Over the weekend, the OECD/G20 Inclusive Framework issued a further agreement (by 131 countries) on the key components of the two-pillar approach to overhaul the way multinational companies are taxed. This follows the earlier G7 agreement and provides a little more detail, although at just 5 pages, the original Blueprints are still a necessary source of reference to fully understand what is being proposed. In summary, only aspects of Pillar Two should now concern the private equity industry.
Pillar One (reallocation of taxing rights to market jurisdictions)
The US government’s advocacy and the G7 communique created a degree of uncertainty about whether the Pillar One proposals would apply to the financial services sector. In moving to a quantitative scoping threshold there was a risk that previously agreed sector exemptions would be lost in negotiations. The good news is that the latest agreement states that “regulated financial services” are excluded from the measure. The original blueprint was more specific as it provided an analysis of why most, but not all, jurisdictions believed it was appropriate to exclude asset management businesses from the scope of Pillar One with a financial services exemption. Without further detail to the contrary at this stage it should be safe to assume asset managers are not within scope, although it would be prudent to fully understand how “regulated” will be defined.
Pillar Two (global minimum tax)
By way of recap, the Pillar Two proposal consists of a number of rules to introduce a global minimum tax. There are two rules that form the GloBE (Global anti-base erosion) rules - the Income Inclusion Rule (which operates like a CFC charge by imposing a top-up tax on a parent entity in respect of low taxed income of subsidiary) and the Undertaxed Payment Rule (which denies deductions or introduces some sort of adjustment if the parent of the low taxed subsidiary is not subject to the Income Inclusion Rule). There is a final rule that is a separate treaty-based rule (not part of GloBE), called the Subject to Tax Rule, that will allow source jurisdictions to impose a limited source taxation on certain related party payments that are subject to tax in the country of receipt below a minimum rate (suggested between 7.5%-9%).
In the latest agreed text it says that investment funds that are the ultimate parent entities or any holding vehicles used in the fund structure will not be subject to the GloBE rules. That’s the good news. The bad news is that this suggests that the Subject to Tax Rule (a standalone rule to the GloBE rules) may apply regardless of sector, and would have significant implications for the payment of interest between connected parties. It is worth pointing out that the detailed commentary in the original Blueprint did say that the scope of application of the Subject to Tax Rule would be consistent with the excluded entities identified in the GloBE rules therefore at this point in time it is not clear whether there has been a material change in the application of the Subject to Tax rule or if providing clarity on this point was felt a detail too far for the five pages of text published. This will be an important area to seek clarity on before the final rules are published in October.