Guidance on Deemed Consolidation test

[Amit Jalan]

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Global Minimum Tax (GMT) - A global deal to ensure big companies pay a minimum tax rate of 15% and make it harder for them to avoid taxation has been agreed by most of Countries in the World, and the Inclusive Framework (IF) is moving aggressively towards implementation of Pillar 2 on 1st January 2024, at least in a phased manner.

With a primary aim to put an end to decades of tax competition between governments to attract foreign investment and discourage multinationals from shifting profits - and tax revenues - to low-tax countries regardless of where their sales are made, it will apply to all Multi-National Entities. GMT will, therefore, impact the bottom line of the companies directly in terms of tax expense and it is expected that entities implementing this regime seamlessly, can benefit from a competitive advantage.

For tax professionals, both on the Consulting and Client side, it is an opportunity for tomorrow and those who enter now will certainly have a first mover’s advantage. Hence it is imperative that tax professionals keep themselves abreast of the dynamics of the new regime, which are expected to change fast as Governments and Tax Departments of the IF get more and more involved. 

In this article we have covered the guidance issued in relation to the deemed consolidation test under GloBE Rules requires the preparation of a set of Consolidated Financial Statements based on an Authorized Financial Accounting Standard in the Ultimate Parent Entity’s (“UPE”) location. We hope this bulletin adds Value in your professional Sphere.

Chapter 1 of the GloBE Rules determines which MNE Groups and Group Entities are subject to the GloBE Rules. Article 1.1 provides that the GloBE Rules will apply to the Constituent Entities of an MNE Group with consolidated revenues of at least EUR 750 million in at least two of the four prior Fiscal Years. Article 6.1 which sets out further rules clarifying the application of the consolidated revenue threshold in the case of mergers and de-mergers.  The consolidated revenue threshold, as mentioned above, is the one that is reported in the Consolidated Financial Statements of the Group. However, where a parent entity does not prepare Consolidated Financial Statements (for e.g. a privately held or a family-owned MNE that is not required to and does not prepare consolidated financial statements), the deemed consolidation test triggers under Article 10.1 paragraph (d) of the GloBE Rules, that requires preparation of a set of Consolidated Financial Statements based on an Authorized Financial Accounting Standard that is either an Acceptable Financial Accounting Standard or another financial accounting standard that is adjusted to prevent any Material Competitive Distortions.

This deemed set of Consolidated Financial Statements is then used for the purposes of applying other parts of the GloBE Rules, for example in determining whether an MNE Group meets the revenue threshold test in Article 1.1 or whether an Entity should be treated as a Constituent Entity of an MNE Group.

The Administrative Guidance makes it clear that the deemed consolidation test does not modify the rules applied under that Authorised Financial Accounting Standard or alter the outcomes that are provided for under the relevant accounting standard.

The guidance also provides that paragraph (b) of Article 10.1 of the GloBE Rules that defines Controlling Interests is also a deemed consolidation test that leverages the consolidation rules under the financial accounting standard used in the preparation of the UPE’s Consolidated Financial Statements. It provides that one Entity with an Ownership Interest in another Entity is treated as holding a Controlling Interest in that Entity where the interest holder would be required to be consolidated with that other Entity if it had prepared Consolidated Financial Statements and thus ties into the deemed consolidation test set out in paragraph (d) of Article 10.1 of the GloBE Rules. Accordingly, the deemed Consolidated Financial Statements in paragraph (b) of the Controlling Interests definition are those that the Entity would have prepared using an Authorized Financial Accounting Standard that is either an Acceptable Financial Accounting Standard or another financial accounting standard that is adjusted to prevent any Material Competitive Distortions.

Note: Under the GloBE Rules, a Material Competitive Distortion exists when the application of a specific principle or procedure permitted by a financial accounting standard that is not an Acceptable Financial Accounting Standard under the GloBE Rules results in an aggregate variation greater than EUR 75 million in a Fiscal Year as compared to the amount that would have been determined by applying IFRS principle or procedure. The aggregate variation refers to the total variation reflected in the Consolidated Financial Statements of the MNE Group, and thus, takes into account the impact of the principle or procedure on all affected transactions of all Constituent Entities of the MNE Group. Where the application of a specific principle or procedure results in a material competitive distortion, the accounting treatment of any item or transaction subject to that principle or procedure must be adjusted to conform to the treatment required for the item or transaction under IFRS.

The administrative guidance provides four examples to illustrate the operation of the deemed consolidation test, particularly drawing out the point that if an accounting standard such IFRS-10 does not or would not require line-by-line consolidation, then the GloBE deemed consolidation requirement would not over-ride that.