Executive summary
On 4 April 2022, the Secretariat of the Organisation for Economic Co-operation and Development (OECD) released a public consultation document (pdf) with draft rules regarding scope under Amount A for Pillar One of the OECD/G20 project on Addressing the Tax Challenges Arising from the Digitalisation of the Economy (the BEPS 2.0 project).
The new taxing right established through Amount A only applies to those Multinational Enterprise (MNE) Groups that fall within the defined scope of Amount A. The scope of Amount A is based on two threshold tests: i) a global revenue test; and ii) a profitability test. Both of these tests are to be met for a Group to be considered a Covered Group under the Amount A rules.
Based on the consultation document, the global revenue test requires a Group to have Total Revenues greater than €20 billion. The profitability test is a three-pronged test that is met if the Group’s Pre-Tax Profit Margin is: i) greater than 10% in the Period; ii) in two or more of the four periods preceding the Period; and iii) on Average across the Period and the four periods immediately preceding the Period.
The agreement by the Inclusive Framework on Base Erosion and Profit Shifting (BEPS) excludes extractives and regulated financial services. Furthermore, it has been agreed that segmentation will occur only in exceptional circumstances where, based on the segments disclosed in the financial accounts, a segment meets the scope rules. The consultation document does not include the rules for the industry exclusions or for segmentation. These rules will be released for public consultation later as standalone documents.
The consultation document is a working document released by the OECD Secretariat to obtain input from stakeholders. It is released without prejudice to the final agreement and does not reflect consensus of the Inclusive Framework member jurisdictions on the substance of the document. The OECD invites comments on the draft rules to be submitted in writing by 18 April 2022.
Detailed discussion
Background
The OECD has been considering tax issues related to the digitalization of the economy since the outset of the original BEPS project in 2013. In 2019, the OECD launched the BEPS 2.0 project, which consists of Pillar One on new nexus and profit allocation rules and Pillar Two on global minimum tax rules.1 Currently, there are 141 jurisdictions participating in the BEPS 2.0 project through the Inclusive Framework.
In October 2021, a final political agreement was reached on key parameters of both pillars and an implementation plan.2 Of the 141 participating jurisdictions, 137 members of the Inclusive Framework have joined this agreement. With respect to Pillar One, one of the agreed parameters is that the scope of Amount A would be MNEs with global turnover above €20 billion and profitability above 10%, calculated using an averaging mechanism.
In December 2021, the OECD announced plans to release a series of Secretariat working documents in the first half of 2022 on the separate building blocks of Amount A in order to obtain stakeholder input, as well as a public consultation document on Amount B in mid-2022. The first of these working documents on Amount A was released on 4 February 2022 as a public consultation document on the nexus and revenue sourcing rules.3 The second working document on Amount A was released on 18 February 2022 as a public consultation document on tax base determinations.4
Overview
On 4 April 2022, the OECD released a public consultation document related to the scope rules for Amount A of Pillar One. The document includes draft model rules that once finalized will be the basis for the substantive provisions of the Multilateral Convention, as well as a template for domestic legislation, through which Amount A will be implemented. The document also includes footnotes with descriptions of additional information that will be included in the Commentary that will support the model rules.
The draft rules provide when a Group is within the scope of the rules (i.e., a Covered Group). The obligations under the Amount A rules only apply to the Group Entities of a Covered Group. A Group is a Covered Group when it meets two tests:
- Global revenue test: Total Revenues of the Group greater than €20 billion. If a Group has a period shorter or longer than 12 months, the €20 billion amount is adjusted proportionally to correspond with the length of the period. Total Revenues means the revenues reported in the Consolidated Financial Statements of the Group in accordance with a Qualifying Financial Accounting Standard and subject to certain adjustments (e.g., exclusion of dividends and equity gain or loss).
- Profitability test: The Pre-Tax Profit Margin5 of the Group is greater than 10% under all three of the tests below:
- In the Period (current period test)
- In two or more of the four periods immediately preceding the Period (prior period test)
- On Average across the Period and the four periods immediately preceding the Period (average test). The average mechanism is a weighted average of the Pre-Tax Profit Margin according to the respective Total Revenues
The draft rules include an anti-abuse provision that will apply as a deterrent to prevent a Group that is held under certain types of entities from being artificially fragmented into numerous Groups in order to circumvent the scope rules, as well as special rules that modify the application of the prior period test and the average test in case of business reorganizations.
The consultation document notes that the Inclusive Framework and the Task Force on the Digital Economy are currently exploring a number of open questions in relation to the Amount A design, including whether the global revenue test should be subject to equivalent rules as the prior period test and the average test (which apply to profitability), and whether the prior period test and the average test should apply, as currently drafted, as a permanent feature of the scope rules or, alternatively, apply as a one-off “entry test” only.
