort the GloBE Income of that specific year, especially if they relate to periods before Pillar Two applied. • Accrued pension expenses: Adjustments are made for certain pension-related expenses or income to align them with actual contributions or distributions. • Stock-based compensation: Differences in accounting and tax treatment of stock-based compensation can lead to adjustments. • Intra-group financing: Specific rules apply to inter-company financing arrangements to prevent artificial shifting of income or expenses. Allocation rules: Where does the income belong? Once the adjustments are made at the individual entity level, the GloBE rules also provide for specific allocation rules. For instance: • Permanent establishments (PEs): The income or loss of a PE, ie a fixed place of business in another country, like a branch, is generally considered to belong to the jurisdiction where the PE is located for GloBE purposes, reflecting its separate economic activity. • Flow-through entities: For entities that are transparent for tax purposes, meaning their income is taxed directly in the hands of their owners, eg partnerships, specific rules determine how their income or loss is allocated among the MNE group members. The importance of GloBE income for Kuwait For Kuwait and its implementation of Pillar Two, the precise calculation of GloBE Income or Loss for each Constituent Entity within our borders is paramount. When we talk about the qualified domestic minimum top-up tax (QDMTT) – Kuwait's strategic mechanism to collect its share of the top-up tax – the QDMTT relies directly on this GloBE Income figure. If an MNE's constituent entities in Kuwait collectively have a positive GloBE Income, but their effective tax rate (ETR), GloBE Income divided by Adjusted Covered Taxes, falls below 15 percent, then a top-up tax will be triggered. This top-up tax is calculated on the 'excess profit' which is directly derived from the GloBE Income, after accounting for a 'substance-based income exclusion (SBIE)', which allows for a routine return on tangible assets and payroll. ETR, top-up tax, excess profit and SBIE are the subject matter of our next articles, so please stay tuned! Challenges and preparations for MNEs in Kuwait For MNEs operating in Kuwait, preparing for GloBE Income calculations presents significant challenges: • Data granularity: Companies need to collect and analyze financial data at a highly granular, entity-by-entity and jurisdictional level – often far more detailed than their current tax or even accounting systems might readily provide. • System readiness: Existing accounting and enterprise resource planning (ERP) systems may not be configured to automatically generate GloBE-compliant income figures, necessitating significant system upgrades or manual adjustments. • Expertise: Understanding and correctly applying the numerous GloBE adjustments requires specialized tax and accounting expertise. A new era of profit measurement The concept of GloBE Income or Loss is a cornerstone of the global minimum tax framework. It represents a shift from diverse national tax bases to a standardized, internationally agreed-upon measure of profit, specifically designed to identify and tax undertaxed income. For Kuwait, mastering the intricacies of GloBE Income calculation is not just about compliance; it is about effectively leveraging the Pillar Two rules to secure our fair share of global corporate profits, ensuring a more stable and prosperous economic future for our nation. As companies adapt, the precision in defining and measuring this 'GloBE Income' will be fundamental to the success of this transformative tax reform. NOTE: Hassan M Abdulrahim is a Senior Instructor (Business) at Canadian College Kuwait and CEO & Co-founder of Visionary Consulting Company
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