Background: The global push for tax reform
Over the past few decades, the global economy has undergone substantial transformations. As businesses transcend borders and digital economies flourish, traditional tax systems have struggled to keep pace. These challenges have raised concerns about BEPS and the overall fairness of the international tax framework. In response, the OECD/G20 Inclusive Framework laid out a two-pillar approach to address the mismatches in tax rules that enable profits to be shifted to low- or no-tax jurisdiction. Pillar One focuses on reallocating taxing rights to ensure that countries can tax profits generated by MNEs within their borders. Pillar Two introduces the concept of a GMT to ensure that MNEs pay a minimum effective tax rate (ETR) of 15% in each jurisdiction that they operate. To achieve this, the OECD prepared the Global Anti-Base Erosion (GloBE) model rules to be adopted into domestic law by over 135 countries, including Canada.
Enacted in June this year, the GMTA incorporates the GloBE model rules into Canadian domestic law. The GMTA rules generally apply to fiscal years beginning on or after Dec. 31, 2023, with the first returns and potential taxes due as early as June 30, 2026.
When does GMTA apply?
The GMTA generally applies to qualifying MNE groups that meet the following conditions:
- The revenue reported in the consolidated financial statements of the ultimate parent entity (UPE) of the MNE group is not less than €750m in at least two of the four fiscal years immediately preceding the relevant fiscal year. For shorter fiscal years (less than 365 days), the revenue threshold is prorated based on the number of days.
- There is at least one constituent entity (being an entity or permanent establishment) located in Canada, in addition to a foreign country.
- The group is not composed entirely of excluded entities (such as non-profit organizations, pension funds, UPEs that are real estate investment vehicles or investment funds, amongst others).
For the purposes of the GMTA, a group generally refers to an UPE along with entities included in its consolidated financial statements, or an entity not part of a consolidated group that has at least one PE in a different jurisdiction than where it is located. Furthermore, an entity includes a corporation, partnership, trust, association or organization, among others. An MNE group is defined as a group with at least one entity or PE located in a different jurisdiction than the UPE.
Top-up tax imposed
The GMT was designed to ensure certain large MNE groups pay ETR of 15% on income in every country they do business. Consequently, qualifying MNE groups that meet the above conditions are required to compute their ETR in each jurisdiction where they have an entity or PE. If the ETR for a particular jurisdiction is below 15%, a top-up tax will be imposed to raise that ETR to 15%. This top-up tax may be reduced by a substance-based income exclusion, which is calculated based on the payroll costs and net book value of tangible assets located in the jurisdiction. The GMTA is effectuated using the following taxing mechanisms:
- Qualified Domestic Minimum Top-up Tax (QDMTT): The QDMTT applies before the Income Inclusion Rule (IIR) and Undertaxed Payments Rule (UTPR). Under QDMTT, the top-up tax is collected from constituent entities in the low-tax jurisdiction where they are located if their ETR falls below 15%, rather than allowing foreign countries to collect this tax under the IIR or UTPR.
- Income Inclusion Rule (IIR): The IIR is the primary rule for charging tax. Under IIR, a top-up tax is imposed at the level of the UPE or intermediate parent entity (IPE) for low-taxed constituent entities. The UPE (or IPE) of the MNE group is required to collect the top-up tax of foreign entities and PEs in jurisdictions that have an ETR of less than 15%, and a QDMTT does not apply.
- Undertaxed Payments Rule (UTPR): The draft legislation released on Aug. 12, 2024 incorporates the UTPR, which acts as a backstop to the IIR and applies where no QDMTT or IIR is imposed. Under UTPR, top-up tax is allocated to countries with entities based on tangible assets and employees in those countries. The top-up tax is imposed by limiting or denying tax deductions or imposing additional taxes on payments made to related entities in jurisdictions with a tax rate below the minimum threshold of 15%.
Safe harbour rules
The GMTA includes specific safe harbour provisions designed to offer temporary or permanent relief under certain conditions. When a safe harbour rule applies, an election must be made as part of the annual GloBE information returns (GIR). The available safe harbours under the GMT rules are as follows:
- Permanent QDMTT: The QDMTT safe harbour applies to a specific entity within an MNE group that operates in a jurisdiction with an approved QDMTT in place, provided a valid election is filed. Consequently, the top-up tax is deemed to be zero for that entity. When applicable, the QDMTT safe harbour eliminates the need for an MNE group to undertake a second calculation of top-up tax under the Pillar Two rules.
