Rules on Corporate Restructurings and HoldingStructures

[Amit Jalan]

The Pillar Two model rules are part of what some consider to be a historic international tax reform. Over 140 countries and jurisdictions agreed to the rules, which are estimated to generate around $150 billion in additional global tax revenues annually. Therefore, the implementation of the Pillar Two model rules is expected to have a material effect on larger listed MNEs around the world.

In our last edition, we discussed in detail on special rules that deal with corporate restructurings (including mergers, acquisitions, and demergers) and covered in detail Article 6.1 relating to application of Consolidated Revenue Threshold to Group Mergers and Demergers.

In this Article we will cover Article 6.2 of the GloBE Rules that applies to Constituent Entities joining and leaving an MNE Group.

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To recap, Chapter 6 contains rules relating to acquisitions, disposals and Joint Ventures, summarised as below:

• Article 6.1 supplements Article 1.1 by providing further rules to assess the consolidated revenue threshold for determining the applicability of the GloBE Rules to an MNE Group and its constituent entities in case of merger and demerger transactions that took place in the prior four-year period.
• Article 6.2 provides special rules for the application of the GloBE Rules that apply when a Constituent Entity enters or leaves an MNE Group during the Fiscal Year.
• Article 6.3 provides special rules for the treatment of transfers of assets and liabilities including as part of a reorganisation.
• Article 6.4 brings certain Joint Ventures within the scope of the GloBE Rules.
• Article 6.5 provides special rules for Multi-Parented MNE Groups.

We have covered below in detail, Article 6.2 which provides special rules for the application of the GloBE Rules that apply when a Constituent Entity enters or leaves an MNE Group during the Fiscal Year.

The GloBE Rules and Commentary are generally drafted on a steady-state basis that assume the MNE Group is comprised of the same Constituent Entities throughout the entire Fiscal Year. When an acquisition or disposition of a Controlling Interest in a Constituent Entity (“target”) takes place during the Fiscal Year, Article 6.2 modifies or clarifies the operation of the GloBE Rules in order to ensure the appropriate outcomes for both the buyer and seller. The rules are intended to produce a smooth separation of the target from the seller Group and a smooth integration of the target into the acquiring MNE Group.

Except to the extent provided in Article 6.2.2, the following provisions apply where the target becomes or ceases to be a Constituent Entity of an MNE Group as a result of a transfer of direct or indirect Ownership Interests in such Entity during the Fiscal Year (the acquisition year):

a) the target will be treated as a Constituent Entity of both the acquiring and disposing MNE Group notwithstanding that its financial performance for the entire Fiscal Year is not consolidated on a line-by-line basis. If an MNE Group disposes a Controlling Interest in the target during a Fiscal Year, it is likely that a portion of its income and expenses will be included in the Consolidated Financial Statements of the disposing MNE Group based on the period in which the target was a member of the Group. Similarly, it is likely that all of the target’s assets and liabilities will be included in the Consolidated Financial Statements of the acquiring MNE Group as well as a portion of its income, expenses, and cash flows based on the period in which the target was a member of the Group.

b) In the acquisition year, each MNE Group shall take into account only the Financial Accounting Net Income or Loss and Adjusted Covered Taxes of the target that are taken into account in the Consolidated Financial Statements of the Ultimate Parent Entity for calculating GloBE tax liability for each MNE Group;

c) In the acquisition year and each succeeding year, the target shall determine its GloBE Income or Loss and Adjusted Covered Taxes using its historical carrying value of the assets and liabilities, i.e. ignore the effect of any purchase accounting consolidation adjustments attributable to the acquisition and treat the acquired target as having the same carrying value in its assets that it had prior to the transfer (i.e. the historical carrying value). Moreover, any adjustment to the carrying value of intangible assets that results from the acquisition, such as goodwill, customer lists, or workforce-in-place, etc. are ignored in the computation of GloBE Income or Loss. Denying a step-up in the target’s inside basis in its assets and liabilities matches the treatment of the seller and purchaser under the GloBE Rules and ensures that gains or losses on the assets and liabilities of the target are not permanently excluded from taxation under the GloBE Rules by virtue of a transfer of its Ownership Interests.

d) The computation of the target’s Eligible Payroll Costs under Article 5.3.3 shall take into account only those costs reflected in the Consolidated Financial Statements of the Ultimate Parent Entity. The Substance-based Income Exclusion is computed for each Constituent Entity under Article 5.3 by aggregating a percentage of Eligible Payroll Costs and Eligible Tangible Assets. Under this para, the amount of Eligible Payroll Costs referred in Article 5.3.3 shall be adjusted by taking into account only the costs that are reflected in the Consolidated Financial Statements prepared by the UPE of the MNE Group. Thus, each MNE Group takes into account the Eligible Payroll Costs arising during its period of ownership and that it bears economic responsibility for.

