In broad terms, the intention of the Pillar Two Rules is to determine the effective tax rate of group companies and compare this to the global 15% minimum rate.
It achieves this by allocating income and tax to ‘constituent entities’ in a jurisdiction and then blending all of the income and tax together to calculate a jurisdictional effective tax rate (ETR).
Importantly the definition of a constituent entity in Article 1.3 of the OECD Model Rules includes permanent establishments.
This means that a company carrying out business activities in another jurisdiction through a PE could be within the scope of the Pillar Two rules in the source jurisdiction.
Each PE is generally treated as separate both from the main constituent entity as well as any other PEs (aside from Stateless PEs).
The Pillar Two Rules include a number of specific provisions to address the application of the rules to PEs. The key issues are:
– Is there a PE for the purpose of the Pillar Two Rules?
– Where is the PE located?
– What income is allocated to the PE?
– What covered taxes are allocated to the PE?
Under Article 10 of the OECD Model Rules, a PE can exist in four cases:
Firstly, if there is a tax treaty in force between the two jurisdictions, the PE definition in the tax treaty applies providing the place of business is treated as a PE for the purpose of that treaty and the source state taxes the income attributable to the PE in accordance with a provision similar to Article 7 of the OECD Model Tax Convention.
Secondly, if there is no tax treaty in force, and a PE is applied under domestic law, the Pillar Two GloBE rules generally apply to treat the PE under domestic law as a separate PE providing the source country taxes the PE on a net basis in a similar way to its own residents.
Thirdly, if there is no corporate income tax system, there is deemed to be a PE for the purposes of the Pillar Two GloBE rules if there would be a PE under the OECD Model Tax Convention and the source state would have had the right to tax the income attributable to it in accordance with Article 7 of the OECD Model Tax Convention.
Finally, a PE is deemed where there is no PE under the three cases above, and the income deriving from the activities of the PE is exempt in the residence jurisdiction (ie the residence of the main entity). This is referred to as a Stateless PE.
It’s worthwhile noting that the effect of these rules is that it is possible to have a PE for Pillar Two even if there is no PE for the purposes of a double tax treaty, and vice versa.
For instance, under many double tax treaties, the profits of airlines in international traffic are taxed in the place of effective management.
This would mean that there would be no Pillar Two PE (as the source state does not tax the income under a provision similar to Article 7 of the OECD Model Tax Convention) and the profits and tax would be allocated to the main entity.
The location of the PE is of key importance as this determines in which jurisdiction the income and covered tax are brought into account for calculating the jurisdictional ETR.
Under Article 10 of the OECD Model Rules, the location of a PE is the source jurisdiction except for PEs that fall within the final definition of a PE (stateless PEs – above) where the PE income is exempt from tax in the main entity.
As a permanent establishment (PE) is treated as a separate constituent entity for Pillar Two GloBE purposes the Pillar Two GloBE income of a PE needs to be determined.
However, the Pillar Two GloBE income rules rely on the financial accounts of the entity which may include the profits attributable to a PE (ie for financial accounting purposes, a PE is not always recognized and there may not be separate financial accounts).
Therefore, Article 3.4 of the OECD Model Rules includes specific provisions to allocate income between an entity and its PEs.
Where a PE exists under a tax treaty, domestic law or would have existed in a jurisdiction with no corporate income tax if there was a tax treaty in place if there are separate financial accounts for the PE, these apply, and the net income or loss is used.
If there are no financial accounts in place, accounts would need to be prepared based on the accounting standard the UPE used to prepare the consolidated financial accounts. The amount of income and expenses attributed to the PE are based on the provisions of the relevant tax treaty or domestic law.
Note that whilst the tax treatment of the income in the PE jurisdiction has no impact on the allocation to the PE jurisdiction, timing differences may adjust the treatment.
For Stateless PEs, the amount attributable to the PE is the amount of tax-exempt income as well as any expenses not taken into account by the main entity because they are attributable to foreign activities.
Given income or losses are attributable to PEs if they are included in the financial accounts of the main entity they would need to be deducted when calculating Pillar Two GloBE income.
If there is a loss in a PE, this will be treated as an expense of the main entity to the extent that the loss of the PE is treated as an expense for domestic tax purposes.
