The Substance-Based Income Exclusion & Low Profit Margin Companies

The substance-based income exclusion (SBIE) under Article 5.3 of the OECD Model Rules favours capital intensive and certain low profit margin companies.

These companies stand to benefit the most given the SBIE is based on the amount of tangible fixed assets and payroll costs in a jurisdiction. 

However, such companies could also benefit from significant tax credits and other allowances in a jurisdiction given the level of tangible assets and payroll costs. This would operate to reduce the Pillar Two effective rate and potentially lead to top-up tax.

Therefore, there is to a certain extent an element of offset, with the higher substance-based income exclusion offsetting the lower effective tax rate.

The SBIE also lessens the impact of tax credits for low-profit margin companies.

The higher ratio of expenses to income means the SBIE carve-outs for these companies will be more significant, reducing top-up tax payable and lessening the impact of the GloBE rules whilst counteracting the impact of expenditure-based tax credits on the overall tax liability.

In this article we look at a detailed example.