In this blog we address the issue of asymmetric treatment caused by the exclusion of equity gains/losses rule in connection with participation impairments and recovery of participations held by a Swiss entity. The Equity Investment Inclusion Election can prevent double taxation in such cases.
On 18 June 2023, the Swiss people voted in favor of implementing the global minimum tax framework (BEPS Pillar Two) as agreed by the OECD/G20 Inclusive Framework.
In this blog series our experts are highlighting practical application issues Swiss MNE groups should think about in order to manage and optimize future top-up tax consequences.
In this blog we address the exclusion of equity gains/losses rule and how it interacts with (tax deductible) participation impairments and (taxable) impairment recoveries of participations held by a Swiss entity. Would the Equity Investment Inclusion Election eliminate any potential double taxation issues?
What do the GloBE Model Rules say?
The GloBE model rules in Article 3.2.1. c) state that equity gains or losses are to be excluded from an entity’s GloBE income or loss. Based on the defined terms in the model rules, an equity gain or loss means a gain, profit or loss included in the financial accounting net income or loss of the constituent entity arising from changes in the fair value of an ownership interest, among others. As impairments are consequences of changes in fair values, they are subject to this rule.
On the other hand, there is no model rule that would exclude the current tax benefit from the impairment from the covered tax calculation.
Further, when there is a recovery of the impairment or a recapture initiated by the tax authority, the recovery (income) is excluded from the GloBE income as well. The current tax due on the recovery does, however, also not qualify as a covered tax based on Article 4.1.3. a) of the model rules.
How is this relevant for Swiss MNE Groups?
Based on the GloBE rules mentioned above, an impairment of a participation held by a Swiss entity would lead to a correction of the GloBE income as the impairment is disregarded. However, the corresponding current tax benefit is not removed from the covered tax calculation. This asymmetry leads to an increase in income while covered taxes remain, and thus to a decrease of the GloBE effective tax rate (ETR) of the Swiss entity and may lead to a (higher) top-up tax.
If the Swiss parent entity can recover the impairment in the future or a tax authority requests a recapture of the impairment, the income tax paid on the release of the impairment does not qualify as a covered tax. In this scenario, however, the GloBE ETR is not negatively affected as both the additional income (recovery) as well as the respective current tax are excluded for the purpose of the GloBE ETR calculation.
As a consequence of the above, the rules would lead to an asymmetric treatment of the tax impact of the impairment and in essence result in double taxation – a top-up tax when building the impairment and a current tax (with no GloBE “relief”, in particular no refund of previous top-up tax) when releasing it.
How can this issue be solved? Would the Equity Investment Inclusion Election be helpful?
With the Administrative Guidance the OECD relased in February 2023, an Equity Investment Inclusion Election has been provided with respect to a jurisdiction that includes profit, gain or loss with respect to an equity investment in the domestic tax base. The election is generally a five-year jurisdictional election which a Filing Constituent Entity may make.
Based on this election the impairments of a participation as well as the recovery of it will be taken into account for GloBE income and covered tax purposes and hence a symmetry is achieved – a clear overall objective of the GloBE rules. However, there are still different views on how this election may be applied in Switzerland and some uncertainties regarding the application of this election, e.g. whether the respective impairments need to be accounted for in the single entity financial statements used for consoliation. Furthermore, respective developments in the application of such an election in other countries (which have a similar system regarding tax deductibility of investment impairments) are to be monitored.
In any case, as of now it is recommended that the impairments are booked not only for statutory purposes but also in the reporting packages of the Contituent Entity prepared under the group accounting standard such as IFRS..