OECD/G20 Inclusive Framework releases fourth tranche of Administrative Guidance on Pillar Two GloBE Rules

On 17 June 2024, the OECD/G20 Inclusive Framework released a fourth tranche of Administrative Guidance on the Pillar Two Global Anti-Base Erosion (GloBE) Rules. The topics covered in the Administrative Guidance are deferred tax liability 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, and securitization vehicles. Companies should review the Administrative Guidance and monitor how it is incorporated in the Pillar Two rules in the jurisdictions where they operate.

Executive summary

On 17 June 2024, the OECD/G20 Inclusive Framework on Base Erosion and Profit Shifting (BEPS) released additional Administrative Guidance (pdf) on the Global Anti-Base Erosion (GloBE) Model Rules, which provides additional information on a series of technical issues under the GloBE Rules. As with the prior tranches of Administrative Guidance, the June 2024 Administrative Guidance will be incorporated in the Commentary to the GloBE Model Rules.

Detailed discussion

Background

In October 2021, the Organisation for Economic Co-operation and Development (OECD) released a statement reflecting the high-level agreement of Inclusive Framework member jurisdictions on core design elements of Pillars One and Two of the BEPS 2.0 project.1

Since that agreement was reached, the Inclusive Framework has released a series of significant agreed documents on the global minimum tax under Pillar Two, including the GloBE Model Rules,2 Commentary to the GloBE Model Rules,3 guidance on GloBE Safe Harbors,4 three packages of GloBE Administrative Guidance,5 and a standard template for the GloBE Information Return.6 The OECD also released a public consultation document on potential dispute prevention and resolution mechanisms for the GloBE Rules, an area under consideration by the Inclusive Framework but on which consensus has not been reached.7 In addition, with respect to the other core element of Pillar Two — the Subject to Tax Rule (STTR) — the OECD has released a model treaty provision together with an accompanying commentary,8 as well as documents with respect to a multilateral instrument that jurisdictions can use to facilitate implementation of the STTR into their tax treaties.9

In addition, on 25 April 2024, the OECD released the Consolidated Commentary to the Model GloBE Rules, which incorporates the three tranches of Administrative Guidance that were issued before the end of 2023. Most recently, on 17 June 2024, the Inclusive Framework released a Question & Answer document providing information regarding peer review process for determining the qualified status of the elements of the global minimum tax that are implemented by jurisdictions.10

June 2024 Administrative Guidance

This is the fourth tranche of Administrative Guidance approved by the Inclusive Framework, following the release of earlier tranches of Administrative Guidance in February 2023, July 2023 and December 2023. The June 2024 Administrative Guidance covers guidance on 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 and treatment of securitization vehicles.

The June 2024 Administrative Guidance will be incorporated into a revised version of the Commentary to the GloBE Model Rules.

DTL recapture

Under Article 4.4.4 of the GloBE Model Rules, a Deferred Tax Liability (DTL) claimed in Adjusted Covered Taxes in any Fiscal Year (beginning with the Transition Year) is subject to recapture if it does not reverse within the subsequent five Fiscal Years (the DTL recapture rule). When a DTL is recaptured, the Adjusted Covered Taxes and the effective tax rate (ETR) for the Fiscal Year in which the DTL was claimed are recomputed without regard to the DTL, and any top-up tax is treated as Additional Current Top-Up Tax under Article 5.2.3.

An exception to the DTL recapture rule is provided for "Recapture Exception Accruals" that do not need to be monitored for recapture. Recapture Exception Accruals include cost recovery allowances on tangible assets, R&D expenses, decommissioning and remediation expenses, fair value accounting on unrealized net gains, foreign exchange gains/losses, insurance reserves and insurance policy deferred acquisition costs and deferred gains resulting from reinvestment in tangible property.

Notably, DTLs associated with intangible assets (including goodwill) and inventory are not Recapture Exception Accruals.

