Canada, as a member of the OECD/G20 Inclusive Framework on BEPS, has
committed to implementing pillar 2. This includes the implementation of a
15 percent global minimum tax for large multinational enterprises
(MNEs) that is based on the global anti-base erosion (GloBE) model
rules, which were adopted by the OECD/G20 Inclusive Framework on BEPS on
December 14, 2021.
The 2023 federal budget did not include any details on the manner in
which pillar 2 will be adopted into Canadian law. Rather, the budget
merely reiterated Canada’s plans to introduce—using a phased
approach—the global minimum tax in line with (1) the GloBE model rules,
(2) the commentary to the rules, and (3) the agreed-upon administrative
guidance. In particular, the budget announced that two primary elements
of the GloBE model rules—namely, the income inclusion rule (IIR) and a
domestic minimum top-up tax—would be introduced later in 2023, with
effect for taxation years beginning on or after December 31, 2023; and
that the undertaxed profits rule (UTPR), which will serve as a backstop,
should follow in 2024, with effect for taxation years beginning on or
after December 31, 2024.
The federal government also announced an intention to share with
provinces and territories the revenues from the global minimum tax. The
2023 federal budget estimates that about Cdn $2.8 billion and Cdn
$2.4 billion will be collected from the global minimum tax in 2025-26
and 2027-28, respectively, if the 18-month period for the filing of the
GloBE reportings is factored into the estimates. Time will show whether
these estimates are realistic (in light of the behavioural responses of
taxpayers and other countries—including the possibility that IIR
estimates may be overstated to the extent that other countries adopt a
QDMTT).
Historically, Canada has offered numerous federal and provincial tax
credits aimed at creating incentives for investment in certain
industries or activities. Federal investment tax credits (ITCs) in
respect of scientific research and experimental development, mineral
exploration, and film production activities are only a few notable
examples of the tax incentives already in place. The 2023 budget
proposed additional ITCs for clean technology and green energy.
In 2022, the federal government announced its plans to introduce three
new ITCs. First, after the release, on March 29, 2022, of the 2030
emissions reduction plan, the 2022 federal budget introduced a
refundable ITC for carbon capture, utilization, and storage (“CCUS ITC”)
and a non-refundable 30 percent critical mineral exploration tax credit
(“CMETC”). Second, in the 2022 fall economic statement, the government
of Canada announced its ambitious plans to introduce a refundable clean
technology ITC and a refundable clean hydrogen ITC. The introduction of
these new refundable ITCs was also driven by Canada’s desire to remain
competitive in attracting investment in clean energy projects after the
enactment of the US Inflation Reduction Act, which provided generous tax
credits to investors in US clean energy projects.
In general terms, the 2023 budget has expanded the application of some
tax credit programs and provided further details on the design of the
CCUS ITC and on the federal government’s plans to introduce the clean
hydrogen ITC in accordance with its promises in the 2022 fall economic
statement. The 2023 budget has also introduced two new refundable
ITCs—namely, a 15 percent ITC for clean electricity and a 30 percent
clean technology manufacturing ITC.
By expanding the existing tax credit programs and introducing new ones,
the federal government expects that the fiscal incentives will make
investments in the relevant Canadian projects more attractive to
investors, including MNEs.
In this context, it is important to consider the pillar 2 treatment of
the ITCs and to understand whether the implementation of pillar 2 could
undermine the attractiveness of ITCs. In particular, a 15 percent global
minimum tax could potentially apply to domestic Canadian activities
(under an IIR or QDMTT) in situations where the effective tax rate, for
pillar 2 purposes, falls below the 15 percent threshold.
In general terms, the GloBE treatment of ITCs depends on whether such credits are
A “qualified refundable tax credit,” defined in article 10 of the GloBE
model rules, is a tax credit that is refunded in cash or cash
equivalents within four years from the date on which a constituent
entity meets the requirements for receiving the tax credit.
A tax credit is considered to be refundable if it is paid in cash or
cash equivalent, including in situations where a tax credit balance is
left after reducing covered taxes. An eligible cash equivalent can
include, inter alia, a discharge of other tax liabilities that are not
covered taxes. It is important to note that if a tax credit is designed
to reduce covered taxes only, it is not refundable and, accordingly, is
not a qualified refundable tax credit.
Qualified refundable tax credits have been accorded favourable treatment
from a GloBE perspective. Conceptually, they are assimilated to
government grants in the sense that the refunded or credited taxes are
still considered to be paid by the constituent entity and to form part
of its covered taxes, while the tax benefit is viewed as income (a
grant) that is included in the GloBE income. For example, a qualified
refundable tax credit of $100 would result in $100 of additional GloBE
income—but it would not reduce covered taxes for the purposes of
computing the effective tax rate. To the extent that the accounting
treatment of qualified refundable tax credits differs from the GloBE
treatment, it should be reversed in determining GloBE income/loss and
covered taxes.
When a portion of the tax credit is actually refundable and meets the
qualified refundable tax credit requirements, only this portion of the
tax credit is included both in the covered taxes and in GloBE income.
