Treatment of CFC Taxes: QDMTTs vs GloBE Rules

Income Inclusion Rule/Under-Taxed Payments Rule

Under Article 4.3.2(c) of the OECD Model Rules, tax paid under a CFC regime is generally allocated for GloBE purposes to the CFC entity.

However, this is subject to a ‘pushdown limitation’ so that tax that relates to passive income allocated to CFCs is restricted 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.

Any remaining covered tax is allocated to the owners (eg the company with the CFC regime in place).

This ensures that the tax allocated to a CFC in relation to passive income is sufficient to reach the 15% global minimum rate and does not artificially increase the covered tax of the CFC (which would increase its ETR and reduce any potential top-up tax liability).

The same applies to tax incurred by permanent establishments (PEs), subject to a special rule for PE losses.

Qualified Domestic Minimum Top-Up Tax

Article 5.1.3 of the Administrative Guidance provides that taxes of the Constituent Entity owner of foreign CFCs are excluded as under the GloBE rules. The exception to this is for taxes subject to the pushdown limitation. This ties with the standard GloBE treatment as above.

However, the QDMTT rules go one step further and requires that covered taxes in a QDMTT ETR calculation should not include taxes paid to another jurisdiction under a CFC regime that otherwise would be allocable under the GloBE rules to a constituent entity located in the jurisdiction.

This rule also applies to any taxes paid by an owner of a permanent establishment in the jurisdiction.

Instead, a CFC regime may provide a credit for a QDMTT imposed on the CFC.

The effect of this is that taxes paid under a CFC regime are not treated as a covered tax for the purposes of a QDMTT, and the effective tax rate may be lower than under the standard GloBE calculation.

One of the reasons for excluding CFC taxes is to avoid a feedback loop where the CFC tax is itself creditable. 

Feedback Loop – Example 

Lets assume Country X levies a corporate income tax at a 5% rate.

Company 1 is located in Country X and has taxable profit of 1M.

Its parent company (Parentco) is located in Country Y. Country Y has a CFC tax regime which levies a tax charge at a 12.5% rate. It provides for foreign tax credit for tax incurred in source jurisdictions.

For this example GloBE income equals the CFC taxable base and the push-down limitation doesn’t apply.

Country X therefore levies CIT of 50K.

ParentCo is taxed on the 1M taxable income at a 12.5% rate (ie tax of 125K). After the foreign tax credit tax of 75K is payable.

If Country X applies a QDMTT, there is GloBE income of 1M and covered tax of 125K ie an ETR of 12.5%. There is therefore a QDMTT liability of 25K.

However, there has now been 150K tax levied on the 1M of income. ParentCo has therefore overpaid CFC tax if it can credit the QDMTT. It has paid 75K of creditable tax in Country X (50K CIT and 25K QDMTT) but the liability should have been 50K (125K-75K).

It therefore requests a refund of 25K excess CFC tax.

But this then results in tax of 100K being paid which would then mean top-up tax of 50K should have been levied under the QDMTT. As such an extra 25K is payable.

This would then continue.

This feedback loop is one of the reasons that the OECD Administrative Guidance does not provide for CFC taxes to be included in the QDMTT ETR.

As such, this essentially amends the rule order for the collection of GloBE tax to: