GloBE model rules: a peek into key provisions

By Noopur Trivedi and Jitesh Golani

Today, the OECD released the much-awaited global anti-base erosion (GloBE) model rules with a commitment to finalize the commentary and safe harbors in early 2022. The rules are segmented into ten chapters – chapter 1 deals with the scope, followed by the key operative rules and provisions for special cases. The rules accommodate a diverse range of tax systems across the globe. This write-up seeks to apprise readers about the key highlights of the rules.

The GloBE rules relate to “Pillar Two” of the 8 October statement on a two-pillar solution to address the tax challenges arising from the digitalisation of the economy, which 137 jurisdictions have agreed to implement. Pillar Two ensures large multinational enterprises (MNEs) pay a minimum level of tax (currently agreed at 15%) on income arising in a jurisdiction.

Scope

In a significant departure from the erstwhile criteria, the rules apply if the MNE Group reports annual revenues of EUR 750 million or more in the consolidated financial statements of the Ultimate Parent Entity in at least two of the four fiscal years immediately preceding the tested fiscal year. The rules also provide for pro-rata adjustment to the EUR 750 million threshold if the fiscal year is other than the 12 months period. Additionally, the rules provide guidance for determining the applicability of GloBE rules in the case of corporate restructurings / holding structures.

Predominantly, the definitions of MNE Group, Group, the Ultimate Parent Entity, and Constituent Entity align with the October 2020 OECD blueprint. Additionally, the rules also clarify that an Ultimate Parent Entity having a foreign permanent establishment shall also be considered a “Group” for GloBE purposes subject to the satisfaction of the consolidated revenues threshold.

The ambit of “Excluded Entities” is expanded to also include a “Real Estate Investment Vehicle that is an Ultimate Parent Entity”. Further, certain subsidiaries of excluded entities are also exempted from applicability of the rules subject to the satisfaction of specified conditions.

Charging provisions

The Income Inclusion Rule (IIR) continues to operate as per the “top-down” approach, i.e., the Ultimate Parent Entity remains liable to pay the top-up tax, provided its jurisdiction adopts the GloBE rules, to the extent of its allocable share in the low-taxed constituent entity. In case the Ultimate Parent Entity jurisdiction does not adopt the GloBE rules, the obligation passes on to the intermediate parent entity. Consistent with the 8 October statement, the “split-ownership” rules apply where minority shareholding is 20 percent or more in a partially owned parent entity (subject to certain exceptions).

The parent entity’s allocable share is determined with reference to an “inclusion ratio”, which has been defined as a ratio of (a) the GloBE Income of the low-taxed constituent entity for the fiscal year, reduced by the amount of such income attributable to ownership interests held by other owners, to (b) the GloBE income of the low-taxed constituent entity for the fiscal year. The rules provide a detailed definition for determining the income attributable to Ownership Interests held by other owners.

The balance top-up tax is collected under the Undertaxed Payments Rule (UTPR) through the denial of a deduction (to the extent possible in the same fiscal year and carried forward if unallocable) that results in an additional cash tax expense for the relevant constituent entities. The UTPR, however, is inapplicable in the case of an investment entity. Consistent with the 8 October statement, the transition rules provide for an exception from the application of the UTPR for an MNE Group in the initial phase of its international activity.

The rules drop the two-step allocation key mechanism and prescribe a new approach for allocation of the top-up tax under the UTPR by considering the weighted average of the number of employees and the net book value of tangible assets, with each being assigned equivalent weights. The number of employees and the net book value of tangible assets pertaining to the investment entity and certain flow-through entities is excluded from the formula for allocating the UTPR top-up tax amount. Further, the rules deny the allocation of the UTPR top-up tax to a jurisdiction in a fiscal year if the amount allocated to that jurisdiction in a prior fiscal year does not result in the constituent entities having an additional cash tax expense equivalent to the UTPR top-up tax allocated in that prior fiscal year.

Computation of GloBE income or loss

The fundamental approach for arriving at the GloBE income/loss of a constituent entity remains the same, i.e., making certain adjustments to the financial income/loss (before considering consolidation adjustments eliminating intra-group transactions) considered in the preparation of consolidated financial statements of the Ultimate Parent Entity. An exception for the use of financial income/loss for a constituent entity determined as per another acceptable/authorized financial accounting standard is permitted provided the financial accounts are maintained based on that standard; information is reliable and permanent differences in excess of EUR 1 million (if any) are conformed to the financial accounting standard used in the preparation of the consolidated financial statements.

The ambit of the adjustments has been expanded to also include gain or loss from the disposition of assets and liabilities (in certain cases), included revaluation method gain or loss, asymmetric foreign currency gain or losses, prior period errors, and changes in accounting principles, and accrued pension expense. The rules also provide for a few jurisdiction-specific electives with respect to adjustments for stock-based compensation, use of fair value or impairment accounting for assets, aggregate asset gains (gains on the disposition of local tangible property), and use of consolidation adjustments for constituent entities located within the same jurisdiction. Separate guidance is provided concerning the treatment of refundable tax credits and for exclusion of expenses attributable to intragroup financing arrangements in certain cases.