The Commentary to Article 4.4.4 of the GloBE Model Rules states that the DTL recapture rule applies to "categories" of DTLs. The primary objective of this section of the June 2024 Administrative Guidance is to clarify how companies are to practically manage the DTL recapture rule in a manner that aligns with the policy objectives of the GloBE Rules and minimizes administrative and compliance burdens for taxpayers and tax administrations. Specifically, the June 2024 Administrative Guidance addresses the scope of DTL "categories," DTL tracking methodologies, and certain simplifications for DTL tracking.

Scope of DTL categories

MNE Groups do not typically measure DTLs or Deferred Tax Assets (DTAs) for each asset or liability individually. Generally, this measurement occurs after aggregating the assets and liabilities into their respective General Ledger (GL) accounts, or after further aggregating GL accounts either at the Balance Sheet (BS) account level, or a sub-BS account level. For example, a BS account could represent a category of assets, such as "Property, Plant, and Equipment" or "Intangible Assets." This BS account may be comprised of several GL accounts for different types of equipment, such as "Manufacturing Equipment," and "Office Equipment." MNE Groups might measure DTLs for the entire "Property, Plant, and Equipment" category (the BS account level) or for specific subsets like "Manufacturing Equipment" (a sub-BS account level). Rarely is DTL measurement based on individual GL accounts or single items.

The June 2024 Administrative Guidance provides that, for purposes of the DTL recapture rule, a Constituent Entity may track its DTLs under three approaches:

1. On an Aggregate DTL Category basis, where two or more GL accounts (within the same BS account or sub-BS account) are grouped and tracked as a single DTL category (subject to meeting specified requirements)
   
   
2. On a GL account basis, where DTLs related to all the assets or liabilities encompassed in a single GL account are grouped and tracked as a single DTL category
   
   
3. On an item-by-item basis, where DTLs related to each single asset or liability are tracked individually

DTLs related to items that are excluded from the computation of the GloBE Income or Loss are not included in a DTL category.

If a DTL category that includes DTLs subject to the DTL recapture rule also includes one or more DTLs that is a Recapture Exception Accrual, the DTL recapture rule nonetheless applies to the entire DTL category.

Aggregate DTL Category requirements

As described above, an Aggregate DTL Category is a DTLs category determined in relation to two or more GL accounts that fall under the same BS account (however, not all GL accounts that fall under the same BS account must be included in the same Aggregate DTL Category).

An Aggregate DTL Category may include both Short-term DTLs (i.e., DTLs that reverse within five Fiscal Years) and Long-term DTLs (i.e., DTLs that do not reverse within five Fiscal Years), subject to meeting certain requirements.

An Aggregate DTL Category may not include the following:

• GL accounts that, on a standalone basis, would always generate a DTA (except as provided in the simplification for Short-term DTLs described below)

• "Swinging" GL accounts (i.e., GL accounts that result in a net DTA or net DTL at different points over the life of the asset/liability)

In addition, DTLs related to the following assets or liabilities may be aggregated only up to the GL account level (i.e., they may not be tracked as part of an Aggregate DTL Category):

• Non-amortizable intangible assets, including goodwill

• Amortizable intangible assets with an accounting life of more than five years

• Related party receivables and payables

DTL tracking methodologies

In general, the net increase of the balance of an Aggregate DTL Category or GL account is treated as a DTL accrual and the net decrease is treated as a DTL reversal. The timing of new accruals combined with reversals could result an aggregate DTL balance appearing constant, adding complexity to DTL tracking for GloBE purposes. Because MNE Groups generally do not trace the balance of a DTL to individual assets or liabilities, the June 2024 Administrative Guidance provides for recapture methodologies to determine whether a DTL reversal relates to accruals from the preceding five Fiscal Years or to a previously recaptured DTL.

The June 2024 Administrative Guidance provides that DTL reversals and recaptures may be tracked under either the FIFO or LIFO methodology, depending on the characteristics of the DTLs that are included in the DTL category.

