• Balazs Karancsi, Expert |

To combat base erosion and profit shifting (BEPS) the OECD’s new proposal (also referred to as “BEPS 2.0”) was released on October 12, 2020 in the form of two reports (blueprints) which are mainly referred to as Pillar One and Pillar Two. Pillar One aims at developing an approach for establishing taxable presence ("nexus") in the digitalised and consumer-facing economy. Pillar Two introduces the concept of a global minimum profit tax.

Pillar One and its impact on the asset management sector

How BEPS 2.0 will impact the financial services industry and more specifically the asset management sector has become clearer through the principles outlined in the blueprints. However, the blueprints still contain some uncertainties and issues to solve.

Amount A of Pillar One is targeting consumer facing businesses (“CFB”) and automated digital services (“ADS”). The blueprints treat financial services companies as out of scope, which group includes banking, insurance and most likely asset management groups. Uncertainty remains in this respect as certain asset management companies and their managed funds are not currently regulated.

It is expected that most asset management services will not be subject of new taxing rights under Pillar One as they will likely fall under the exemption of regulated financial services and / or because asset management services do not typically meet the definition of CFB or ADS activities.

For fintech companies there are additional questions as to whether they will be considered under financial services and therefore out of scope, as banking and insurance requirements do not necessarily apply to them.

Even though Pillar One will likely not be applicable to financial services, we encourage financial businesses to follow the OECD’s updates.

Pillar Two and its impact on the asset management sector

Pillar Two does not include any carve-out of financial services and should therefore be an area of focus for asset managers. Globally, Pillar Two addresses the tax base erosion issue and more specifically tax base erosion through transferring profits to low tax jurisdictions. For this purpose, under the Income Inclusion Rule (“IIR”), Pillar Two proposes a "top-up" tax that applies to the parent company based on the taxable income of foreign subsidiaries and permanent establishments if that income was subject to tax at an effective tax rate ("ETR") below a "minimum rate". An alternative to this approach is the so-called Undertaxed Payment Rule (“UPR”) where high tax countries would deny the deduction of payments that are going out from entities in their own jurisdiction to low tax countries.

To the extent it operates from low tax jurisdictions, the part of the financial services industry that exceeds the likely threshold of EUR 750 million will thus be affected.

Are there remedies to counter these new proposals?

From a first analysis of the blueprint it appears that the IIR will be difficult to mitigate where it is adopted. However, with respect to the UPR, some degree of mitigation is deemed to be available.

The solutions that MNE groups will put in place in order to mitigate the impact of Pillar Two will likely involve changing the transaction flows and/or selecting alternative jurisdictions unaffected (or impacted to a lower degree) by Pillar Two. In either case, transfer pricing consideration will be of high importance.

Finally, it must be noted that the top-up tax is triggered by the ETR based on the consolidated accounts, where an ETR is then also required to be calculated by jurisdiction. As one need to define the per country ETR it means intra-group transactions must be recorded at arm’s length.

What can you do?

Although asset managers will likely not be subject to Pillar One, those whose consolidated revenue exceeds EUR 750 million will be affected by Pillar Two. In order to limit your exposure:

  • Assess your global footprint to see if you are present in low or non-taxed jurisdictions;

  • Review your intercompany transaction flows in order to determine if the way they are structured would be impacted under proposed Pillar Two rules; and

  • Ensure that your intercompany transactions are priced at arm’s length and your profit allocation follows value creation.