Pillar Two GloBE income that is subsequently earned by the PE is treated as income of the main entity up to the amount treated as an expense by the main entity.
This has the effect of increasing the ETR of the main entity in the year of the loss (as Pillar Two income is reduced) and reducing it in future years. This ties in with the potential cash-flow issues that may arise from a loss-making PE.
As PEs are treated as separate constituent entities for the purpose of the Pillar Two GloBE rules, there needs to be some way of allocating adjusted covered taxes to the PE for the purpose of calculating the jurisdictional ETR.
In some cases, the main entity may not have separate financial statements for the PE, and the taxes paid by the PE may be included in the taxes incurred by the main entity.
Covered taxes are allocated to a PE under Article 4.3 of the OECD Model Rules by the following mechanism:
1. Identify the PE’s share of the main entity’s domestic taxable income. This should be able to be identified from the corporate income tax return process.
2. Identify the main entity’s tax liability arising from the PE’s taxable income. This is straightforward if the PE is subject to a separate tax rate. In other cases, the main entity’s tax liability (before any foreign tax credit) needs to be allocated to the PE.
3. Determine the amount of any tax credit allowed in the main entity in respect of the PE’s taxable income.
The tax determined using these steps is deducted from the covered tax for the main entity and allocated to the PE for inclusion in the standard jurisdictional blending calculation.
If there is a loss under the Pillar Two GloBE rules for a PE, Article 3.4.5 of the OECD Model Rules provides that this will be treated as an expense of the main entity to the extent that the loss of the PE is treated as an expense for domestic tax purposes. Pillar Two GloBE income that is subsequently earned by the PE is treated as income of the main entity up to the amount treated as an expense by the main entity.
As the loss is allocated to the main entity, Article 4.3.4 of the OECD Model Rules also provides that any adjusted covered taxes associated with the income are also allocated to the main entity up to the maximum corporate income tax on the income in the jurisdiction.
Note in this case, any deferred tax asset created and subsequently unwound in the main entity isn’t taken into account in adjusted covered taxes by either the PE or the main entity.
This does not affect the treatment of the domestic law tax loss, which is subject to the general deferred tax regime.
Yes, the definition of a constituent entity in Article 1.3 of the OECD Model Rules includes permanent establishments.
There are a number of special provisions in the Pillar Two Rules that apply to Permanent Establishments (PEs). This is because PEs are treated as a separate constituent entity from the main entity for Pillar Two purposes. As such, there needs to be a uniform way of allocating income and tax to the PE to calculate its ETR (or its part in the jurisdictional ETR).
On December 19, 2024, Luxembourg’s Parliament approved a law to amend its Global Minimum Tax Law to implement aspects of the OECD Administrative Guidance.
The Isle of Man has issued a domestic top up tax cessation form for entities that are located in the Isle of Man that are intending to enter liquidation, dissolution or any other form of winding up, or otherwise cease to be located in the Isle of Man for DTUT purposes
On December 13, 2024, the Tax Laws (Amendment) Act, 2024 was published in the Official Gazette. It comes into force on December 27, 2024 and includes a domestic minimum top-up tax.
On December 17, 2024, the Dutch Parliament approved a draft law to amend the GMT Law. This includes a number of amendments to implement further aspects of the February 2023 and July 2023 OECD Administrative Guidance and some aspects of the December 2023 OECD Administrative Guidance.
On December 17, 2024, the Chamber of Deputies approved Bill 3817/24 that repeats Provisional Measure No. 1,262/2024 and implements the DMT. It will be sent to the Senate.
In December 2024, the Malaysian Inland Revenue Board (MIRB) issued guidance on the interpretation and administration of the Pillar Two global minimum tax applicable from January 1, 2025.
On 12 December 2024, the Cyprus House of Representatives voted to approve local legislation to implement Pillar 2. The Law will come into effect once it is published in the official Government Gazette.
On December 15, 2024, Bahrain issued Decision no. (172) of 2024 to provide for the Executive Regulations for the DMTT law. This provides the detailed rules for the operation of the DMTT.
On December 10, 2024, the Australian GloBE legislation received Royal Assent.
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