Article 10 of the GloBE model rules also defines a “non-qualified
refundable tax credit” —a tax credit that is fully or partially
refundable but that does not meet the qualified refundable tax credit
requirements. This definition also includes tax credits that are
commonly referred to as non-refundable tax credits since they can be
used only to eliminate or reduce covered taxes but are not refundable in
cash or cash equivalents.
A non-qualified refundable tax credit is excluded from both GloBE
income/loss and covered taxes to the extent that it is reflected in the
accounting net income (loss) and tax expense in the applicable financial
statements. For example, a non-qualified refundable tax credit of $100
would result in a $100 reduction to covered taxes, with no additional
income for the purposes of computing the GloBE income/loss.
For MNEs, qualified refundable tax credits are usually more valuable
than non-qualified refundable tax credits. For example, assume that an
MNE earns $500 of GloBE income and pays $100 of income tax (at a
20 percent effective tax rate). If that MNE received a $100 qualified
refundable tax credit, it would have, for the purposes of pillar 2, $600
of GloBE income and $100 of covered taxes, which would result in a
16.7 percent effective tax rate and no global minimum tax. However, if
that MNE received a $100 non-qualified refundable tax credit, it would
have $500 of GloBE income and no covered taxes—resulting in a 0 percent
effective tax rate and a global minimum tax of $75.
Despite the foregoing discussion, it may be beneficial in some
circumstances to receive a non-qualified refundable tax credit. For
example, in a situation where a material substance-based income
exclusion effectively eliminates all or almost all excess profits that
are subject to the global minimum tax, non-qualified refundable tax
credits can be more beneficial because they do not give rise to
additional GloBE income that could otherwise increase excess profits.
Qualified flowthrough tax benefits are tax credits (other than qualified
refundable tax credits) and tax loss benefits, which flow to an
investor as a return of (rather than a return on) the investment. The
tax loss benefit is a tax-deductible loss multiplied by the applicable
statutory tax rate.
The GloBE concept and treatment of qualified flowthrough tax benefits
were introduced in the administrative guidance that was released on
February 2, 2023 to accommodate certain US tax-transparent structures
(also known as “partnership flips”) widely used by investors to invest
in certain US real estate or green energy projects. In broad outline,
these structures involve the following: US tax equity investors provide
project financing to become holders of a majority interest in a US
partnership in order to obtain access to non-refundable tax credits and
losses generated by the eligible projects, and to use them to decrease
or eliminate the investors’ US income tax liabilities. Once the
investors get a return of their investment and, where applicable, an
agreed rate of return thereon, ownership interests in the partnership
flip and the investors become holders of minority interests in the
partnership.
The administrative guidance has clarified that the character of tax
credits is preserved regardless of whether they are received directly or
through tax-transparent entities. The guidance also allows MNEs to opt
for an alternative GloBE treatment of equity investments (including
investments in US partnership-flip structures) by filing a five-year
equity investment inclusion election.
If an investor has a qualified ownership interest (as defined in the
administrative guidance) in a tax-transparent entity that is a
partnership flip and receives an income or loss allocation therefrom,
the investor’s GloBE income or loss would not include such income or
loss, and its adjusted covered taxes would not include any taxes or tax
benefits relating to the disregarded GloBE income or loss, as the case
may be.
Instead, the qualified flowthrough tax benefits (that is, eligible tax
credits and tax loss benefits) received are included in computing the
adjusted covered taxes of the investor to the extent that these benefits
have reduced tax expenses for accounting purposes.
The investor decreases its investment in a qualified ownership interest
to the extent of the qualified flowthrough tax benefits, distributions
(including returns of capital), and proceeds from a disposition of the
qualified ownership interest (or a portion thereof).
If an investment in a qualified ownership interest is reduced below
zero, the excessive investment reduction decreases the adjusted covered
taxes of the investor provided that it is attributable to the tax
benefits or, where applicable, to the non-tax benefits that previously
increased the adjusted covered taxes.
Article 4.4.1(e) of the GloBE model rules prescribes an adjustment in
determining the total deferred tax adjustment amount that is accounted
for in computing adjusted covered taxes; with this adjustment, all
deferred taxes relating to the generation or use of any tax credits
should be disregarded. It follows from this that if there is a change in
the deferred taxes relating to the generation and use of the tax
credits, the relevant changes in deferred taxes should also be excluded
from the computations.
If the federal government contemplates using the tax incentives
announced in the 2023 budget to attract investments from MNEs in the
relevant projects, it should consider designing the ITCs in a way that
will ensure their favourable treatment from a GloBE perspective. It
would be helpful, too, if Finance reviewed the existing tax incentives,
including those associated with the flowthrough shares of Canadian
resource companies, from a GloBE standpoint and—where necessary or
appropriate—adapted or replaced them so that Canada remains
tax-competitive and attractive to foreign investors in the post-pillar 2
era. The OECD’s report on the impact of the global minimum tax on tax
incentives can help achieve this goal. The recommendation above applies
equally to provincial governments that have introduced, or plan to
introduce, tax incentives that are targeting MNEs.
Patrick Marley and Oleg Chayka
Osler Hoskin & Harcourt LLP, Toronto
International Tax Highlights
©2023, Canadian Tax Foundation and IFA Canada
© International Fiscal Association (Canadian Branch) 2021. All rights reserved.