Moreover, the draft rules include a placeholder for exceptional scoping provisions that may apply to a disclosed segment as reported in a Group’s Consolidated Financial Statements, and also for the agreed two targeted exclusions for Extractives and Regulated Financial Services.
Business reorganizations
Where a Group Merger occurs in the Period or any of the three periods immediately preceding the Period (the Merger Period) the profitability test is amended so that the Pre-Tax Profit Margin and the Total Revenues of the Acquiring Group are used for the periods prior to the Group Merger. If there is no Acquiring Group, the Existing Group’s Consolidated Financial Statements are used for the calculation of the Pre-Tax Profit Margin and the Total Revenues for the periods prior to the Group Merger.
The Commentary will elaborate on how the Acquiring Group and Existing Group are identified in the case of a Group Merger as well as the inclusion of practical examples.
Likewise, when a Group Demerger happens in the Period or any of the three periods immediately preceding the Period (the Demerger Period) the profitability test is amended such that the Pre-Tax Profit Margin and Total Revenues of the Demerging Group are used for the periods prior to the Group Demerger.
Exclusions
When a Group meets the global revenue test and the profitability test and conducts Extractive Activities or Regulated Financial Services, the Group is a Covered Group only if it meets the non-excluded global revenue test and non-excluded profitability test. If, after the reapplication of those tests, the Group is below either threshold, the Group is not in scope of Amount A.
In addition, certain Entities are Excluded Entities for Amount A purposes. An Excluded Entity cannot be a Group Entity, and its revenues and profits are not included in the calculations. Further, an Excluded Entity is exempt from the main administrative obligations under the draft rules.
Excluded Entity is defined as an Entity that is one of the following:
- A Governmental Entity
- An International Organization
- A Non-Profit Organization
- A Pension Fund
- An Investments Fund that is an Ultimate Parent Entity (UPE)
- A Real Estate Investment Vehicle that is a UPE
The definition of Excluded Entity also includes Entities that are owned by one or more of the Excluded Entities listed above if specified ownership thresholds and activity conditions are satisfied.
Segmentation
The consultation document includes a placeholder for exceptional scoping provisions that may apply to a disclosed segment as reported in a Group’s Consolidated Financial Statements. The preamble to the draft rules state that these rules will operate in limited circumstances to bring a disclosed segment in scope of Amount A where the disclosed segment meets the revenue and profitability thresholds, discussed above, on a standalone basis, but the Group as a whole does not. The placeholder paragraph is slightly different and may be read that segmentation may be applicable in other cases as well. The detailed provisions governing the application of Amount A to a disclosed segment will be provided in a separate document that will be released at a later date.
Anti-fragmentation rule
The draft rules include an anti-abuse rule to prevent a Group from being artificially fragmented into different Groups with the purpose of being out of scope of the rules. An Internal Fragmentation occurs when the Group is separated into two or more Groups, each with a UPE owned directly or indirectly by the same Excluded Entity, Investment Fund or Real Estate Investment Vehicle that has a Controlling Interest.
When the UPE of a Group that has gone through an Internal Fragmentation is owned (directly or indirectly) by an Excluded Entity, an Investment Fund or a Real Estate Investment Vehicle that has a Controlling Interest and the Group has Total Revenues of €20 billion or less in the Period, the global revenue test is deemed to be met in that period if:
- The Group meets the profitability test.
- The sum of the Total Revenues of the Group and the other Groups resulting from the same Internal Fragmentation for the Period is greater than €20 billion.
- It is reasonable to conclude that failing the global revenue test was one of the principal purposes of the Internal Fragmentation.
The consultation document notes that the Commentary will elaborate on the practical application of the principal purpose test, including examples and guidance on the relevant facts and circumstances to consider when assessing whether failing the global revenue test was one of the principal purposes of the Internal Fragmentation.
Implications
If adopted, the application of the draft model rules would have significant implications for companies that are in scope of Pillar One Amount A, affecting the amount of profits to be re-allocated to market jurisdictions and leading to new compliance requirements including requiring a new calculation of a tax base separate from the entity-based domestic tax base calculations.
Companies that could be in scope of Pillar One Amount A should monitor these developments closely and start evaluating the impact of the proposed rules. They should also consider the opportunity to submit comments on the consultation document.
For additional information with respect to this Alert, please contact the following:
Ernst & Young Belastingadviseurs LLP, Rotterdam
- Ronald van den Brekel
- Marlies de Ruiter
- Maikel Evers
Ernst & Young Belastingadviseurs LLP, Amsterdam
- David Corredor Velasquez
- Roberto Aviles Gutierrez
Ernst & Young Limited (New Zealand), Auckland
- Matt Andrew
Ernst & Young LLP (United States), New York
- Jose A. (Jano) Bustos
- Joana Dermendjieva
Ernst & Young LLP (United States), Washington, DC
- Barbara M. Angus
- Mike McDonald
For a full listing of contacts and email addresses, please click on the Tax News Update: Global Edition (GTNU) version of this Alert.
