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Pillar Two Arms-Length Requirement

Pillar Two - Arms Length Requirement

Arms-length basis for Intra-Group Transactions

Article 3.2.3 of the OECD Model Rules applies an arms-length requirement for transactions between constituent entities in different jurisdictions. This should generally apply in any case due to transfer pricing policies under domestic tax laws.

Although these transactions may be eliminated in the consolidated financial accounts, given the Pillar Two GloBE income or loss is based on the entity’s financial accounts they would need to be considered.

If the financial accounts agree to an arms-length basis no adjustment would need to be made. However, if for tax purposes a different value is used to apply the arms-length basis an adjustment to Pillar Two GloBE income would then need to be made.

Note that this only applies to the value of intra-group transactions, not the timing of intra-group transactions. Therefore, no adjustment is required to adjust the timing of an item in the financial accounts to the timing under domestic tax law.

The arms-length basis doesn’t generally apply to transactions between group entities in the same jurisdiction, as the jurisdictional blending rules will generally eliminate them anyway. For more information on jurisdictional blending, see ETR calculation and top-up tax.

There are two exceptions to this:

1. a transfer of an asset between group entities in the same jurisdiction that gives rise to a loss that is included in the Pillar Two GloBE income or loss. In this case the arms-length basis needs to be applied otherwise an MNE could artificially manufacture losses.

2. Transactions between a minority-owned constituent entity or investment entity and other constituent entities aren’t subject to the standard jurisdictional blending and their ETR is calculated on a standalone basis. As such the transactions wouldn’t be eliminated in the jurisdictional blending calculation. Therefore, an arms-length requirement applies to these transactions. For more information, see minority-owned entities.

Arms-Length Requirement – Example

MNECo1 is located in Country A, which has a corporate income tax rate of 20%.

MNECo2 is located in Country B, which has a 0% rate of corporate income tax.

MNECo1 and MNECo2 are both wholly owned by UPE, and this is an MNE group within the scope of Pillar Two.

image showing group structure for example showing the pillar two arms-length requirement

MNECo2 provided group marketing services to MNECo1. The financial accounts of both MNECo1 and MNECo2 reflect expenses and income of 5,000,000 euros.

However, for tax purposes, MNECo1 deducts 7,500,000 euros.

In this case, 2,500,000 euros is effectively not subject to tax in Country A and is not subject to top-up tax in Country B.

As such, to apply the arms-length requirement MNECo1 is required to add back 2,500,000 euros of its expense for the Pillar Two GloBE income calculation, and MNECo2 is required to reflect additional income of 2,500,000 euros in its Pillar Two GloBE income calculation.

Adjustments can also apply when there is a unilateral transfer pricing adjustment.

For instance, if in the above example MNECo1 had deducted an expense of 3,000,000 euros for tax purposes as a result of a unilateral transfer pricing adjustment, this would increase taxable income subject to corporate income tax by 2,000,000 euros in MNECo1, but that 2,000,000 of income is also subject to top-up tax in MNECo2.

Therefore, MNECo1 is required to reduce its expense in the calculation of Pillar Two GloBE income by 2,000,000 euros and MNECo2 is required to reduce its Pillar Two GloBE income by 2,000,000 euros.

Note that if the result of an adjustment to the arms-length basis would result in double taxation or non-taxation, then no adjustment is made.

For instance, if in the example above MNEco2 reflected income of 4,000,000 euros for tax purposes and the corporate income tax rate was 10%, no adjustment would be required.

Although the deduction in MNECo1 is 5,000,000 euros, this is included in Pillar Two GloBE income and is subject to top-up tax in MNECo2. Therefore, no adjustment is permitted.


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