The FIFO methodology assumes that reversals relate to the oldest accruals. The FIFO methodology is a less conservative tracking approach due to risk of short-term DTLs "shielding" long-term DTLs (i.e., the actual reversal of a Short-term DTL could potentially be treated as a reversal of a Long-Term DTL, because the FIFO methodology assumes DTL reversals occur on a "first in, first out" basis).

The FIFO methodology may only be used under the following conditions:

• DTLs are determined in relation to a single GL account.

• DTLs are determined in relation to an Aggregate DTL Category that consists solely of DTLs with a "similar reversal trend" (i.e., DTLs that reverse within a two-year period of each other).

• DTLs are determined in relation to an Aggregate DTL Category that consists of GL accounts without a similar reversal trend, but the MNE Group can demonstrate that the FIFO methodology appropriately recaptures DTLs that reverse beyond five years.

Where the FIFO methodology cannot be used, the more conservative LIFO methodology must be used. The LIFO methodology assumes that reversals relate to the most recent accruals (i.e., reversals occur on a "last in, last out" basis).

Both the FIFO and LIFO methodologies quantify the recaptured DTL amount based on the yearly movement of the DTL's Unjustified Balance. The Unjustified Balance represents the total amount of the DTL that has not reversed before the end of the "Testing Period" (i.e., the five-year period that follows the year in which the DTL was accrued and claimed in Adjusted Covered Taxes (the Tested Fiscal Year)). The Unjustified Balance is the excess (if any) of the Outstanding DTL Balance (i.e., the DTL balance as of the end of the Testing Period, computed starting from the Transition Year) over the Maximum Justifiable Amount.

The Maximum Justifiable Amount is determined differently depending on whether FIFO or LIFO methodology is used.

• Under the FIFO methodology, the Maximum Justifiable Amount is the sum of the net increases in the Outstanding DTL Balance for each Fiscal Year in the Testing Period in which there was a net increase in the Outstanding DTL Balance.

• Under the LIFO methodology, the Maximum Justifiable Amount is the greater of zero or the net amount of the DTL accruals and reversals that occurred during the Testing Period.

The Unjustified Balance of the current Fiscal Year is compared with the previous Fiscal Year's Unjustified Balance (if any). An increase in the Unjustified Balance represents the DTL accrual to be recaptured. A decrease in the Unjustified Balance is treated as a reversal of (i) a recaptured DTL, (ii) an Unclaimed Accrual (discussed below), or (iii) a pre-Transition Year DTL.

DTLs imported pursuant to Article 9.1.1 of the GloBE Model Rules (i.e., pre-Transition Year DTLs) are not subject to the DTL recapture rule. Reversals attributable to pre-Transition Year DTLs are not part of the Outstanding DTL Balance; otherwise, such reversals would be treated as reversals of DTLs that accrued starting from the Transition Year.

Under the FIFO methodology, any DTL reversals during the Testing Period are first allocated to the pre-Transition Year DTLs to the extent thereof, and such DTL reversals are ignored in determining the Outstanding DTL Balance and Maximum Justifiable Amount. Once the amount of those pre-Transition Year DTLs is exhausted, subsequent reversals will be included in the computation of these amounts.

Under the LIFO methodology, any DTL reversals are first allocated to the Outstanding DTL Balance to the extent thereof, and then to pre-Transition Year DTLs.

The June 2024 Administrative Guidance provides several numerical examples of the FIFO and LIFO methodologies, including their application to reversals of pre-Transition Year DTLs.

