Group financing companies are popular amongst MNE groups. They allow for the distribution of cash-flows amongst group members in a tax efficient manner, and enable a centralized hub for intercompany loans.
The tax implications of group financing companies are well documented. Not least the transfer pricing/arms-length requirements and the importance of mitigating withholding tax via double tax treaties and multilateral agreements (such as the EU Interest and Royalties Directive).
However, the global minimum tax under
Pillar Two of the OECD two-pillar solution also includes a number of provisions that can impact on group financing companies, and in particular the extent to which they will be subject to Pillar Two
top-up tax, unless they are reorganised.
– it is designed to pool assets (which may be financial and non-financial) from a number of investors (some of which are not connected);
– it invests in accordance with a defined investment policy;
– it allows investors to reduce transaction, research, and analytical costs, or to spread risk collectively;
– it is primarily designed to generate investment income or gains, or protection against a particular or general event or outcome;
– investors have a right to return from the assets of the fund or income earned on those assets, based on the contributions made by those investors;
– the entity or its management is subject to a regulatory regime in the jurisdiction in which it is established or managed (including appropriate anti-money laundering and investor protection regulation); and
– it is managed by investment fund management professionals on behalf of the investors.
This is clearly targeted at more traditional investment funds an a group financing company is also unlikely to meet all these requirements.
There is a specific carve-out for entities that are 95% owned by investment funds (or through a chain) and that operate exclusively or almost exclusively to hold assets or invest funds for the benefit of Investment Entities. If this was the case, the financing entity would be an excluded entity, although in most cases this is also unlikely to apply.
As, such the general Pillar Two provisions are likely to apply. The extent to which the group financing entity will be subject to top-up tax depends on whether it is located in a jurisdiction that is a low-taxed jurisdiction. Jurisdictional blending means that other entities in the jurisdiction (aside from any
investment entities or
minority owned entities) are taken into account when determining the Pillar Two effective tax rate (ETR).
As such, even if a group financing company had an ETR below 15% on a standalone basis, if there are other high-taxed group entities in the jurisdiction, the jurisdictional ETR may be above 15%.
In many cases, the determination of jurisdiction of choice for a group financing company would be determined by specific features of the domestic tax regime (eg the ability to fully offset interest against income) and the availability of an effective double tax treaty network to minimise withholding tax on inbound interest flows. The latter is generally present in more developed jurisdictions with a large number of treaty partners. Nevertheless, there are a number of low-tax jurisdictions that fit this requirement (eg Ireland). For more information on global tax rates, see our
Global Map of corporate tax rates.
Withholding Taxes
Group financing companies receive predominantly interest income from group companies. Expenses are interest payments to third party lenders or another group company.
When calculating the GloBE ETR, the starting point is the financial accounts of the constituent entity. Withholding tax on interest that is withheld by other group companies is reflected in the current tax expense of the group financing company given it is a liability of the financing company, and not the payor company (which effectively acts as a tax collection agent). Therefore, there should not be any specific Pillar Two adjustments required in regards to this.
If interest receipts were classed as a distribution of profits by the payor entity (for example if the amount of interest payable was dependent on the results of the company, many jurisdictions treat this as a distribution of profits). Interest withholding tax would then not apply, and under most double tax treaties, the dividend withholding tax rate would be used.
Article 4.3.2(e) of the OECD Model Rules requires withholding tax (and other net basis taxes) on distributions to be allocated to the paying entity for Pillar Two GloBE purposes. Therefore, if significant withholding tax on the distribution was reflected in the financial statements, this would need to be reallocated to the payor company. The result of this could be a lower GloBE ETR than expected based purely on an analysis of the financial accounts.
There is also a slight difference where the top-up tax is collected via a QDMTT. In this case, withholding taxes on dividends are allocated to the jurisdiction of the payee but not any net basis taxes. As such, care would need to be taken to ensure that any such tax remained with the group financing (recipient) company and was taken into account when calculating its ETR (potentially increasing the QDMTT ETR and reducing any top-up tax).
As such group financing companies receiving income as profit distributions as opposed to interest should carefully review the impact of the Pillar Two Rules.
CFC Pushdown Rule
Another aspect that should be considered is the Pillar Two CFC Pushdown Rule. A low-taxed group financing entity may fall under CFC Rules given it receives predominantly passive income. As such, a parent entity may be taxed directly on low-taxed profits irrespective of whether those profits are distributed.
Article 4.3.2(c) of the OECD Model Rules provides that CFC tax of a parent entity that is included in the financial accounts of the parent entity is allocated to the CFC.
As such, this could potentially reduce the Pillar Two ETR of a parent entity, whilst increasing the Pillar Two ETR of the CFC.
Note that the tax pushed down under the CFC rule is subject to a restriction in that it is limited to the lower of:
– the actual amount of covered tax that relates to the passive income in the parent jurisdiction; and
– the top-up tax percentage in the subsidiary jurisdiction multiplied by the subsidiary’s passive income taxed under the CFC/hybrid regime.
This is provided by Article 4.3.3 of the OECD Model Rules.
You can more on this at CFC Pushdown, and can see the operation with our CFC Pushdown Limitation Tool.
There is also an amendment to this where the jurisdiction applies a QDMTT. In particular, CFC tax is not pushed down for QDMTT purposes. As such, where there is a low-taxed group financing company with a parent that is taxed on its income under a CFC regime, the CFC tax is not included in the QDMTT top-up tax calculation of the group financing company.
