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Group Financing Companies and Pillar Two

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 proposed 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. 
In this members article we look at group financing companies from the perspective Pillar Two. 
Excluded Entities
The Pillar Two Rules can classify certain entities as excluded entities. Whilst their revenue is still taken into account for the purpose of determining the 750 million revenue threshold, excluded entities are not subject to top-up tax or payment obligations under the income inclusion rule or the under-taxed payments rule
Investment funds that are the UPE of an MNE group are excluded entities.  It is unlikely in most cases that the group financing company would be the UPE. In addition, the definition of investment fund in Article 10 of the OECD Model Rules is relatively restrictive in that it needs to meet all of the following conditions:
  • 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