OECD publishes Pillar Two model rules on IIR and UTPR

The GloBE rules will apply to multinational enterprises (MNEs) having a revenue of at least € 750 million in their annual consolidated financial statements in at least two of the four fiscal years immediately preceding the relevant fiscal year. The GloBE rules include a list of excluded entities that is largely in line with the last proposal published October 2020 and the July and October 2021 statements published by the OECD.

Main new elements

• The revenue threshold test has been extended to two of the four previous fiscal years instead of the immediately preceding fiscal year.
• The list of excluded entities has been extended to “Real Estate Investment Vehicles” that are ultimate parent entities (UPEs) of an MNE.
• Investment funds only qualify as excluded entities if they are a UPE of an MNE.
• Entities held by excluded entities are only excluded if:
  • an interest is held of at least 95% and provided they serve for holding/investment purposes or only carry out activities that are ancillary to those of the excluded entity; or
  • an interest is held of at least 85% and provided that substantially all income constitutes excluded dividends, equity gains or equity losses.

The GloBE rules set forth an ETR test that is calculated on a jurisdictional basis. The GloBE rules use a common definition of “Covered Taxes” and “GloBE Income or Loss”.

GloBE Income or Loss is determined by reference to the MNE’s “Financial Accounting Net Income or Loss” derived from the consolidated financial statements of the UPE, with several adjustments.

The GloBE rules provide for further details on the exclusion of international shipping income from the GloBE ETR computation. The GloBE rules also clarify to which jurisdiction income of permanent establishments, flow-through entities and reverse hybrid entities should be allocated for purposes of the GloBE ETR computation.

The starting point for determining Covered Taxes would be the current tax expense of the MNE’s constituent entities in a jurisdiction accrued in the Financial Accounting Net Income or Loss. Covered Taxes are essentially taxes on income and on corporate equity, taxes imposed in lieu of such taxes and taxes levied under distribution-based corporate tax systems. Tax credits if refundable or payable within a four-year period are treated as reduction or addition.

The MNE’s ETR in a given jurisdiction would be the total Covered Taxes (after adjustments) of the constituent entities in that jurisdiction divided by the aggregate net GloBE Income or Loss of these entities. If the Jurisdictional ETR is below 15%, all entities (other than excluded entities) in the jurisdiction will be low-taxed constituent entities, regardless of their own individual ETR.

Main new elements

• In addition to the adjustments to the Financial Accounting Net Income or Loss already announced, adjustments include:
  
  
  • the option for constituent entities in relation to stock-based compensation to substitute the amount allowed as deduction in its local tax base for the amount expensed in their financial accounts in order to prevent top up tax in relation to book-to-tax differences in this respect.
  • adjustments should be made for asymmetric functional currency gains or losses.
• Special rules apply for the banking sector and insurance companies.
• Specific rules apply for computation of Covered Taxes in relation to (i) uncertain tax positions and (ii) covered taxes related to income excluded from the GloBE tax base.
• Covered Taxes do not include Top-up Tax levied under the IIR or taxes levied under a domestic top-up tax (when the jurisdictional ETR is below 15% and is similar to the GloBE rules).
• The taxes and income or loss of qualified investment entities are disregarded.
• Detailed guidance is provided on post-filing tax adjustments. Such adjustments should in principle be considered in the ETR computation for the fiscal year in which the adjustment is determined (rather than the fiscal year to which the adjustment relates).

Deferred tax accounting / loss carry forward

• Different from the proposal of October 2020, the GloBE rules now prescribe the use of deferred tax accounting to reconcile differences between financial accounting and tax results.
  • Certain adjustments are however made in the GloBE rules to the existing deferred tax accounts, e.g., a capped credit for deferred tax liabilities at the minimum 15% rate and a recapture mechanism for unpaid tax within five years.
  • Pre-regime losses are in principle also taken into account via the use of deferred tax accounting at the lower rate of 15% or the domestic tax rate.
  • The losses and temporary differences are reflected as adjustment to the calculation of the amount of Covered Taxes.
  • Upon election, a simplified GloBE loss carry forward equivalent can be applied instead of deferred tax accounting.

The “Top-up Tax” percentage is the difference between 15% and the lower jurisdictional ETR. The Top-up Tax is determined by applying Top-up Tax percentage to the “Excess Profits” of the relevant jurisdiction.

The Excess Profits are the net GloBE Income or Loss in the specific jurisdiction minus an optional “Substance-Based Income Exclusion” which, as anticipated, is based on a percentage of 10% (gradually reduced to 5% a period of 10-years) of certain payroll costs and 8% (gradually reduced to 5% over a period of 10-years) of the carrying value of certain tangible assets.

Special rules apply as regards minority-owned entities, i.e., entities in which the UPE has a direct or indirect equity interest that carries rights to profits, capital or reserves of 30% or less.

The (optional) de minimis exclusion is confirmed in the GloBE rules. No Top-up Tax applies in a jurisdiction if in a fiscal year the average GloBE revenue (i.e., average of GloBE revenue of the fiscal year and the two previous ones) is less than € 10 million and the average GloBE Income is less than € 1 million.

Main new elements

• The Top-up Tax should be increased by an additional amount of top-up tax due, further to adjustments in prior years impacting the ETR computation in that prior year.
• The Top-up Tax should be decreased with an amount payable under a domestic rule effectively applying the minimum ETR requirement domestically in a manner consistent with the GloBE rules.

The UPE is primarily liable for all Top-up Tax under the IIR, followed by a top-down approach. As a backstop, the UTPR can apply if low-taxed income not brought into charge under an IIR remains.

Main new elements

• Compared to the proposal of October 2020, the UTPR is allocated to all jurisdictions that have a qualifying UTPR in place. Allocation is based on a two-factor allocation key allocating taxing rights pursuant to a formulary approach based on the carrying value of qualified tangible assets and the number of employees.

The GloBE rules introduce the tax compliance mechanism.

Main new elements

• Each constituent entity – or a designated local entity on its behalf - shall file a specific GloBE information return following a standardized template. If the MNE’s UPE (or a designated filing entity) in effect files such return, the constituent entities have instead an obligation to notify the tax administration of the filing entity.
• The GloBE information return and notification should be filed no later than 15 months after last day of the relevant fiscal year (however an 18 month period applies for the first GloBE information return).
• Safe harbours may apply to the Top-up Tax for a jurisdiction pursuant to certain conditions and upon election.
• The final design of any safe harbours, as well other aspects of administration, compliance and co-ordination will be developed further in consultation with business and stakeholders and presented in 2022.

The rules also address certain specific situations, e.g.,

• the impact of mergers, acquisitions or disposals of constituent entities on the jurisdictional determination of the GloBE ETR and on the thresholds;
• the application of the GloBE rules in case of distribution-based regimes; and
• the treatment of joint ventures and the position where a UPE is a flow-through entity.