Simplifications for DTL tracking

Under the exception for tracking Short-term DTLs, if a Constituent Entity can demonstrate, based on objective facts, that all DTLs in an Aggregate DTL Category or GL account are Short-term DTLs, it is not required to put a tracking system into place for those DTLs. The June 2024 Administrative Guidance provides several examples of DTLs that can be objectively determined are Short-term DTLs (i.e., DTLs that fully reverse within five Fiscal Years):

• A DTL related to an intangible asset that is amortized straight-line over ten years for accounting purposes and straight-line over five years for tax purposes

• DTLs related to receivables when the receivable will be collected, written off, or otherwise monetized within five fiscal years

• DTLs related to different inventory valuation methods when the inventory is sold over a period shorter than five fiscal years

This simplification may apply to an existing Aggregate DTL Category or GL account that is comprised exclusively of Short-term DTLs. In addition, Constituent Entities may separate an existing Aggregate DTL Category that contains Short-term DTLs and Long-term DTLs to apply this simplification only to the Short-term DTLs. If an existing Aggregate DTL Category has only Short-term DTLs and DTAs, the DTAs can be included in the Aggregate DTL Category to benefit from this simplification.

The Unclaimed Accrual election is an annual election that allows a Constituent Entity to exclude a DTL accrual in a given Fiscal Year if it is not expected to reverse, in its entirety, by the end of the fifth subsequent Fiscal Year. When the Unclaimed Accrual election is made, the DTL is instead taken into account in the computation of the Adjusted Covered Taxes in the year of its reversal. The June 2024 Administrative Guidance provides that Unclaimed Accrual elections are made consistently with the tracking approach used for a DTL (i.e., at the Aggregate DTL Category, GL account, or item level).

The June 2024 Administrative Guidance also provides that a Constituent Entity may make an "Unclaimed Accrual Five-Year Election" regardless of any expectations regarding the reversal period of the GL account or Aggregate DTL Category as a whole. If a Constituent Entity makes an Unclaimed Accrual Five-Year Election, all relevant DTL accruals and reversals of the DTL category (i.e., an Aggregate DTL Category or GL account) are excluded from Adjusted Covered Taxes until the election is revoked.

Divergence between GloBE and accounting carrying values

The June 2024 Administrative Guidance clarifies how MNE Groups should determine Adjusted Covered Taxes of Constituent Entities in cases where the accounting and GloBE carrying value, and the DTA/DTL determined therefrom, diverge. It also provides guidance in relation to the GloBE treatment of intragroup transactions accounted for at cost by the acquiring Constituent Entity.

Divergences in carrying values

The GloBE Rules generally rely on the amounts reflected in the financial accounts of a Constituent Entity used in the preparation of the Consolidated Financial Statements as the starting point for determining the GloBE Income or Loss and Adjusted Covered Tax. However, there are cases where the GloBE Rules require a Constituent Entity to determine its GloBE Income or Loss and Adjusted Covered Taxes by reference to a carrying value that may be different from the carrying value reflected in the financial accounts otherwise used for GloBE purposes. The affected articles of the GloBE Model Rules are:

• Article 3.2.1(i), which adjusts a Constituent Entity's Financial Accounting Net Income or Loss for accrued pension expense

• Article 3.2.2, which provides an election to substitute the amount of stock-based compensation allowed as a deduction in the computation of a Constituent Entity's taxable income for the amount of stock-based compensation expense reported in the financial accounts

• Article 3.2.3, which requires MNE Groups to apply the Arm's-Length Principle to certain intragroup transactions to protect the integrity of jurisdictional blending

• Article 3.2.5, which provides an election to determine gains and losses using the realization principle in lieu of fair value accounting

• Article 6.2.1(c), which provides that a target in the acquisition year and each succeeding year is to determine its GloBE Income or Loss and Adjusted Covered Taxes using its historical carrying value of the assets and liabilities

• Article 6.2.2, which provides that certain acquisitions or disposals of a Controlling Interest in a Constituent Entity are to be treated as an acquisition or disposal of the assets and liabilities

• Article 6.3.1, in circumstances where Article 3.2.3 applies in respect of asset transfers not recorded at arm's length and requires a transaction between Constituent Entities located in different jurisdictions that (i) is not recorded in the same amount in the financial accounts of both Constituent Entities or (ii) is not consistent with the Arm's-Length Principle to be adjusted so as to be in the same amount and consistent with the Arm's-Length Principle