e) The computation of carrying value of the target’s Eligible Tangible Assets for purposes of Article 5.3.4 shall be adjusted proportionally to correspond with the length of the period during the Fiscal Year that the target was a Constituent Entity of each MNE Group. The carrying value of the Eligible Tangible Assets is determined based on the amount recorded for the purpose of preparing the Consolidated Financial Statements, including any purchase accounting consolidation adjustments attributable to the acquisition. This means that the acquisition of a Controlling Interest in a target will result in a step-up in a target’s inside basis in its assets for the purposes of the Substance-based Income Exclusion, notwithstanding that it does not produce a similar step-up for the purposes of calculating GloBE Income or Loss. The difference in treatment between paragraphs (d) and (e) can be explained on the grounds that the tangible asset carveout is based on the economic cost of the investment made by the MNE Group in the tangible asset located in the relevant jurisdiction which is more accurately determined by looking to the fair value of that asset at the time of acquisition than the historical cost of that asset as recorded by the target.

f) With the exception of the GloBE Loss Deferred Tax Asset, the deferred tax assets and deferred tax liabilities of a Constituent Entity that are transferred between MNE Groups shall be taken into account under the GloBE Rules by the acquiring MNE Group in the same manner and to the same extent as if the acquiring MNE Group controlled the Constituent Entity when such assets and liabilities arose. The exception to this para is the GloBE Loss Deferred Tax Asset, which arises in connection with a GloBE Loss Election under Article 4.5 with respect to a particular jurisdiction. Because the GloBE Loss Deferred Tax Asset arises in respect of a Net GloBE Loss in a particular jurisdiction of the MNE Group that makes the election, it is considered a jurisdictional attribute of the electing MNE Group, rather than an attribute of the Constituent Entities located in the jurisdiction and cannot be transferred to another MNE Group.

g) Deferred tax liabilities of the target that has previously been included in its Total Deferred Tax Adjustment Amount shall be treated as reversed for purposes of applying Article 4.4.4 by the disposing MNE Group and treated as arising in the acquisition year for purposes of applying Article 4.4.4 by the acquiring MNE Group, except that in such cases any subsequent reduction to Covered Taxes under Article 4.4.4 shall have effect in the year in which the amount is recaptured. This para is intended to relieve the disposing MNE Group of the need to recapture deferred tax liabilities that do not reverse (through payment or otherwise) within the five-year period required by Article 4.4.4. This para also reduces compliance and administrative burdens that would arise if the deferred tax liabilities were subject to recapture based on their accrual dates in the disposing MNE Group by allowing the target to start a new five-year period under Article 4.4.4 for all of its deferred tax liabilities when it joins the acquiring MNE Group. This para does not apply to Recapture Exception Accruals described in Article 4.4.5 because they are not subject to the requirements of Article 4.4.4 before or after the acquisition date.

h) If the target is a Parent Entity and it is a Group Entity of one or both MNE Groups during the acquisition year, it shall apply separately the provisions of the IIR to its Allocable Shares of the Top-up Tax of Low-Taxed Constituent Entities (LTCE) determined for each MNE Group. The determination of whether a Constituent Entity in which the target has an Ownership Interest is an LTCE must be made separately with respect to both the MNE Group that the target left and the MNE Group that the target joined. By virtue of this, the same Constituent Entity could be an LTCE of the disposing MNE Group but not an LTCE of the acquiring MNE Group, or viceversa, for example, because one MNE Group has high-taxed Constituent Entities located in the same jurisdiction sheltering the low-tax outcome of the target.

Article 6.2.2 provides that the acquisition or disposal of a Controlling Interest in a Constituent Entity will be treated as an acquisition or disposal of the assets and liabilities (and therefore the rules in Article 6.3 will apply) if:

a) The jurisdiction in which the target Constituent Entity is located, or in the case of a Tax Transparent Entity, the jurisdiction in which the assets are located, treats the acquisition or disposal of that Controlling Interest in the same or similar manner as an acquisition or disposition of the assets and liabilities; and

b) imposes a Covered Tax on the seller based on the difference between the tax basis of the underlying assets and liabilities, and the consideration received in exchange for the Controlling Interest; or the difference between that tax basis and fair value of the assets and liabilities.