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Qualified Refundable Tax Credits

Pillar Two - Qualified Refundable Tax Credits

Contents

What is a Qualified Refundable Tax Credit?

Under Article 10 of the OECD Model Rules, a Qualified Refundable Tax Credit is a refundable tax credit paid as cash or available as cash equivalents within four years from the date when a constituent entity satisfies the conditions for receiving the credit. A common example of this could be an R&D refundable tax credit.

In order to be refundable, any amount of the tax credit that has not been used to reduce covered taxes (eg corporate income tax) is either payable as cash or cash equivalent.

Cash equivalent includes checks, as well as the ability to use the credit to discharge liabilities other than a Covered Tax liability. If the credit is only available to reduce Covered Taxes, i.e. it cannot be refunded in cash or credited against another tax, it is not a qualified refundable tax credit.

In addition, the refund amount must not be limited to any ‘tax liability’. It may therefore be that a refund limited by the amount of payroll taxes would not be a qualified refundable tax credit.

See our member’s articles:

R&D – practical examples of the treatment of R&D expenditure under the Pillar Two GloBE rules
Analysis of R&D Tax Credit Regimes Internationally and their Treatment under Pillar Two
How are Qualified Refundable Tax Credits Treated?

For the purposes of the Pillar Two GloBE rules, Article 3.2.4 of the OECD Model Rules provides that they are treated as Pillar Two GloBE income and not a reduction in covered taxes. 

Example – Refundable v Non-Refundable Tax Credits

An MNE has GloBE income of 10 Million euros and Covered Tax of 1 Million euros.

This would equate to an effective tax rate (ETR) of 10%. Top-up tax would be 500,000 euros (15%-10%* 10 million).

If a tax credit of 200,000 euros was granted, the treatment would depend on whether it was a refundable or non-refundable tax credit. 

If it was refundable, the 200,000 euros would be added to GloBE income to increase it to 10,200,000 euros. The revised ETR would be 9.804%. Top-up tax would be 529,992 euros (5.196% * 10,200,000). 

If the tax credit was non-refundable it would reduce covered tax to 800,000 euros. The ETR would be 8%. Top-up tax would therefore be 700,000 euros (7% * 10 Million).

 No Tax CreditQRTCNon-QRTC
Covered Tax1,000,0001,000,000800,000
Pillar Two Income 10,000,00010,200,00010,000,000
Globe ETR10.000%9.804%8.000%
Top-Up Tax %5.000%5.196%7.000%
Top-Up Tax500,000529,992700,000

Therefore, whilst both refundable and non-refundable tax credits reduce the ETR (and therefore increase the top-up tax percentage), generally a refundable tax credit would not decrease the ETR as much as a non-refundable tax credit.

Refundable Tax Credits and the Substance-Based Income Exclusion

There is some overlap between the Substance-Based Income Exclusion and Refundable Tax Credits. This is because Refundable Tax Credits effect GloBE income and the Substance-Based Income Exclusion is itself deducted from GloBE income to determine the profits (termed ‘excess profits’ in the OECD Model Rules) that are subject to the top-up tax percentage.

This results in the Substance-Based Income Exclusion reducing top-up tax at a slightly higher rate for refundable tax credits as opposed to non-refundable tax credits.

For example, if in the above example the Substance-Based Income Exclusion was 200,000 euros, this would reduce the profits on which the top-up tax percentage was levied.

For refundable tax credits this would reduce the profits to 10 million euros and for non-refundable tax credits to 9,800,000 euros. Therefore top-up tax would be 519,600 for a refundable tax credit and 686,000 for a non-refundable tax credit. This is a top-up tax reduction of 1.9608% for a refundable tax credit and a 2% reduction for a non-qualifying tax credit. 

The table below shows the top-up tax and percentage reductions for various levels of substance-based income exclusion.

Amount of Substance-Based Income Exclusion Top-Up Tax Refundable Tax CreditTop-Up Tax Non-Refundable Tax Credit% Decrease Refundable Tax Credit% Decrease Non-Refundable Tax Credit
200,000519,600686,0001.9608%2%
500,000504,012665,0004.9020%5%
750,000491,022647,5007.3529%7.5%
1,000,000478,032630,0009.8039%10%
2,500,000400,092525,00024.5098%25%
5,000,000270,192350,00049.0196%50%
7,500,000140,292175,00073.5294%75%
9,000,00062,35270,00088.2353%90%

When is a Qualified Refundable Tax Credit not Beneficial?