• Article 6.3.2, which requires an acquiring Constituent Entity in a GloBE Reorganisation to determine its GloBE Income or Loss after the acquisition using the disposing Entity's carrying values of the acquired assets and liabilities upon disposition

• Article 6.3.3, which requires an acquiring Constituent Entity in a GloBE Reorganisation wherein a disposing Constituent Entity recognizes Non-qualifying Gain or Loss to determine its GloBE Income or Loss after the acquisition using the disposing Entity's carrying value of the acquired assets and liabilities upon disposition adjusted consistent with local tax rules to account for the Non-qualifying Gain or Loss

• Article 6.3.4, when an MNE Group makes an election to align the outcomes under the GloBE Rules with those that apply under local tax law and the Constituent Entity recognizes gain or loss and adjusts the carrying value of its assets and liabilities for purposes of the GloBE Rules

If the GloBE Income or Loss of a Constituent Entity is calculated based on an asset's or liability's carrying value that differs from that used to determine the deferred tax expense accrued in the financial accounts of a Constituent Entity, any deferred tax expense or benefit accrued in connection with a DTA or DTL related to the asset or liability is no longer appropriate for computing the Total Deferred Tax Adjustment Amount under Article 4.4 of the GloBE Model Rules to determine the Adjusted Covered Taxes of the Constituent Entity.

The June 2024 Administrative Guidance clarifies that for the determination of the Total Deferred Tax Adjustment Amount, any DTA or DTL must be computed based on the GloBE carrying value and then adjusted in accordance with the relevant accounting standard. The deferred tax expense or benefit in respect of such DTA or DTL and its subsequent adjustment must then be used to compute the Total Deferred Tax Adjustment Amount. In circumstances where the GloBE carrying value of an asset or liability is adjusted to be aligned with the tax carrying value, the related deferred tax expense or benefit recorded for accounting purposes will be disregarded for GloBE purposes. If the GloBE carrying value does not match the local tax carrying value, a DTA or DTL based on the GloBE carrying value (calculated in accordance with the relevant accounting standard) must be taken into account for purposes of determining the Adjusted Covered Taxes, even if there was no DTA or DTL recorded (for instance, because the accounting carrying value and tax basis were equal). If the initial recognition exception applies under the relevant accounting standard and would continue to apply in the context of the required adjustments for GloBE purposes, the DTA or DTL would not be included in calculating the Total Deferred Tax Adjustment amount even though the GloBE carrying value differs from the tax basis.

Clarifications regarding effect of divergences between GloBE and accounting carrying value and Transition Rules

Article 6.2.1(c) of the GloBE Model Rules specifies that purchase price accounting adjustments are excluded for the purposes of determining the carrying value of an asset or a liability for GloBE purposes, even if the transaction occurs before the GloBE Rules come into effect. There is only one exception to this rule, which applies where the financial accounting standard used to prepare the Consolidated Financial Statements permits "push down" adjustments to the carrying value of assets and liabilities that were attributable to the purchase of a business to the separate accounts of the acquired Constituent Entity. In such a case, the Constituent Entity may use the carrying value reflected in its separate accounts if the acquisition occurred prior to 1 December 2021 and no sufficient records are available to determine the Financial Accounting Net Income or Loss with reasonable accuracy based on the unadjusted carrying values of the acquired assets and liabilities.

The June 2024 Administrative Guidance clarifies that where Article 6.2.1(c) of the GloBE Model Rules applies to an asset or liability of a Constituent Entity, the GloBE carrying value is the relevant value for the purposes of determining the amount of any resulting DTA or DTL for the purposes of Article 9.1.1.

The June 2024 Administrative Guidance further specifies that Articles 3.2.3, 6.2.2 and 6.3.1 through Article 6.3.4 of the GloBE Model Rules should only apply to Constituent Entities in the Transition Year (i.e., first Fiscal Year that the MNE Group comes within the scope of the GloBE Rules in respect of that jurisdiction) and subsequent Fiscal Years.

