Where this applies, Article 4.2.2(e) of the Model rules also excludes the tax paid by the insurance company from covered taxes.
Article 4.2.1 of the
Model Commentary provides that taxes imposed in lieu of a generally applicable CIT are
Covered Taxes for GloBE purposes. As such state premium taxes imposed in lieu of income taxes are treated as covered taxes, and may therefore increase an insurance companies ETR, minimizing any top-up tax liability.
Recapture Exception Accruals
Article 4.4.4 of the
OECD Model Rules implements a recapture rule for
deferred tax liabilities. This applies when the deferred tax liability has not reversed within five years of the fiscal year in which it was originally recognized.
When this recapture applies, the MNE group is required to recompute its
effective tax rate (ETR) for the year the deferred tax liability was originally recognized. If there is then any top-up tax, this top-up is added to the top-up tax for the current year.
Certain deferred tax liabilities are excluded from the recapture rule, so they do not need to be adjusted for, even if they take more than five years for the deferred tax liability to release. These are referred to as ‘Recapture Exception Accruals’.
Article 4.4.5 (e) of the Model Rules includes fair value accounting on unrealised gains as a deferred tax recapture exception accrual.
This would include increases in the value of the investments assets of insurance companies given gains on these investments may not brought into account for tax purposes until they have been realised through a sale. This only applies providing fair value accounting is also applied for GloBE purposes.
Article 4.4.5 (g) of the Model Rules provides that insurance reserves and deferred acquisition costs are also Recapture Exception Accruals.
Insurance companies generally qualify for a tax deduction for amounts reserved for future claims (based on regulatory capital requirements). Where regulatory capital requirements exceeds accounting reserves this creates a deferred tax liability that may apply for a long period.
Ensuring that the deferred tax liability for insurance reserves avoids the significant distortions in the GloBE ETR that would otherwise apply to insurance companies.
The reference to deferred acquisition costs includes where an insurer is required to recognise the difference in the fair value of the acquired insurance contracts and insurance obligations assumed on acquisition.
Whilst the recapture exception accrual for insurance reserves is useful for insurance companies it is unclear whether this treatment also applies to derivatives related to these provisions which may generate significant deferred tax liabilities.
Lack of Physical Substance
Insurance companies generally do not hold large amounts of tangible assets as part of their business activity. This can have some impact on the application of the GloBE rules.
The substance-based income exclusion is effectively a carve-out for expenditure on tangible fixed assets and payroll costs. The amount of the exclusion feeds directly into the top-up tax calculation as it reduces excess profits which are then used to calculate the initial top-up tax.
Because insurance companies do not generally hold deploy significant tangible assets, the tangible asset carve-out aspect of the substance-based income exclusion is not expected to provide significant relief. It would only be if there was a large number of employees/other staff that the substance-based income exclusion would have a real impact on any top-up tax liability.
In order to benefit from the exclusion, the requirements in Article 9.3.2 of the
OECD Model Rules need to be met:
Firstly, the MNE group can qualify for the exclusion if it has constituent entities in no more than five jurisdictions outside the ‘reference jurisdiction’. The reference jurisdiction is defined in Article 9.3.3 of the
OECD Model Rules as the jurisdiction where the MNE group has the highest total value of its tangible assets based on the net book value of the assets held by constituent entities in that jurisdiction.
The exclusion is for a five-year period but the jurisdictions don’t have to remain the same, they can differ over the five-year period provided there are no more than five.
Secondly, the value of tangible assets cannot exceed 50 million euros in all jurisdictions aside from the reference jurisdiction. Therefore the total value of the assets outside the main base of operations must be 50 million euros or less.
Given insurance companies do not generally hold large amounts of tangible assets this exception may delay the imposition of the UTPR for some insurance MNEs.
Insurance Investment Entities
General
A key issue is that the GloBE ETR of Insurance Investment Entities is not subject to the general jurisdictional blending calculation, and they are treated separately along with other investment entities. For more information on jurisdictional blending, see
ETR Calculation and Top-Up Tax.
Therefore, the GloBE income and covered taxes of Insurance Investment Entities and other investment entities is effectively merged to calculate the jurisdictional
effective tax rate.
Article 10.1 of the
Model Rules defines an Insurance Investment Entity as an entity that would qualify as an Investment Fund or Real Estate Investment Vehicle but for the fact that it is wholly-owned by an insurance company and established in relation to liabilities under one or more insurance or annuity contracts.
An Insurance Investment Entity may be wholly-owned by a single entity, or by a number of entities which are all part of the same MNE Group. However, the owner(s) must be subject to regulation in their residence jurisdiction as an insurance company.
Tax Transparency Election
A constituent entity can make a
tax transparency election in respect of its ownership interest in an Insurance Investment Entity under Article 7.5 of the OECD Model Rules. This then changes the Pillar Two tax treatment as it treats the GloBE income of the Insurance Investment Entity as accruing to the constituent entity owner in proportion to its ownership entitlement.
It is only available where the constituent entity owner is subject to tax on a fair value accounting method on its interest in the Insurance Investment Entity (such as under a mark-to-market accounting policy) and the tax rate levied on the income for the owner is at least 15%.
The purpose behind the election is to align the GloBE rules with the domestic tax treatment for the owner of the Insurance Investment Entity. The election applies to both directly held and indirectly held Insurance Investment Entities.
Under domestic law, the constituent entity owner would be subject to tax on the income of the Insurance Investment Entity anyway (calculated on fair value changes).
This election simply pushes up the income to the constituent entity owner for the GloBE income calculation to match the timing under domestic law.
One of the criticisms of this is that in some countries, such as Germany, changes of the fair value of the ownership interest in the investment entities are not taxed. In others, such as France, some investors are taxed on changes of the fair value as required but others are not and are taxed on the historic value of their ownership interests.
Therefore, this election is either not applicable in some jurisdictions or only on a few investment entities or insurance investment entities in others.
Taxable Distribution Method Election
Article 7.6 of the
Model Rules provides an election so that the fund’s distributions or deemed distributions are included in the ETR calculation of the investor.
Under the GloBE Rules this applies to just investment entities. However, Article 3.1 of the
OECD Administrative Guidance extends this to Insurance Investment Entities.
Restricted Tier One Capital issued by Insurers is treated in a similar way to Additional Tier One Capital for the Banking sector under Article 3.2.10 of the GloBE Rules.
Distributions are treated as expenses of the issuer and income of the holder in the computation of GloBE Income or Loss.
As the financial accounting income or loss figure is a below-the-line figure, dividends are generally included in this amount. However, for tax purposes, many countries have some form of participation exemption for intra-group dividends (with differing requirements in terms of shareholdings and length of ownership).
Whilst any type of Constituent Entity of an MNE Group can make this election, whether they are insurance companies or not, it is expected that it would mainly apply to insurance companies.
