P2 applies to all entities that form part of a multinational group with annual revenues of at least €750M. This also includes entities (incl. partnerships) that are treated as transparent for local tax purposes.

Flow-Through Entities

P2 uses the term Flow-Through Entities (𝐅𝐓𝐄𝐬) for entities that are fiscally transparent in the jurisdiction in which they are created. P2 has special rules to allocate the income and taxes of such FTEs.

An exception exists for entities tax resident and subject to tax in a different jurisdiction than where they are created. E.g., a US LLC that is disregarded for US tax purposes but tax resident in the Netherlands. Such an entity is not an FTE.

P2 contains two types of FTEs, depending on the treatment of the entity in the jurisdiction of its owners: (i) Tax Transparent Entities (𝐓𝐓𝐄𝐬) and (ii) Reverse Hybrid Entities (𝐑𝐇𝐄𝐬):

  • If the FTE is treated as transparent by its owner, it is a TTE.
  • If the FTE is treated as opaque by its owner, it is an RHE.

If an FTE has multiple owners that classify the entity differently for tax purposes, it will be treated as TTE to the extent its owners classify it as tax transparent and as RHE to the extent its owners classify it as opaque.

The main difference between TTEs and RHEs is the allocation of income and taxes for P2 purposes. In this Snippet, we focus on the treatment of TTEs.

Impact of status as TTE

The P2 rules contain three steps for allocating income and taxes of a TTE:

  1. The income and taxes are reduced to the extent allocable to owners that are not group entities.
  2. If the activities of a TTE give rise to a permanent establishment (𝐏𝐄), the income and taxes are allocated to such PE.
  3. The remaining income and taxes of a TTE is allocated to its owners, unless the TTE is the Ultimate Parent Entity (𝐔𝐏𝐄) of a group.

These steps should (absent a PE) effectively result in allocating all income and taxes of the TTE to its owners and including it in the effective tax rate calculation of its owners. An example of a TTE is a disregarded US LLC held by a US Inc. Under P2, the income of this disregarded US LLC is allocated to the US Inc. These rules therefore align the local tax treatment of a TTE (taxable at owner level) and the P2 treatment of such entity (allocation of income to the owner).

In case of a TTE that is the UPE, generally no allocation takes place, and hence, the income and taxes remain with the TTE. As a TTE is generally not subject to tax, this allocation of income may have adverse Pillar Two consequences (subject to certain exceptions not further discussed in this Snippet).

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