Peter Varga on the so-called. the top-up tax

In recent years, the EU has adopted a number of legislative provisions to combat illegitimate tax optimisation in cross-border business activities. A number of them, including this proposal, come from the OECD, which has been very active on this issue. This proposal on the so-called. The countervailing tax, as well as many of the legislative changes already in place, can be simplistically characterised as aiming to shift the taxation of profits to the countries in which those profits are generated. Often these profits have been, and still are to some extent, shifted to countries with lower tax burdens, with the result that tax revenues and the overall fairness of competition suffer. We took a closer look at this topic with Peter Varga.

1/ The Ministry of Finance of the Slovak Republic submitted for inter-ministerial comment procedure, which started on 3. 8. 2023 A draft law on a top-up tax to ensure a minimum level of taxation for multinational enterprise groups and large domestic groups. What do you think of this news, which follows on from the EU’s activities?

Peter Varga: This proposal for a global minimum tax represents a continuing effort to eliminate the tax practices of multinational corporations, through which they shift profits to jurisdictions where they are subject to no or very low taxation. It is the minimum tax that is intended to discourage multinationals in this endeavour and thus level the overall playing field. There are well-known cases of large technology giants who, thanks to the openness of countries such as the Netherlands or Ireland, are able to tax their profits from countries such as Slovakia at minimum rates. This puts them at a possibly unfair competitive advantage economically. Any competitor of such companies that does not have the infrastructure to shift profits to more favourable jurisdictions is thus at an economic disadvantage. This is because it has to tax its profits even if it wants to reinvest them, thus reducing its investment potential and putting it at a disadvantage against companies that effectively (abusively) exploit different tax regimes in different countries.

And so from the point of view of the idea and the vision, it seems like a sensible step. I am concerned, however, whether it will be too much of an administrative burden for the companies and groups concerned to comply with the requirements of this legislation. For example, the relatively recently adopted EU DAC Directive 6, which pursues a similar objective, often poses a perhaps disproportionately high administrative and interpretative challenge for those concerned. A number of affected entities are addressing this challenge by ignoring this legislation. Certainly, Slovakia itself, which is most responsible for the concrete implementation in practice, will have a say in this potential for simple implementation and unambiguous interpretation. It is therefore to be hoped that the actual implementation in the individual Member States will be easier and that those concerned will be able to set up their procedural procedures with relative agility.

2/ In practice, various items not included in the calculation of the tax base or various tax reliefs are also a problem. Does this mean that realistically these items would already be taxed, or how can this be understood? Please clarify.

Peter Varga: Exactly. At EU level, there is currently no harmonisation of tax bases for income taxation as we know it for VAT. As Member States have not conferred this competence on the EU in primary law, the issue of direct taxation is therefore a matter for Member States to legislate on. There are, of course, exceptions where EU law takes precedence over national law on direct taxes, but these exceptions relate primarily to fundamental economic freedoms, in particular the freedom of establishment. Thus, in the absence of greater harmonisation in the area of income tax to date, this Directive must also address the issue of harmonisation of effective tax rate calculations. Thus, it cannot be calculated simply by taking the tax liability of the entity concerned and comparing it with the revenue or taxable income under local rules. For this purpose, a relatively complex procedure for calculating a harmonised base and a harmonised effective tax rate needs to be applied.

For example, for the calculation of the effective tax rate, the Directive differentiates between dividends from the so-called portfolio investments and other dividends. On the basis of this differentiation, the effective tax rate calculated on the basis of Slovak regulations is modified. Slovak tax regulations do not distinguish between dividends in this context. And there are many such examples. As a result, the effective tax rate determined under the Directive does not necessarily even approach the effective tax rate calculated under Slovak regulations. Since the harmonisation modifications are relatively complex and the Directive is to be followed by local Slovak legislation, it would certainly be beneficial to the Slovak addressees of these changes if the law implementing the Directive was adopted as soon as possible and was in the required interpretable form.

3/ Only large entities belonging to multinational groups or large national groups are likely to be realistically affected by the top-up tax. Try to be more specific about what companies are involved, who will be realistically affected, and what level of tax rate will the entities be taxed at compared to current market conditions?

Peter Varga: It doesn’t necessarily have to be only multinational entities. The legislation also affects companies from the so-called. a “large-scale domestic group”, where all the companies are located in one EU Member State. The ultimate real impact on the taxation of the group is difficult to predict from this position as it depends on a number of individual circumstances such as the set-up of the structure, the income and cost structure or the tax incentives in place and so on.

4/ This is a very specific tax affecting very few entities. Since the consolidated turnover of EUR 750 million was set for all EU Member States, the turnover set in this way is obviously very high for Slovakia. How do you see it realistically? Will any company operating domestically ever achieve such a turnaround?

Peter Varga: We have several dozen companies in Slovakia that individually have revenues exceeding EUR 750 million. If we add to this the Slovak companies whose group revenues reach this level, we certainly get an interesting number of companies that are to some extent affected by this regulation. The extent to which this is the case depends mainly on the position of these companies in the groups or the level of taxation and jurisdiction of the individual companies in a particular group. Some complexity is added by the fact that Slovak companies can also tax their profits at an effective rate lower than 15% under Slovak law (without taking into account the aforementioned harmonisation modifications), which also has an impact on the obligations under this legislation. So the extent of the impact of this legislation on Slovak businesses is probably not fully graspable at this point.

5/ What do you foresee the impact of this legislative innovation on the market – specifically on business, the state budget, etc.? What benefits or risks do you see there? Is it not just a formal tax, the terms of which do not really translate into practice?

Peter Varga: I believe that the main motive of this regulation is not necessarily to increase tax revenues for individual Member States, but to achieve a greater degree of fairness in taxation. It is the large foreign conglomerates that have the means and flexibility to arrange their tax affairs in a way that can reduce the effective taxation of corporate profits in the so called “onshore” jurisdictions to single digits, in some cases even approaching zero. However, only practice will tell what the real impact will be.

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