Pillar 2 GloBE rules technical series: Understanding MNE group structures through the lens of the GloBE rules

One of the fundamental exercises for in-scope multinational enterprise (MNE) groups subject to Pillar 2 GloBE rules is to gain an in-depth knowledge of constituent entities (CEs) and permanent establishments (PEs) on a country-by-country basis. It is an important task that will help ensure calculations required to determine your top-up tax liability in each jurisdiction are accurate. In addition, understanding how an MNE group is determined, which CEs to include and exclude, and how to identify PEs and ultimate parent entities (UPEs) are vital considerations in applying GloBE’s top-up tax principles. So, how do you define an in-scope MNE group and its constituent parts, and what are the main issues groups face?

Firstly, the Pillar 2 GloBE rules apply to all MNE groups with annual revenue exceeding €750m in two of the last four fiscal years, based on consolidated financial statements over a four-year period. The aim is to ensure that a minimum tax rate is paid in each jurisdiction where a constituent entity within the group is based. 

For labelling purposes, the OECD describes an MNE group as any group that includes at least one constituent entity (CE) or permanent establishment (PE) that is not located in the ultimate parent entity’s (UPE) jurisdiction and is not an excluded entity (but see further below). However, to get a clearer picture of what an MNE group looks like, we need to get more comfortable with the exact meaning and impact of terms used when referring to MNE group structures.

A group is defined as a collection of entities that are related through ownership or control such that the assets, liabilities, income, expenses and cash flows of those entities are either:

• included in the UPE’s consolidated financial statements (or would be if it were required to produce consolidated financial statements), or
• excluded from the UPE’s consolidated financial statements solely on size, materiality grounds, or because the entity is held for sale. 

Similarly, an entity located in one jurisdiction with one or more PEs located in other jurisdictions is also considered part of the group, provided that the entity is not a part of another group.

Drilling down further

For the purposes of Pillar 2 rules, it’s important to drill down further to define CEs, PEs and UPEs.

Based on the definition that an entity is defined as any legal person (other than an individual) or an arrangement that prepares separate financial accounts (such as a partnership or trust) then a CE is going to be any entity that is included in a group, or a PE of a main entity.

A UPE is:

• owns, directly or indirectly, a controlling interest in any other entity, and

• is not owned, directly or indirectly, by another entity with a controlling interest

So based on the above, an entity cannot be considered the UPE of a group if there is another entity higher in the ownership chain that is required, or would have been required under acceptable financial accounting standards, to consolidate that entity in its financial statements on a line by line basis. Acceptable financial accounting standards are generally defined as International Financial Accounting Standards (IFRS) or Generally Accepted Accounting Principles (GAAP). 

To be considered an MNE group, the UPE must have, directly or indirectly, at least one foreign subsidiary or PE in a jurisdiction outside that of the UPE, even if that foreign subsidiary or PE doesn’t earn income.

Additional complexities

When discussing UPEs, it’s essential to establish what constitutes a controlling interest, as this is critical to assessing how the GloBE model rules apply. A controlling interest is an ownership interest in an entity where the interest holder:

• is required to consolidate the entity’s assets, liabilities, income, expenses, and cash flows on a line-by-line basis in accordance with an acceptable financial accounting standard; or
• would have been required to consolidate the entity’s assets, liabilities, income, expenses, and cash flows on a line-by-line basis if the interest holder had prepared the consolidated financial statements.

However, it gets more complex when group structures are covered by a number of different global tax regimes or where joint ventures (JVs) and JV groups are involved. For the purposes of the GloBE rules, in most cases, a JV group is treated as an MNE Group within an MNE Group. To understand how this works, it’s important to unpack the definition and impact of a JV.

Firstly, JVs are not CEs of an MNE Group because their income, expenses, assets, and liabilities are not consolidated with the rest of an MNE group on a line-by-line basis. However, the low-taxed income of a JV may be brought within the scope of the GloBE rules for an MNE group owning interests in the JV, if its financial results are reported under the equity method in the consolidated financial statements of the UPE. The key is to look for a related party with at least a 50% ownership interest.  An ownership interest means any equity interest that carries rights to the profits, capital or reserves of an entity,

A JV subsidiary is considered an entity whose assets, liabilities, income, expenses, and cash flows are consolidated by a JV under an acceptable financial accounting standard. A JV Group is comprised of a JV parent (which cannot itself be a UPE subject to Pillar 2, nor an excluded entity, nor an entity that holds assets or investment funds for the benefit of its investors) and its JV subsidiaries.

Determining the location of entities under Pillar 2

The location of PEs and CEs under Pillar 2 is essential as it determines the applicable tax jurisdiction for top-up tax calculations. It’s helpful to refer to Article 10 of the OECD’s model rules for definitions that will help define a number of situations and how to apply the rules accordingly, including information on stateless entities, and also how to apply tax treaty terms to assess where a particular entity or PE is located for Pillar 2 purposes.   