The income and expenses of permanent establishments (treated as separate constituent entities) are to be computed as per the applicable tax treaty, domestic tax law, or as per the OECD Model Tax Convention in residuary situations. Further, the GloBE loss of a permanent establishment shall be treated as an expense of the head office entity (referred to as the “main entity”) to the extent allowed under the domestic laws of the latter. Subsequent GloBE income of such a permanent establishment shall be considered as income of the main entity. Special rules are provided for the allocation of GloBE income/loss of a flow-through entity to other constituent entities.

Adjusted covered taxes

The fundamental tenets of the ‘covered tax’ definition mostly remain the same, i.e., taxes recorded on income/profits, taxes imposed in lieu of generally applicable corporate income tax, taxes on distributed profits, deemed profit distributions, etc. Further, the rules prescribe a new approach for computing the numerator of the effective tax rate (ETR) computation and require starting with the current tax expense recorded in the financials subject to certain adjustments, including the deferred tax adjustment and items in equity/other comprehensive income. For the purposes of elimination of temporary/timing differences, the October 2020 OECD blueprint deliberated on two options – the deferred tax approach and the carry-forward mechanism – with the latter being recommended. In the latest rules, the deferred tax approach has regained significance for jurisdictional ETR computation purposes.

The current tax relating to uncertain tax positions is generally reduced from the quantum of covered taxes and added back only upon payment. Interestingly, covered taxes exclude top-up tax accrued by a constituent entity under a qualified domestic minimum top-up tax. In addition to providing guidance for the allocation of covered taxes in special circumstances, the rules also restrict allocation of covered taxes on a constituent entity’s passive income to the extent such covered taxes exceed the top-up tax on such income includible under any controlled foreign company tax regime or fiscal transparency rule.

The rules also allow an MNE Group to make a GloBE loss election for a jurisdiction for creation of a GloBE loss deferred tax asset in the year in which there is a GloBE loss for the jurisdiction, that can be utilized against the net GloBE income for the jurisdiction in any subsequent fiscal year (subject to certain conditions). Further, special provisions deal with post-filing adjustments and tax rate changes.

Computation of ETR and top-up tax

The rules maintain the basic premise of computing the ETR on a jurisdictional basis. The net GloBE income of jurisdiction for a fiscal year is derived as a summation of GloBE income of all constituent entities as reduced by the GloBE loss of those constituent entities within a jurisdiction.

If the ETR is below the minimum rate (15%), the rules require the application of the substance-based income exclusion, which is the sum of the payroll and tangible asset carve-out. The payroll carve-out is 5% of the eligible payroll costs of eligible employees that perform activities of the MNE Group in the jurisdiction. The tangible asset carve-out is equal to 5% of the carrying value of eligible tangible assets located in such jurisdiction. As a part of transitional relief, the carve-out rate for eligible payroll costs and tangible assets shall be 10% and 8%, respectively, in the fiscal year beginning 2023; ultimately, both rates shall gradually reduce to 5% over the course of 10 years.

The total quantum of jurisdictional top-up tax for a given fiscal year is computed as a sum of (a) top-up tax on the GloBE income post-substance-based income exclusion and (b) additional current top-up tax, which is then reduced by (c) domestic top-up tax.

Additional current top-up tax is the incremental top-up tax arising pursuant to the recalculation of ETR and top-up tax of a prior year, pursuant to certain specified situations. The domestic top-up tax is the amount payable under a qualified domestic minimum top-up tax of the jurisdiction for the fiscal year.

In line with the 8 October statement, the rules provide for a de minimis exclusion, wherein the MNE Group can elect to deem the top-up tax for the constituent entities located in a jurisdiction as zero for a fiscal year if a) the average GloBE revenue for such jurisdiction is less than EUR 10 million, and b) the average GloBE income or loss for such jurisdiction is less than EUR 1 million (including a loss) in that fiscal year. The average is to be computed based on the current and two preceding fiscal years. The exclusion is not applicable in the case of stateless / investment entities.

The rules also introduce a new concept of “minority-owned subgroup”, which though being a part of an MNE Group, may be considered as a separate MNE group for GloBE purposes. There are dedicated chapters in relation to the application of the GloBE rules in the context of tax neutrality and distribution regimes.

Other rules

The rules detail the administrative requirement to file a standardized information return for each jurisdiction that has adopted the GloBE rules. Such a return would be filed either by a constituent entity or a designated local entity on behalf of the former within 15 months after the last day of the reporting fiscal year, subject to certain exceptions. Detailed guidance on the application of GloBE rules in the transition year has been laid out.

Concluding thoughts

In early 2022, the OECD is expected to release the commentary relating to the model rules and also address its co-existence with the US global intangible low-taxed income (GILTI) rules. Further, the model rules for the subject to tax rule, together with a multilateral instrument for its implementation, are expected to be released in the early part of 2022. Stakeholders shall be allowed to participate in a public consultation event on the implementation framework that is expected to be held in February 2022 and on the subject to tax rule in March 2022.

 — Noopur Trivedi and Jitesh Golani are international tax professionals-cum-researchers, based in India.

The views and opinions expressed are personal. The authors graciously invite any comments from readers at [email protected] to discuss and debate this intriguing international tax reform.