Pillar Two: Distribution Tax Regimes

Some aspects of a distribution tax regime fit in with the Pillar Two GloBE Rules nicely.

For instance, the Estonian distribution tax relies on the financial accounts, just like the GloBE Rules. There are limited book-to-tax adjustments unlike in most traditional corporate income tax regimes.

However, the issue with distribution tax regimes relates to the timing of income and tax suffered for the purpose of calculating the GloBE ETR.

As such, ensuring that a distribution tax regime is accommodated by the Pillar Two GloBE Rules requires some specific adjustments to the general rule. Article 7.3 of the OECD Model Rules implements this. 

The key issue is that a company may not distribute profits for a number of years. They would have GloBE income but no or limited tax suffered on that income which would lead to a sizeable Pillar Two top-up tax liability. 

In the years that profits were distributed and a distribution tax charge was incurred, the tax levied may be substantial compared to the income for the year, resulting in no top-up tax. The tax suffered does not, therefore, tie in with annual taxable income. 

Distribution Tax Regimes under the GloBE Rules

The way that the Model Rules incorporate distribution tax regimes is by deeming an amount of tax to have been suffered on the income to the lower of:

•  the amount that would have been suffered under the 15% global minimum rate; and 
• the amount of distribution tax that would have been paid if the Constituent Entities in the jurisdiction had distributed all of their income during the fiscal year.

After doing this, a Deemed Distribution Tax Recapture Account is created.

This tracks the amount of the deemed distribution tax, and reduces it for losses and distributions.

If the Deemed Distribution Tax Recapture Account is not reduced to zero (on a rolling basis) within four years after the year of creation then the balance on the account is clawed back and included in adjusted covered taxes. 

A Deemed Distribution Tax Recapture Account is applied to the entire jurisdiction to ensure that jurisdictional blending applies. 

Note that the distribution tax regime election is made on an annual basis. This means that the next four years are considered in relation to the year of creation. Any future years where there is deemed distribution tax are then considered separately and there is a new four year window. This ensures that distribution tax is correctly tracked to the year of creation. 

How the Deemed Distribution Tax Recapture Account Applies

When the Distribution Tax Regime Election is made, any amount of deemed distribution tax for that year is added to the account. Then in the following four years, this account is reduced for:

• any distribution tax actually paid in the jurisdiction (in chronological order)
• a GloBE loss for the jurisdiction. The reduction in the deemed distribution account is based on the 15% global minimum rate * the amount of the GloBE loss and again applies in chronological order. 
• any Recapture Account Loss Carry-forward. This applies when a GloBE loss for a jurisdiction exceeds the amount in the Deemed Distribution Tax Recapture Account.

If the Deemed Distribution Tax Recapture Account is not reduced to zero by the end of the fourth fiscal year after it was created, the top-up tax is recalculated for the year of creation.

The outstanding balance on the distribution account is effectively clawed back and deducted from adjusted covered taxes for that year. 

Example – Deemed Distribution Tax Recapture Account

X Co is resident in Estonia which applies a distribution tax regime. The distribution tax is applied at 20% on a net basis (ie 100 of distributable reserves would suffer tax of 20 and the distribution would be 80).