Kuwait's pursuit of fair global taxation

Kuwait Times

4 days ago

Kuwait's recent implementation of the BEPS Pillar Two framework, through Law 157/2024 and its executive regulations, has introduced a new paradigm for the taxation of large multinational enterprises (MNEs). We have explored the foundational elements: understanding 'GloBE Income or Loss' as the standardized profit base and 'Adjusted Covered Taxes' as the relevant tax burden. Now, we arrive at the pivotal moment where these two concepts converge to determine if an MNE owes additional tax - the calculation of the Effective Tax Rate (ETR) and, if needed, the top-up tax. This article will demystify these crucial computations, showing how the 15 percent global minimum tax is enforced and how Kuwait strategically ensures that any top-up tax arising from economic activities within its borders directly benefits the nation through its Qualified Domestic Minimum Top-up Tax (QDMTT).
Step 1: The jurisdictional blending approach - A collective view
Unlike traditional tax systems that often look at individual companies, Pillar Two takes a jurisdictional blending approach. This means that for each country where an MNE group operates, e.g., Kuwait, the GloBE income or loss and the adjusted covered taxes of all constituent entities of that MNE group located in that specific jurisdiction are aggregated.
Why aggregate? Because the goal is to determine if the MNE's overall operations in a given country are effectively taxed below 15 percent. Aggregating allows for an average to be taken across all the group's entities in that location, preventing MNEs from manipulating the effective rate by having some high-taxed and some low-taxed entities in the same country. So, for Kuwait, an MNE group will first sum up the GloBE Income of all its entities based here, and then sum up their Adjusted Covered Taxes.
Step 2: The core formula - Calculating the Effective Tax Rate (ETR)
Once we have the aggregated GloBE income and adjusted covered taxes for a particular jurisdiction, the calculation of the Effective Tax Rate (ETR) is straightforward: Jurisdictional ETR = aggregated adjusted covered taxes for the jurisdiction aggregated GloBE income for the jurisdiction.
For example, if an MNE's constituent entities in Kuwait have an aggregated GloBE income of KD 100 million and have paid KD 10 million in adjusted covered taxes, their jurisdictional ETR would be: KD 10 million = 10 percent KD 100 million.
This 10 percent ETR is now compared against the 15 percent global minimum tax rate. But, what if the ETR is a loss or zero GloBE income?
Special rules apply if the aggregated GloBE income for a jurisdiction is a loss or zero. In such cases, if the adjusted covered taxes are positive, the ETR calculation would result in an undefined or negative rate. The GloBE rules generally treat the ETR as being below 15 percent in such scenarios, which means a top-up tax could still be triggered, but specific computations would apply to ensure fairness. The key is that the absence of taxable profit does not automatically mean immunity from the Pillar Two rules if taxes have been significantly reduced.
Step 3: Determining the top-up tax percentage - The shortfall
If the calculated jurisdictional ETR is less than 15 percent, then a 'top-up tax percentage' is determined. This simply represents the difference between the 15 percent minimum rate and the MNE's actual ETR in that jurisdiction. Top-up tax percentage = 15 percent (minimum rate). Jurisdictional ETR now, using our example where the ETR for Kuwait was 10 percent:
Top-up tax percentage = 15 percent? 10 percent = 5 percent
This 5 percent is the additional rate of tax that needs to be levied to bring the overall effective tax rate up to the 15 percent minimum.
Step 4: Calculating 'excess profit' with the substance-based income exclusion (SBIE)
Before applying the top-up tax percentage, the GloBE rules introduce a crucial element, that is the substance-based income exclusion (SBIE). This is a vital policy carve-out designed to ensure that Pillar Two taxes only 'excess profits' - those profits that are not directly attributable to real economic activities, like having employees or physical assets, in a jurisdiction. It aims to reward MNEs for genuine investment and discourage purely artificial profit shifting. The SBIE is calculated as a fixed return, i.e. a percentage, on the MNE's:
Eligible payroll costs
The payroll expenses of eligible employees performing substantive activities in the jurisdiction.
Eligible tangible assets: The carrying value of tangible assets, like property, plant, and equipment, located in the jurisdiction and used in the MNE's business. For a transitional period, starting at 9.6 percent for payroll and 7.6 percent for tangible assets, phasing down to 5 percent over ten years, a portion of income derived from these substantive activities is excluded from the profits subject to top-up tax. SBIE = (payroll carve-out percent x eligible payroll costs) + (tangible assets carve-out percent x eligible tangible assets)
The 'excess profit' for a jurisdiction is then calculated as: excess profit = aggregated GloBE income. SBIE If the GloBE income is less than or equal to the SBIE, then the excess profit is considered zero, and no top-up tax would be due even if the ETR is below 15 percent.
This is a crucial simplification for MNEs with substantial physical presence and employees.
Step 5: Computing the gross top-up tax
Now, the top-up tax percentage is applied to the excess profit to arrive at the gross top-up tax for the jurisdiction: Gross top-up tax = top-up tax percentage x excess profit. Let's continue our example: If the Aggregated GloBE income was KD 100 million, and assuming a SBIE of KD 20 million, then: excess profit = KD 100 million. KD 20 million = KD 80 million and the gross top-up tax would be: Gross top-up tax = 5 percent x KD 80 million = KD 4 million. This KD 4 million is the total top-up tax that needs to be collected to bring the MNE's effective tax rate in Kuwait up to 15 percent.
Step 6: Reducing the top-up tax with Kuwait's QDMTT
This is where Kuwait's strategic decision to implement a qualified domestic minimum top-up tax (QDMTT) becomes immensely beneficial. As discussed, the QDMTT ensures that any top-up tax calculated for MNE entities located in Kuwait is paid directly to the Kuwaiti tax authorities. The final top-up tax amount that would be allocated to other jurisdictions, under the IIR or UTPR, is reduced by the amount of QDMTT paid in Kuwait. Allocable top-up tax (to other jurisdictions) = gross top-up tax?
QDMTT paid in Kuwait
If Kuwait collects the full KD 4 million under its QDMTT, then there would be no remaining top-up tax for other countries to collect from this MNE's Kuwaiti operations. This guarantees that the revenue stays within our national borders. Importance for MNEs in Kuwait: For multinational enterprises operating in Kuwait, understanding these computations is not merely an academic exercise. It directly impacts their future tax liabilities and compliance requirements. They will need:
Robust data systems: To accurately track and report GloBE income and adjusted covered taxes for all their Kuwaiti entities.
Scenario planning: To model the potential impact of Pillar Two on their effective tax rates and overall tax burden in Kuwait.
Expert guidance: To navigate the complexities of these calculations and ensure compliance with Law 157/2024 and its executive regulations.
A fairer share for Kuwait
The calculation of the effective tax rate and the resulting top-up tax is the operational core of Pillar Two. By establishing a clear, step-by-step process, the GloBE Rules ensure transparency and consistency in determining if an MNE is paying its fair share. For Kuwait, the meticulous design of its QDMTT means that our nation is not just a participant in this global tax reform, but an active beneficiary. By capturing the top-up tax arising from economic activity within its jurisdiction, Kuwait secures vital revenue, fosters a more equitable business environment, and reinforces its commitment to modern, fair international taxation. This intricate dance of numbers ultimately leads to a stronger, more prosperous future for all in Kuwait.
NOTE: Hassan M Abdulrahim is a Senior Instructor (Business) at Canadian College Kuwait and CEO & Co-founder of Visionary Consulting Company