GLOBAL MINIMUM TAX SERIES – PART 2020 – Constituent Entities and Excluded Entities

[Amit Jalan]

Friends

In order to implement GloBE Rules, each country will enact the rules into its local legislation. The OECD remains committed to an ambitious timeline, with the intention for implementation by the end of 2023. As on date, over 138 members of the Inclusive Framework approved the two-pillar solution with over 50 jurisdictions taking steps to implement the Global Minimum Tax regulation.

Pillar 2 arose out of the OECD’s BEPS project and aims to end the ‘race to the bottom’ on tax rates by ensuring that multinationals meeting certain criteria, most important being its consolidated turnover exceeding Euro750 million, pay a minimum effective corporate tax rate of 15% regardless of the local tax rate or tax base.

After it is determined that the MNE Group is within the scope of the GloBE Rules upon the in-scope test being met, the identification of entities that are Constituent Entities and those that are Excluded Entities is a key aspect to determine. In this edition we have discussed covered this in detail.

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After it is determined that there is an MNE Group and that the Group is within scope of the GloBE Rules, it is then important to identify the following:

i) Constituent Entities

ii) Excluded Entities

Constituent Entities

Simply stated, Constituent Entities are entities in the MNE Group that are subject to the Pillar Two GloBE rules and Entities that are Excluded Entities are not subject to the GloBE Rules.

As per Article 1.3 of the GloBE Rules, a Constituent Entity is:

• any Entity that is included in a Group; and

• any Permanent Establishment (“PE”) of a Main Entity as above-mentioned Entity, i.e. PEs of Constituent Entities are treated as separate constituent entities. We have covered in detail, the understanding on PEs within the 16th edition of this series including the types of PEs and their GloBE Income or Loss and Covered Taxes calculations and allocation mechanisms within the GloBE Rules. Article 1.3 further provides that a Constituent Entity does not include an Entity that is an Excluded Entity.

Excluded Entities

Article 1.5 of the GloBE Rules specifies those Entities that are Excluded Entities and therefore not subject to the GloBE Rules. Qualification as an Excluded Entity has three practical effects under the GloBE Rules:

i) The IIR and UTPR do not apply to Excluded Entities. For example, only Constituent Entities are required to apply the IIR in accordance with Article 2.1. Therefore, an Excluded Entity that is the UPE of the MNE Group is not required to apply the IIR, and the rule must then be applied by the next Entity in the ownership chain (that is not itself an Excluded Entity).

ii) The GloBE attributes of Excluded Entities (including their profits, losses, taxes, tangible assets, payroll expenses, etc.) are removed from the various computations under the GloBE Rules, except for the application of the revenue threshold for determination of whether the GloBE Rules apply to the MNE Group.

iii) Excluded Entities do not have any administrative obligations under the GloBE Rules, such as the filing of GloBE Information Return or providing any information related to their income, taxes, assets, etc. in the GloBE Information Return; other than only the information relating to the location of the Excluded Entities within the Corporate Structure of the MNE Group as required under Article 8.1.4(b) or any other information as agreed in the GloBE Implementation Framework.

As per Article 1.5.1 of the GloBE Rules, the following are treated as an Excluded Entity:

i) a Governmental Entity;

ii) an International Organisation;

iii) a Non-profit Organisation;

iv) a Pension Fund;

v) an Investment Fund that is an Ultimate Parent Entity (“UPE”); or

vi) a Real Estate Investment Vehicle that is a UPE.

Each of the above types of Entities are defined within Article 10.1 of the GloBE Rules, however generally, these entities would not be subject to accounting consolidation anyway.

The Excluded Entities identified as investment funds and real estate investment vehicles that are UPE of MNE group are excluded from the GloBE Rules in order to protect their status as tax neutral investment vehicles. If an Investment Fund or Real Estate Investment Vehicle is not the UPE of the MNE Group it can still be treated as a Constituent Entity of the MNE Group provided it otherwise meets the consolidation requirements of Article 1.2 and Article 1.3. However, such Investment Funds and Real Estate Investment Vehicles are then considered as Investment Entities and subject to special rules for calculation of ETR in Article 7.4 through to 7.6.

Article 1.5.2 extends the exclusion to Constituent Entities that are owned by such Excluded Entities provided that the following tests are met: 
a) where at least 95% of the Entity is owned (directly or through a chain of excluded Entities) by one or more Excluded Entities (other than a Pension Services Entity) and where that Entity:

i. operates exclusively or almost exclusively to hold assets or invest funds for the benefit of the Excluded Entity; or

ii. only carries out activities that are ancillary to those carried out by the Excluded Entity. Section 1.5 of the OECD Administrative Guidance states that a wholly owned subsidiary of an Excluded Entity which borrows funds from third parties to make direct acquisitions of assets (including Ownership Interests in operating companies), should be treated as holding assets and investing funds for the benefit of its Excluded Entity parent, provided that the condition that the assets must be held or the funds invested for the benefit of the Excluded Entity, is met.

b) where at least 85% of the value of the Entity is owned (directly or through a chain of Excluded Entities), by one or more Excluded Entities (other than a Pension Services Entity) provided that substantially all of the Entity’s income is Excluded Dividends or Excluded Equity Gain or Loss that is excluded from the computation of GloBE Income or Loss in accordance with Articles 3.2.1(b) or (c).

Section 1.5 of the OECD Administrative Guidance further provides that where an Entity meets the definition of an Excluded Entity, the activities undertaken by the PE are not considered separate when applying the Activities Test (i.e., substantially all of the Entity’s income is Excluded Dividends or Excluded Equity Gain or Loss). Hence, all its activities, including those undertaken by its PEs, are excluded from the GloBE Rules.

Article 1.5.3 provides an option to the Filing Constituent Entity to elect not to treat an Entity as an Excluded Entity. The election is a Five-Year Election and when made, the GloBE Rules will apply to the Entity in the same manner as they apply to any other Constituent Entity of the MNE Group. This could be beneficial in some cases, particularly with regard to the charging mechanisms under the GloBE Rules.

For example, a Filing Constituent Entity may elect to treat an Entity as a Constituent Entity rather than an Excluded Entity in order to apply the IIR and not the UTPR with respect to the Top-up Tax of the Low Taxed Constituent Entity (LTCE). Thus, an MNE Group with a UPE that is an Investment Fund which is an Excluded Entity, but which is subject to consolidation under the relevant Accounting Standard, may make this election whereafter the UPE can apply the IIR to its subsidiaries instead of subjecting all of its Constituent Entities to UTPR