The importance of GloBE income for Kuwait

Kuwait Times

2 days ago

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.
Why adjustments are essential: Bridging the gaps
If the GloBE Rules simply used accounting profit, they would not achieve their goal of a consistent global minimum tax. Accounting rules are designed for financial reporting to investors and stakeholders, not primarily for tax purposes. Similarly, domestic tax laws are shaped by national economic and social policies, leading to deductions, exemptions, and timing differences that vary widely from country to country.
The purpose of GloBE adjustments is to neutralize these differences, ensuring that the 15 percent minimum tax is applied to a uniform and comparable profit base worldwide. Think of it as creating a common language for profit that all countries can understand and apply for Pillar Two purposes.
Key adjustments: What gets added back or taken out?
The GloBE Rules specify a comprehensive list of adjustments to the financial accounting net income or loss. 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