Inclusive Framework BEPS Agreement

On 14 March 2022, the OECD/G20 Inclusive Framework on BEPS (IF) published the following documents to provide comprehensive technical guidance on the interpretation and application of the GloBE Model Rules released in December last year:

• Commentary on the GloBE Model Rules (228 pages)
• Illustrative Examples (49 pages)

The OECD’s press release on the release of the above documents can be accessed via this link.

The Commentary includes detailed elaboration on each article in each chapter (i.e. Chapters 1 to 10) of the GloBE Rules whereas the Illustrative Examples include examples on selected articles in Chapters 2 to 7 of the GloBE Rules.

We highlight below some of the issues discussed or clarified in the Commentary and the Illustrative Examples. Please note the list below is not an exclusive list of issues of interest. A Hong Kong BEPS publication with more detailed discussion of the Commentary and Illustrative Examples from a Hong Kong business perspective will be issued separately.

Some of the issues addressed or clarified in the Commentary are:

1. Computation of the EUR 750m annual consolidated revenue threshold – although excluded entities are not subject to the GloBE Rules, the revenue of any excluded entities has to be included in applying the threshold to the extent such revenue is consolidated into the group’s financial accounts.
   
2. Excluded Dividends and Excluded Equity Gains or Losses – please see the tables below (extracted from the Commentary) which summarise what are included and excluded in the computation of GloBE income or loss in terms of dividend income and gains/losses from disposal of ownership interest:
   

   Dividends or other distributions received or accrued in respect of:	Portfolio Shareholding (i.e. carrying rights to less than 10% of the profits, capital, reserves or voting rights of the distributing entity)	Non-Portfolio Shareholding (i.e. carrying rights to at least 10% of the profits, capital, reserves and voting rights of the distributing entity)
   Short-term shareholding (i.e. economically held for less than one year)	Included Dividend	Excluded Dividend
   Non- Short-term shareholding (i.e. economically held for at least one year)	Excluded Dividend	Excluded Dividend

   Gains and losses arising from the disposition of	Portfolio Shareholding (I.e. carrying rights to less than 10% of the profits, capital, reserves or voting rights of the distributing entity)	Non-Portfolio Shareholding (i.e. carrying rights to at least 10% of the profits, capital, reserves and voting rights of the distributing entity)
   Short-term shareholding (i.e. economically held for less than one year)	Included gain/loss	Excluded gain/loss
   Non- Short-term shareholding (I.e. economically held for at least one year)	Included gain/loss	Excluded gain/loss

3. The 5-Year Election on unrealised revaluation gains/losses (i.e. election to use realisation method in lieu of fair value accounting) – under this election, gain or loss associated with an asset or liability will arise when the same is disposed and all fair value or impairment gain or loss will be excluded when computing the GloBE income or loss. A Five-Year Election remains in force indefinitely until a group actively revokes it. The election cannot be revoked within five fiscal years after an Election Year, and another election cannot be made within five fiscal years after a revocation year.
4. Included Revaluation Method Gain or Loss – For gains/losses from revaluation of property, plant and equipment (PPE) recognised in Other Comprehensive Income (OCI) under the revaluation model of the financial accounting standards that would not subsequently pass through the profit or loss account, the GLoBE Rules require such gains/losses (i.e. the gross amount without netting off any associated current or deferred Covered Taxes) to be included in the computation of the GloBE income or loss. The associated current or deferred Covered Taxes will then be included in the Adjusted Covered Taxes amount. The Commentary clarifies that if deferred tax expense is recognised on revaluation gains in the OCI despite the gains being exempt from local tax (because the deferred tax expense is calculated on the basis that the carrying amount of a PPE will be realised by using it to generate taxable profits rather than through sale), Covered Taxes should not be increased by the deferred tax liability recognised if the sale of the asset will be exempt from local tax.
   
5. International shipping income exclusion – In considering whether income from leasing of ships on a bare boat charter basis (dry lease income) can qualify for the exclusion, references are made to the Commentary on Article 8 of the OECD Model Tax Convention. In particular, dry lease income will not be regarded as international shipping income except when the leasing is an ancillary activity of an enterprise engaged in the international operation of ships. Under the GloBE Rules, dry lease income is considered as international shipping income (instead of ancillary) as an exception, under the condition that the lessee is also a constituent entity (CE) of the same MNE Group and has International Shipping Income. The GloBE Rules also exclude income from bare-boat chartering-out by a shipping company to another shipping enterprise (an enterprise that operates ships) that is not a CE provided that the charter does not exceed three years. It would appear from the above that income derived by a banking group that provides ship financing (e.g. by means of a finance lease) to other shipping enterprises and that does not itself engage in any international operation of ships will not qualify for the exclusion.
   