Although a Qualified Refundable Tax Credit will not reduce the Pillar Two ETR as much as a non-qualifying tax credit, this does not mean that it is always beneficial. 

In particular, where there is a high ratio of the substance-based income exclusion to GloBE income, it may be that a non-qualifying tax credit is actually more beneficial as this reduces the top-up tax payable. 

Example

An MNE has Pillar Two GloBE income of 10 million euros in Country X, covered tax is 200,000 euros and the substance-based income exclusion is 10 million euros. 

In this circumstance, a Qualified Refundable Tax Credit of 100,000 euros actually increases top-up tax compared to an equivalent non-qualifying tax credit:

 No Tax CreditQRTCNon-QRTC
Covered Tax200,000200,000100,000
Pillar Two Income 10,000,00010,100,00010,000,000
Tangible Fixed Assets100,000,000100,000,000100,000,000
Payroll Costs100,000,000100,000,000100,000,000
Globe ETR2.0000%1.9802%1.0000%
Top-Up Tax %13.0000%13.0198%14.0000%
Substance-Based Income Exclusion 10,000,00010,000,00010,000,000
Top-Up TaxNil13,020Nil

Accounting and Pillar Two Treatment

This generally follows the accounting treatment which treats them akin to government grants (for example under IAS 20.) As such, if the tax credit is treated as income in the financial accounts, no adjustment is required. However, if the tax credit is reflected in the current tax expense in the financial accounts, an adjustment is required.

Under the Pillar Two GloBE rules the adjustment is made by adding the amount to covered taxes (see Additions to Covered Taxes) and including it in Pillar Two GloBE income to reverse the accounting treatment.

Conversely, a tax credit that isn’t a Qualified Refundable Tax Credit is not treated as Pillar Two GloBE income, but as a reduction to covered taxes.

Therefore, if it was treated as income in the financial accounts, an adjustment to covered taxes must be made to reduce Pillar Two GloBE income and reduce covered taxes.

If a tax credit is partially refundable and partially non-refundable, the above rules apply separately to the refundable and non-refundable elements.

Qualified Refundable Tax Credits – Example 1

A tax credit that was a qualified refundable tax credit was posted in the accounts as:

As it’s reflected in the current tax expense and not as an above-the-line credit as income, the accounting entry is effectively reversed to show the credit as income by:

If the tax credit had already been reflected as income, no Pillar Two GloBE adjustment would be required eg:

Treating a tax credit as a qualified refundable tax credit as opposed to a non-refundable tax credit can have a significant impact on the Pillar Two GloBE ETR.

Qualified Refundable Tax Credits – Example 2

Company A has financial accounting income of 5,000,000 euros and covered taxes of 500,000 Euros.

Its ETR is 10%.

However, if the financial accounts included a Qualified Refundable Tax Credit of 250,000 euros in the current tax expense, this would be added back to increase covered taxes to 750,000 euros and reflected in income, to increase Pillar Two GloBE income to 5,250,000.

The new ETR would be 14.2%, which would significantly reduce any top-up tax liability.

Qualified Refundable Tax Credit Calculator

FAQs

Under Article 10 of the OECD Model Rules, a Qualified Refundable Tax Credit is a refundable tax credit paid as cash or available as cash equivalents within four years from the date when a constituent entity satisfies the conditions for receiving the credit. A common example of this could be an R&D refundable tax credit.

Qualified Refundable Tax Credits are treated income for Pillar Two GloBE purposes, as opposed to being reflected as a reduction in adjusted covered taxes. If this accords with the financial accounting treatment no adjustment is required. If the financial accounting treatment reflects these tax credits in the tax expense a GloBE adjustment is required.

If a refundable tax credit doesn’t meet the definition of a refundable tax credit, it would be a non-qualified refundable tax credit. 

This is treated as a reduction to the tax expense for Pillar Two purposes. If this accords with the financial accounting treatment, no adjustment is required for calculating GloBE income. If not, the Credit to income in the P&L is effectively reversed and this is then a reduction from covered taxes.

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