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Why most MNEs won’t benefit from the substance-based exclusion

The substance-based income exclusion is one of the key carve-outs in the GloBE income calculation.  

It provides a measure of relief from the Pillar Two top-up tax for an MNEs payroll and tangible fixed asset costs in a jurisdiction. The idea behind this is that the Pillar Two rules are aimed in part at combatting base erosion risks. Tangible assets and payroll are indicators of actual physical presence in a jurisdiction.
 
The substance-based income is based on 5% (excluding any transitional rules) of the value of qualifying payroll and tangible assets.  This is then deducted when determining ‘excess profits’ which is what the top-up tax percentage is applied to. It therefore directly reduces the profits that are subject to top-up tax.
 
However, for most MNE groups, the benefit of the substance-based income exclusion may be more apparent than real.
 
There are a number of reasons for this.
The Amounts at Stake
In many cases in order to achieve really noticeable reductions in the top-up tax liability, the payroll and tangible asset costs in comparison to the GloBE income would need to be substantial.
 
You can see the impact of the substance-based income exclusion in this simple interactive tool:

Lee Hadnum

Lee Hadnum

Lee is a qualified Chartered Accountant and Chartered Tax Adviser. A former Senior Tax Analyst at Bloomberg Tax, Lee began his career in Ernst & Young's Entrepreneurial Services department and has 20 years of international tax planning experience. Lee's books have been recommended by The Times, The Guardian and The Telegraph.

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