6. Definition of “Covered Taxes” – taxes on net income under Pillar One and taxes arising from the Subject to Tax Rule are regarded as Covered Taxes.
   
7. The GloBE Loss Election – When the election is made, the adjusted deferred tax approach (i.e. the mechanism to address temporary differences set out in Article 4.4) does not apply and temporary differences may result in top-up tax. The election provides for an indefinite carry-forward of the GloBE Loss Deferred Tax Asset. It is generally expected to be of greatest utility as a simplification in jurisdictions that do not impose a corporate income tax or impose one at a very low rate.
   
8. Tangible asset carve-out –The carve-out includes the carrying value of a leased tangible asset in the same way as an asset owned by a CE. For purposes of the GloBE Rules, a right-of-use asset in respect of a tangible asset will be treated the same as ownership of the tangible asset notwithstanding variations in the treatment of the asset in the financial accounts. Separately, Agreed Administrative Guidance as part of the Implementation Framework will be developed to address cases where a tangible asset is not located in any jurisdictions (e.g. a satellite) or located in multiple jurisdictions at different times during a fiscal year (e.g. an aircraft of an international airline).
   
9. Treatment of deferred tax accounting attributes under the transition rules – The transition rules allow existing deferred tax accounting attributes at the beginning of the Transition Year, including deferred tax assets resulting from prior year losses, to be used in the calculation of the effective tax rate under the GloBE Rules. As an example, if a CE incurred a tax loss of ($100) in a year before the GloBE Rules applied, a deferred tax expense of ($15) (i.e. deferred tax benefit) will be included in the Total Deferred Tax Adjustment Amount (i.e. an increase in the Covered Taxes amount) when the associated tax loss is used in a fiscal year in which the GloBE Rules apply. However, utilisation of such deferred tax benefit associated with the carried forward tax losses is subject to the losses being able to be utilised under the local tax law.
   
10. Definition of “investment fund” – there is a detailed discussion on the various criteria for meeting the investment fund definition, including a clarification that the “regulatory regime” requirement is intended to encompass the different approaches to prudential regulation of investment funds and fund managers (including appropriate anti-money laundering and investor protection regulation). However, since an investment fund would not normally be required to consolidate the accounts of its investments under IFRS 10, it may not be common for an investment fund to meet the annual consolidated revenue threshold to be in-scope of the GloBE Rules.
    
11. Definition of “permanent establishment” in a tax treaty context as it applies to the operation of aircraft in international traffic – a Hong Kong resident airline with an office in Jurisdiction A through which it carries out part of its international aircraft transportation business will not be regarded as having a PE in Jurisdiction A for the GloBE Rules purpose if Jurisdiction A is not able to tax the profits of the PE by virtue of Article 8 of the tax treaty between Hong Kong and Jurisdiction A. 

The Illustrative Examples include a number of examples to illustrate the application of various aspects of the GloBE Rules, including:

1. Application of the top-down approach, the split-ownership rules and the offset mechanism under the Income Inclusion Rule;
   
2. Application of the Undertaxed Payment Rule (UTPR) and the allocation of top-up tax under the UTPR;
   
3. Determination of the short-term portfolio shareholding when shares are acquired / sold in tranches and computation of the amount of excluded dividends in computing the GloBE income or loss;
   
4. Special rules for intra-group financing arrangement under which the intra-group financing expenses of a CE in a low tax jurisdiction may be excluded in computing the GloBE income or loss; and
   
5. Situation where a GloBE top-up tax is imposed in a fiscal year where a CE has a local tax loss that is greater than the GloBE loss due to a permanent difference (e.g. non-taxation of capital gains under the domestic tax law).
   

As the next step, the IF will develop the GloBE Implementation Framework to support tax authorities and MNE groups in the consistent implementation and administration of the GloBE Rules. As the first step in this process, the IF is undertaking a public consultation to collect inputs from stakeholders on the matters they consider need to be addressed as part of the Implementation Framework. The four specific questions raised in the public consultation of which comments are sought can be found in this link. Interested parties can send their comments to the OECD no later than 11 April 2022.