Moreover, the June 2024 Administrative Guidance provides that to the extent that Article 9.1.3 of the GloBE Model Rules applies to an asset that has been subject to Article 6.2.1(c), the relevant carrying value for purposes of determining DTA and DTL is the GloBE carrying value established by Article 6.2.1(c).

Intra-group transactions accounted for at cost

In cases where intragroup transactions are accounted for at cost on pre-consolidation financial statements, the selling entity does not record income and the buying entity records a DTA to the extent there is a basis step-up for local tax purposes. This treatment has raised questions as to how these transactions are treated under Article 6.3.1 of the GloBE Model Rules, which provides that a disposing Constituent Entity "will include" the gain or loss on disposition in the computation of its GloBE Income or Loss and that an acquiring Constituent Entity "will determine" its GloBE Income or Loss using the acquiring Constituent Entity's carrying value of the acquired assets and liabilities determined under the accounting standard used in preparing the Consolidated Financial Statements.

The February 2023 Administrative Guidance clarified that intra-group transfers of assets and liabilities under Article 6.3.1 of the GloBE Model Rules must be treated for GloBE purposes in accordance with Article 3.2.3. Consequently, in cross-border intra-group transactions the Arm's-Length Principle applies, and the transaction must be reflected at fair value for GloBE purposes regardless of whether the MNE Group accounted for the transaction at the carrying value of the disposing Constituent Entity.

The June 2024 Administrative Guidance now clarifies that Article 3.2.3 of the GloBE Model Rules also applies to the acquiring Constituent Entity, meaning that the acquiring Constituent Entity must compute its GloBE Income or Loss on the basis that the asset (or liability) was acquired at arm's-length price. The arm's-length price should be the same for the disposing Constituent Entity and the acquiring Constituent Entity. Therefore, any DTA or DTL in relation to the acquired asset (or liability) must be computed for purposes of determining Adjusted Covered Taxes under Article 4.4 of the GloBE Model Rules based on the acquired asset's (or liability's) carrying value for GloBE purposes.

The June 2024 Administrative Guidance further provides that the determination of a DTA based on the GloBE carrying values does not displace the relevant accounting standard (e.g., the Initial Recognition Exemption in International Accounting Standard 12, Income Taxes, would continue to be applicable in light of the required GloBE adjustments). In addition, a DTL determined for GloBE purposes is subject to recapture for purposes of Article 4.4.4 of the GloBE Model Rules (the DTL recapture rule), unless the DTL meets the definition of Recapture Exception Accrual in Article. 4.4.5.

Furthermore, the June 2024 Administrative Guidance specifies that for assets and liabilities subject to impairment testing under the relevant financial accounting standard, the GloBE carrying value will not undergo independent impairment testing if it differs from the accounting carrying value, meaning that MNE Groups are not required to conduct separate impairment testing based on the GloBE carrying value. Impairment of the assets' (or liabilities') GloBE carrying value (and the related effects on the Constituent Entity's Adjusted Covered Taxes and GloBE Income or Loss) will only occur if the accounting value is subject to an impairment in accordance with the relevant financial accounting standard. In such a case, the GloBE carrying value will be reduced to match the accounting carrying value.

Interaction between divergences in GloBE and accounting carrying values and Substance-based Income Exclusion

The June 2024 Administrative Guidance provides that any adjustment to the carrying value of an asset for GloBE purposes does not affect the carrying value for the Substance-based Income Exclusion.

Allocation of cross-border current taxes

The June 2024 Administrative Guidance provides a new four-step formula for the cross-border allocation, or "pushdown," of current taxes from one Constituent Entity to another Constituent Entity under a cross-crediting corporate tax system.

