Introduction

On June 17, 2024, the OECD/G20 Inclusive Framework unveiled its fourth tranche of Administrative Guidance on the Pillar Two Global Anti-Base Erosion (GloBE) Rules. This new guidance addresses several technical issues essential for multinational enterprises (MNEs) to understand and comply with the GloBE Rules. The latest guidance is part of an ongoing effort to refine and clarify these rules, helping MNEs navigate the complex international tax landscape effectively.

Background

The OECD’s Base Erosion and Profit Shifting (BEPS) project aims to combat tax avoidance strategies that exploit gaps and mismatches in tax rules to artificially shift profits to low or no-tax locations. In October 2021, the OECD released a high-level agreement on the core elements of Pillar One and Pillar Two of the BEPS 2.0 project. Since then, the Inclusive Framework has issued several key documents, including the GloBE Model Rules, Commentary, and multiple tranches of Administrative Guidance, providing detailed instructions on applying these rules.

June 2024 Administrative Guidance Overview

The fourth tranche of Administrative Guidance focuses on five main areas among others:

• Deferred Tax Liability (DTL) Recapture
• Divergence Between GloBE and Accounting Carrying Values
• Allocation of Cross-Border Current and Deferred Taxes
• Allocation of Profits and Taxes Involving Flow-through Entities
• Securitization Vehicles

Deferred Tax Liability (DTL) Recapture

Article 4.4.4 of the GloBE Model Rules mandates that DTLs claimed in Adjusted Covered Taxes must reverse within five fiscal years or face recapture. The new guidance provides detailed instructions on managing DTL recapture, including defining DTL categories and establishing FIFO (First In, First Out) and LIFO (Last In, First Out) methodologies for tracking.

Key Points:

• Scope of DTL Categories: DTLs can be tracked on an Aggregate DTL Category basis, a General Ledger (GL) account basis, or an item-by-item basis. This flexibility allows MNEs to choose the most practical method for their accounting systems.
• DTL Tracking Methodologies: The FIFO methodology assumes that the oldest DTLs reverse first, while the LIFO methodology assumes that the most recent DTLs reverse first. The choice of methodology depends on the characteristics of the DTLs being tracked.
• Simplifications for DTL Tracking: Simplifications are provided for tracking short-term DTLs, which are expected to reverse within five fiscal years. These simplifications aim to reduce the administrative burden on taxpayers.

Divergence Between GloBE and Accounting Carrying Values

The guidance addresses how to handle DTA/ DTL divergences between GloBE and accounting carrying values. This includes adjustments for pension expenses, stock-based compensation, asset revaluations, etc. Key articles affected by these divergences include Articles 3.2.1(i), 3.2.2, 3.2.3, and others that deal with specific accounting and tax treatments.

Key Points:

• GloBE Income or Loss Calculations: Adjustments to carrying values for GloBE purposes must be reflected in the calculation of GloBE Income or Loss to ensure consistency.
• Deferred Tax Adjustments: DTAs and DTLs must be computed based on GloBE carrying values, and any adjustments should align with the relevant accounting standards.

Allocation of Cross-Border Current Taxes

A new four-step formula is introduced for allocating current taxes across borders. This formula helps ensure that taxes are attributed correctly, preventing double taxation and maintaining the integrity of the GloBE system.

Key Steps:

• Determine Foreign-Source Income: Calculate the taxpayer’s foreign-source income, including amounts attributable to foreign PEs or Entities.
• Calculate Allocable Covered Taxes: Determine the taxpayer’s total current tax expense attributable to foreign-source income.
• Calculate Cross-Crediting Allocation Keys: Develop allocation keys to distribute taxes accurately among foreign PEs or Entities.
• Allocate Allocable Covered Taxes: Use the allocation keys to distribute the current tax expense correctly.

Allocation of Cross-Border Deferred Taxes

The guidance includes a five-step formula for allocating deferred taxes related to cross-border transactions. This ensures that deferred taxes are appropriately pushed down to relevant entities.

Key Steps:

• Separate DTAs and DTLs: Identify DTAs and DTLs related to foreign PEs or Entities.
• Disaggregate Net Basis DTAs/DTLs: Separate net basis DTAs/DTLs to ensure accurate tax allocation.
• Allocate Non-GloBE Income: Distribute deferred tax expense for income that is not GloBE Income.
• Allocate Non-Passive GloBE Income: Distribute deferred tax expense for non-passive GloBE Income.
• Allocate Passive GloBE Income: Apply the Passive Income limitation for Hybrid Entities, Reverse Hybrid Entities, or CFCs.

Allocation of Profits and Taxes Involving Flow-through Entities

The guidance clarifies specific issues in applying the GloBE Model Rules to Flow-through Entities and Hybrid Entities. This includes the classification of these entities and appropriate allocation of profits and taxes between jurisdictions.

Key Points:

• Classification of tax status of the Flow-through Entities: The tax classification of the flow through entities should be determined by the tax laws of the next owner up the chain who is not a Flow-through Entity.
• Tax Allocation: Taxes paid by indirect owners on a Reverse Hybrid Entity’s income should be allocated to the entity itself to ensure accurate ETR computations.

Securitization Vehicles

The guidance addresses the treatment of securitization vehicles, ensuring that these entities are appropriately included or excluded from QDMTT calculations.

Key Points:

• Definition of Securitization Entities: Entities participating in securitization arrangements and meeting specific criteria can be excluded from QDMTT.
• QDMTT Exclusion: Jurisdictions can exclude securitization entities from QDMTT or impose top-up tax liabilities on other entities within the jurisdiction.

Implications for Businesses

The new guidance provides crucial clarifications for MNEs, requiring them to adapt their tax strategies to comply with the GloBE Rules. Key areas of focus include managing DTL recapture, handling divergences in carrying values, and accurately allocating cross-border taxes.

Key Considerations:

• Effective Tax Planning: Companies need to implement robust tax planning and compliance mechanisms to manage the complexities of the GloBE Rules.
• Legal and Financial Implications: Understanding the detailed guidance helps mitigate risks associated with tax liabilities and legal challenges.

Conclusion

The OECD/G20 Inclusive Framework’s ongoing release of Administrative Guidance on the GloBE Rules underscores the dynamic nature of international tax compliance. MNEs must stay informed and adaptable to these evolving regulations to ensure compliance and optimize their global tax strategies. The June 2024 guidance marks another significant step towards a more transparent and equitable international tax system, aligning with the broader objectives of the BEPS project.

For further details and in-depth examples, businesses and tax professionals should refer to the official OECD documents and the June 2024 Administrative Guidance on the GloBE Rules, accessible on the OECD’s website.