Pillar One: assessing the asset management carve-out

On 6 May the OECD published its proposals for the exclusion of regulated financial services activities from Pillar One of the BEPS 2.0 project.

Pillar One is the initiative to reform the rules that govern the allocation of the right to tax the profits of MNE groups. Under the Pillar One rules a greater share of those taxing rights will be attributed to the countries where groups’ customers are located. The new rules will initially only apply to the largest and most profitable groups – those with revenues of at least €20bn and a profit margin of at least 10%. In time, the revenue threshold will reduce to €10bn bringing more groups into scope of the rules.

What’s the rationale for excluding regulated financial services businesses?

Pillar One was motivated by concerns that the existing profit allocation rules focus too much on physical presence. That means businesses that can operate in a market without a significant physical presence – most obviously, digital businesses – can generate significant profits from sales in a country realising commensurate taxable profits there.

For many financial services groups, however, the key factor that will determine where taxable profits are realised is the location of capital, which is governed by regulatory requirements. This means financial services businesses are less able to control where taxable profits are realised through structuring, and there is more acceptance that their profits are taxed in the “right” place.

How does the exclusion work?

The exclusion applies to several kinds of financial services activity, including retail and investment banking, insurance and asset management. The definition of excluded asset management activities is broad and worded in general terms, rather than referring to specific kinds of regulated fund or activity.

Exclusion is assessed on an entity-by-entity basis. For example, any entity in a group that earns 75% or more of its gross income from excluded asset management activities will be wholly excluded, while any entities that do not meet that threshold will not. A group with excluded activities will only be in scope of Pillar One if its non-excluded activities would meet the revenue and profitability thresholds in their own right.

Is this settled?

Not necessarily. The consultation document pointedly reminds readers that the proposals do not represent the final or consensus views of the Inclusive Framework countries, and notes that some countries believe that reinsurance and asset management ought not to be excluded.

That these activities are covered in the published proposals indicates that most countries want them excluded from Pillar One, however this is not a done deal. The OECD is inviting public comments on the exclusion proposals until 20 May, so financial services industry stakeholders with an interest should consider making their voices heard.

Keep up to date with the latest developments and other useful information on our BEPS 2.0 hubpage.