- Permanent simplified calculations: This safe harbour applies to an MNE group’s non-material constituent entity (NMCEs) within a particular jurisdiction, as long as specific conditions are met and a valid election is filed. Typically, this safe harbour also considers the top-up tax to be zero for the NMCE. An NMCE generally refers to an entity excluded from the UPE’s consolidated financial statements solely due to its size or materiality.
- Transitional Country-by-Country reporting: These safe harbours are applied on a jurisdiction-by-jurisdiction basis utilizing the group’s Country-by-Country report. Where the specific requirements and tests are satisfied and a valid election is filed, this temporary provision simplifies the reporting requirements and generally reduces the top-up amount to zero. This relief is available only for fiscal years beginning before Jan. 1, 2027, and ending before July 1, 2028.
- Transitional UTPR safe harbour: The draft legislation proposed transitional UTPR safe harbour rule for fiscal years that begin on or after Dec. 31, 2024. The proposed rule deems the top-up amount of each constituent entity of the MNE group to be nil for the purpose of computing the total UTPR top-up amount if certain conditions are satisfied.
Additionally, eligible MNE groups that are in the "initial phase of international activity" may be exempt from Canada’s QDMTT for up to five years under the GMT rules, provided certain conditions are met and no foreign IIR applies. The draft legislation also proposed similar rules for UTPR deeming the tax to be nil.
Filing obligations
The OECD has developed a standardized GIR that contains certain information on the MNE group. The GIR can be filed by the UPE of an MNE group (or another designated filing entity chosen by the group) on behalf of the group.
If the UPE (or designated filing entity) files the GIR in the foreign jurisdiction where it is located, and that jurisdiction has a qualifying competent authority agreement with Canada (which provides for the automatic exchange of these returns), the GIR does not need to be filed in Canada. However, in such a case, each entity of the MNE group located in Canada must notify the Canada Revenue Agency (CRA) of the identity and jurisdiction of the filing entity. On the other hand, if the UPE or designated filing entity is located in Canada, or if there is no qualifying competent authority agreement with the relevant foreign jurisdiction, the return must be filed in Canada within 15 months of the end of the relevant fiscal year. For the first year in which the MNE group is subject to the GMTA, the return must be filed within 18 months.
Furthermore, an entity that is liable to pay tax in Canada under the IIR or QDMTT provisions is also required to file a separate return, which has the same due date as the GIR. Similar to the GIR, where more than one entity is required to file a QDMTT or IIR return, the group can designate one such entity to file the respective return, provided they are resident in Canada. The draft legislation also proposes similar return filing requirements for UTPR rules.
Penalties
Significant penalties may arise if an MNE group fails to comply with Canada’s GMT rules, as outlined below. However, transitional penalty relief may be available in certain circumstances.
- Failure to file or late filing of GIR: A penalty of $25,000 per month for each complete month the GIR is late from the due date to the day on which the GIR is filed or the notification is made, up to a maximum of 40 months (i.e., $1,000,000). This penalty can also be applied where the GIR is insufficiently completed or for failure to notify the CRA of a foreign GIR filing. Each entity in the MNE group located in Canada is jointly and severally liable for any penalties.
- Late filing of IIR or QDMTT return: A penalty of 5% of the unpaid tax (that was payable when the return was due) plus 1% of that unpaid tax multiplied by the number of complete months (up to 12 months) for which the return remains outstanding (with a maximum penalty of 17% of the unpaid balance).
Additional penalties may apply for repeated failure to file, false omissions, or failing to comply or provide the required information after receiving a notice. The CRA may also apply general anti-avoidance rule (GAAR) to “abusive” transactions undertaken to avoid the GMT.
Take action now!
Small businesses that are part of qualifying MNE fall within the GMTA’s scope. Businesses need to analyze the potential impact of the GMTA and consider the requirements of the new legislation. Additionally, affected businesses will need to gather extensive data on each of their country of operation to perform complex calculations. MNE groups should take action now, as compliance complexity and data collection may pose challenges for small businesses.
