Use our Qualified Refundable Tax Credit Calculator to see the impact of a tax credit being qualifying or non-qualifying.
Under Article 10 of the OECD Model Rules, a Qualified Refundable Tax Credit is a refundable tax credit paid as cash or available as cash equivalents within four years from the date when a constituent entity satisfies the conditions for receiving the credit. A common example of this could be an R&D refundable tax credit.
In order to be refundable, any amount of the tax credit that has not been used to reduce covered taxes (eg corporate income tax) is either payable as cash or cash equivalent.
Cash equivalent includes checks, as well as the ability to use the credit to discharge liabilities other than a Covered Tax liability. If the credit is only available to reduce Covered Taxes, i.e. it cannot be refunded in cash or credited against another tax, it is not a qualified refundable tax credit.
In addition, the refund amount must not be limited to any ‘tax liability’. It may therefore be that a refund limited by the amount of payroll taxes would not be a qualified refundable tax credit.
For the purposes of the Pillar Two GloBE rules, Article 3.2.4 of the OECD Model Rules provides that they are treated as Pillar Two GloBE income and not a reduction in covered taxes.
An MNE has GloBE income of 10 Million euros and Covered Tax of 1 Million euros.
This would equate to an effective tax rate (ETR) of 10%. Top-up tax would be 500,000 euros (15%-10%* 10 million).
If a tax credit of 200,000 euros was granted, the treatment would depend on whether it was a refundable or non-refundable tax credit.
If it was refundable, the 200,000 euros would be added to GloBE income to increase it to 10,200,000 euros. The revised ETR would be 9.804%. Top-up tax would be 529,992 euros (5.196% * 10,200,000).
If the tax credit was non-refundable it would reduce covered tax to 800,000 euros. The ETR would be 8%. Top-up tax would therefore be 700,000 euros (7% * 10 Million).
| No Tax Credit | QRTC | Non-QRTC | |
|---|---|---|---|
| Covered Tax | 1,000,000 | 1,000,000 | 800,000 |
| Pillar Two Income | 10,000,000 | 10,200,000 | 10,000,000 |
| Globe ETR | 10.000% | 9.804% | 8.000% |
| Top-Up Tax % | 5.000% | 5.196% | 7.000% |
| Top-Up Tax | 500,000 | 529,992 | 700,000 |
Therefore, whilst both refundable and non-refundable tax credits reduce the ETR (and therefore increase the top-up tax percentage), generally a refundable tax credit would not decrease the ETR as much as a non-refundable tax credit.
There is some overlap between the Substance-Based Income Exclusion and Refundable Tax Credits. This is because Refundable Tax Credits effect GloBE income and the Substance-Based Income Exclusion is itself deducted from GloBE income to determine the profits (termed ‘excess profits’ in the OECD Model Rules) that are subject to the top-up tax percentage.
This results in the Substance-Based Income Exclusion reducing top-up tax at a slightly higher rate for refundable tax credits as opposed to non-refundable tax credits.
For example, if in the above example the Substance-Based Income Exclusion was 200,000 euros, this would reduce the profits on which the top-up tax percentage was levied.
For refundable tax credits this would reduce the profits to 10 million euros and for non-refundable tax credits to 9,800,000 euros. Therefore top-up tax would be 519,600 for a refundable tax credit and 686,000 for a non-refundable tax credit. This is a top-up tax reduction of 1.9608% for a refundable tax credit and a 2% reduction for a non-qualifying tax credit.
The table below shows the top-up tax and percentage reductions for various levels of substance-based income exclusion.
| Amount of Substance-Based Income Exclusion | Top-Up Tax Refundable Tax Credit | Top-Up Tax Non-Refundable Tax Credit | % Decrease Refundable Tax Credit | % Decrease Non-Refundable Tax Credit |
|---|---|---|---|---|
| 200,000 | 519,600 | 686,000 | 1.9608% | 2% |
| 500,000 | 504,012 | 665,000 | 4.9020% | 5% |
| 750,000 | 491,022 | 647,500 | 7.3529% | 7.5% |
| 1,000,000 | 478,032 | 630,000 | 9.8039% | 10% |
| 2,500,000 | 400,092 | 525,000 | 24.5098% | 25% |
| 5,000,000 | 270,192 | 350,000 | 49.0196% | 50% |
| 7,500,000 | 140,292 | 175,000 | 73.5294% | 75% |
| 9,000,000 | 62,352 | 70,000 | 88.2353% | 90% |
When is a Qualified Refundable Tax Credit not Beneficial?
Although a Qualified Refundable Tax Credit will not reduce the Pillar Two ETR as much as a non-qualifying tax credit, this does not mean that it is always beneficial.