For PEs, the jurisdiction location is determined by a number of situations. For example, 

• A treaty jurisdiction applies if the PE is treated as resident in a jurisdiction.
• Where a treaty requires the authorities to agree which is the jurisdiction of residence, and no agreement exists, or if the treaty does not give relief and the constituent entity is tax resident in both jurisdictions, the Pillar 2 jurisdiction is determined by the ‘taxable presence’ location.  This is where the most covered tax (excluding CFC tax) is paid, or where the greatest substance is located.
• A taxable presence jurisdiction applies if the PE is located in a jurisdiction where no tax treaty applies, but the PE has income subject to tax by that jurisdiction on a net basis.
• If a PE is located in a jurisdiction with no corporate income tax system, but the PE meets the OECD definition of a PE, it will be treated as located in that no corporate tax jurisdiction for Pillar 2 purposes.

If none of the above applies or it is unclear if an entity within the MNE group is based in a jurisdiction that conforms to any of these scenarios, the entity will be treated as a stateless entity. A stateless entity can further complicate the MNE group determination and top-up tax calculations. 

In assessing jurisdictional location of entities, there is a distinction between flow through entities and non-flow through entities.

For non-flow through entities, the tax jurisdiction location is based on where the entity is created, managed or using similar criteria. If the location cannot be determined on that basis, the Pillar 2 location is based on the jurisdiction where the entity was created (the creation jurisdiction).

Flow through entities are treated as stateless entities, except where they are UPEs, or are required to apply an income inclusion rule (IIR) as an intermediary entity, when they are treated as located in the jurisdiction where they were created. 

Understanding excluded entities

A further piece of the puzzle is to understand excluded entities. These are entities that fall within the scope of the GloBE rules but are not considered CEs. It’s important to note that while excluded entities are not subject to the operative provisions of the GloBE rules, their revenue is still taken into account for purposes of applying the consolidated revenue threshold test to determine whether an MNE Group is in scope of the GloBE rules.

Excluded entities include governmental entities such as sovereign wealth funds, international organisations, and non-profit organisations. Other excluded entities include pension funds and any investment funds or real estate investment vehicles that are the UPE of an MNE group.

In addition, entities owned by excluded entities that hold assets or invest funds and only carry out ancillary activities, or that derive income substantially from excluded from the GloBE tax base, are also treated as excluded entities. 

So, where an MNE group has an excluded entity or part of an excluded entity subgroup, those entities are not included in jurisdictional calculations of a qualified domestic minimum top-up tax (QDMTT), IIR, or undertaxed profits rule (UTPR). However, as mentioned earlier, excluded entities do have to be included in the revenue threshold test. Subject to the further comments noted below, this ensures that where an excluded entity has an ownership interest in a non-excluded entity, the income of the non-excluded entity is included in jurisdictional top-up tax calculations. 

Entities owned by excluded entities can themselves be excluded entities where they meet an ownership and activities test. This operates such that where 95% of the subsidiary entity’s value is owned directly or indirectly through a chain of excluded entities, the subsidiary will be an excluded entity where it operates exclusively, or almost exclusively, on behalf of that excluded entity or only carry out activities that are ancillary to those carried out by the excluded entity. 

An entity is also an excluded entity where at least 85% of the value of the entity is owned (directly or through a chain of excluded entities) by one or more excluded entities (other than a Pension Services Entity), provided that substantially all of the entity’s income is excluded dividends or excluded equity gains or losses that are excluded from the computation of GloBE Income or Loss.

References above to ‘almost’ and ‘substantially’ require an element of judgement where it will be instructive to refer to OECD guidance on interpretation.

Main issues and next steps

Once the MNE group structure has been determined, you can apply the consolidated revenue threshold test of €750m with more confidence. However, there will always be certain issues that need further consideration in terms of the requirement to report revenue in two of the four previous fiscal years. Examples include where a new MNE group has been recently created or when mergers and de-mergers impact GloBE reporting requirements. 

As a first step, it’s essential to understand an MNE group structure and its constituent parts through the lens of the Pillar 2 GloBE rules. Achieving a higher level of clarity on how all the pieces fit together within the MNE group will help navigate what is a new and complex global tax regime. 

The next article in this Pillar 2 GloBE rules technical series will detail further complexities of MNE group structures, what groups need to consider and take a closer look at issues such as non-material constituent entities (NMCEs) and JV groups. 

For a more comprehensive explanation of MNE group structure definitions, please listen to our webcast #2: Pillar 2 Technical Series: MNE Group Determination, where you can download technical slides giving examples and more in-depth details and examples.

You may also be interested in the first webcast in this technical series. See #1: Pillar 2 Technical Series: Overview & Transition Years.