In particular, where there is a high ratio of the substance-based income exclusion to GloBE income, it may be that a non-qualifying tax credit is actually more beneficial as this reduces the top-up tax payable.
An MNE has Pillar Two GloBE income of 10 million euros in Country X, covered tax is 200,000 euros and the substance-based income exclusion is 10 million euros.
In this circumstance, a Qualified Refundable Tax Credit of 100,000 euros actually increases top-up tax compared to an equivalent non-qualifying tax credit:
| No Tax Credit | QRTC | Non-QRTC | |
|---|---|---|---|
| Covered Tax | 200,000 | 200,000 | 100,000 |
| Pillar Two Income | 10,000,000 | 10,100,000 | 10,000,000 |
| Tangible Fixed Assets | 100,000,000 | 100,000,000 | 100,000,000 |
| Payroll Costs | 100,000,000 | 100,000,000 | 100,000,000 |
| Globe ETR | 2.0000% | 1.9802% | 1.0000% |
| Top-Up Tax % | 13.0000% | 13.0198% | 14.0000% |
| Substance-Based Income Exclusion | 10,000,000 | 10,000,000 | 10,000,000 |
| Top-Up Tax | Nil | 13,020 | Nil |
For more information, see: When is a Qualified Refundable Tax Credit not beneficial?
Accounting and Pillar Two Treatment
This generally follows the accounting treatment which treats them akin to government grants (for example under IAS 20.) As such, if the tax credit is treated as income in the financial accounts, no adjustment is required. However, if the tax credit is reflected in the current tax expense in the financial accounts, an adjustment is required.
Under the Pillar Two GloBE rules the adjustment is made by adding the amount to covered taxes (see Additions to Covered Taxes) and including it in Pillar Two GloBE income to reverse the accounting treatment.
Conversely, a tax credit that isn’t a Qualified Refundable Tax Credit is not treated as Pillar Two GloBE income, but as a reduction to covered taxes.
Therefore, if it was treated as income in the financial accounts, an adjustment to covered taxes must be made to reduce Pillar Two GloBE income and reduce covered taxes.
If a tax credit is partially refundable and partially non-refundable, the above rules apply separately to the refundable and non-refundable elements.
A tax credit that was a qualified refundable tax credit was posted in the accounts as:
Dr Current Tax – Balance Sheet
Cr Current Tax – P&L
As it’s reflected in the current tax expense and not as an above-the-line credit as income, the accounting entry is effectively reversed to show the credit as income by:
Dr Current Tax – P&L
Cr Other Income – P&L
If the tax credit had already been reflected as income, no Pillar Two GloBE adjustment would be required eg:
Dr Bank
Cr Other Income
Treating a tax credit as a qualified refundable tax credit as opposed to a non-refundable tax credit can have a significant impact on the Pillar Two GloBE ETR.
Company A has financial accounting income of 5,000,000 euros and covered taxes of 500,000 Euros.
Its ETR is 10%.
However, if the financial accounts included a Qualified Refundable Tax Credit of 250,000 euros in the current tax expense, this would be added back to increase covered taxes to 750,000 euros and reflected in income, to increase Pillar Two GloBE income to 5,250,000.
The new ETR would be 14.2%, which would significantly reduce any top-up tax liability.
An exception applies to tax credits that accrue to operations that are treated
under the equity method of accounting. The equity method is used when a company must account for the profits or loss of another entity it has a substantial, but not controlling, ownership interest in.
Under GLoBE rules, the income attributable to these entities is not included in the
consolidation of earnings and would therefore be excluded from the GloBe effective tax rate calculation. As such, tax credits attributable to these operations would
not be affected by the GLoBE rules.
Under Article 10 of the OECD Model Rules, a Qualified Refundable Tax Credit is a refundable tax credit paid as cash or available as cash equivalents within four years from the date when a constituent entity satisfies the conditions for receiving the credit. A common example of this could be an R&D refundable tax credit.
Qualified Refundable Tax Credits are treated income for Pillar Two GloBE purposes, as opposed to being reflected as a reduction in adjusted covered taxes. If this accords with the financial accounting treatment no adjustment is required. If the financial accounting treatment reflects these tax credits in the tax expense a GloBE adjustment is required.
If a refundable tax credit doesn’t meet the definition of a refundable tax credit, it would be a non-qualified refundable tax credit.
This is treated as a reduction to the tax expense for Pillar Two purposes. If this accords with the financial accounting treatment, no adjustment is required for calculating GloBE income. If not, the Credit to income in the P&L is effectively reversed and this is then a reduction from covered taxes.
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