Under Article 4.3.2 of the GloBE Model Rules, taxes included in the separate financial accounts of a Constituent Entity (i.e., the taxpayer) with respect to income of a foreign PE or Entity generally may be pushed down to that foreign PE or Entity, if it is itself a Constituent Entity. The June 2024 Administrative Guidance provides a common mechanism to push down an amount of the taxpayer's current taxes to a PE, a CFC, a Hybrid Entity, a Reverse Hybrid Entity or a Constituent Entity that made a distribution to the taxpayer (each referred to here as a foreign PE or Entity), where the taxpayer's domestic tax regime allows for cross-crediting of foreign taxes.

The pushdown mechanism is a four-step allocation formula, as follows:

1. Determine the taxpayer's foreign-source income
2. Calculate Allocable Covered Taxes
3. Calculate the Cross-Crediting Allocation Keys
4. Allocate Allocable Covered Taxes using the Cross-Crediting Allocation Keys

Where the taxpayer's domestic tax regime uses Foreign Tax Credit (FTC) limitations for multiple "baskets" (and cross-crediting is allowed in each basket), the four-step allocation formula must be applied for each separate basket.

Note that the June 2024 Administrative Guidance does not apply to taxes arising under a Blended CFC Tax Regime, such as the global intangible low-tax income (GILTI) regime in the United States. The OECD provided a temporary allocation rule for Blended CFC Tax Regimes in the February 2023 Administrative Guidance, which will continue to apply for that purpose.

Step 1: Determine the taxpayer's foreign-source income

The first step is to determine the taxpayer's foreign-source income.

Foreign-source income means the taxpayer's taxable income that is treated as coming from foreign sources for purposes of determining its FTC limitation under its domestic tax regime. In general, this should include any amounts of the taxpayer's taxable income that are attributable to a foreign PE or Entity, as well as any amounts upon which the taxpayer incurred foreign tax "directly" (e.g., a royalty received by the taxpayer that incurred foreign withholding tax). In addition, any amount of the taxpayer's domestic-source income that is included in the GloBE Income or Loss of a foreign PE or Entity must be re-sourced to foreign-source income. This includes any amount of a disregarded payment (as characterized under the domestic tax regime) that is included in the GloBE Income of a foreign PE or Entity. Lastly, any amount of the taxpayer's foreign-source income that is either excluded from GloBE Income or Loss or is earned by an Excluded Entity should remain in the computation.

Foreign-source income is a net concept. Where the taxpayer's taxable income inclusion from a foreign PE or Entity is a net amount (e.g., the taxpayer has a CFC inclusion based on a hypothetical distribution from the CFC), that net amount is its foreign-source income. In contrast, the taxpayer's domestic tax regime could require that the taxpayer include only gross income items attributable to a foreign PE or Entity, to which expenses are then allocated and apportioned. In that case, expenses that are allocated or apportioned solely for purposes of the taxpayer's domestic FTC limitation should be excluded from the taxpayer's foreign-source income, unless the expense was also included in the GloBE Income or Loss of a foreign PE or Entity. This is particularly relevant to US taxpayers, as it should generally require backing out any expenses that would otherwise be allocated or apportioned to foreign-source income in an Internal Revenue Code (IRC) Section 904(d) category.

Step 2: Calculate Allocable Covered Taxes

The second step is to compute the taxpayer's Allocable Covered Taxes, which is effectively the taxpayer's total current tax expense with respect to its domestic tax regime that is attributable to foreign-source income, as determined in the first step.

The formula for determining Allocable Covered Taxes is: Total current tax expense accrued by the taxpayer with respect to the applicable domestic tax regime, reduced by:

• Domestic tax liability without regard to any foreign-source income (or "hypothetical domestic tax liability")

• Blended CFC taxes

• Domestic tax liability attributable to remaining FTC baskets

The first amount in the formula is the taxpayer's total current tax expense with respect to the domestic tax regime. If the taxpayer is subject to multiple domestic taxes that are each a "Covered Tax" for Pillar Two purposes, the formula must be applied separately to determine Allocable Covered Taxes for each one. As noted in Step 1, if the taxpayer incurs any domestic tax liability with respect to excluded income or an Excluded Entity, those domestic taxes remain in the computation until after Step 4.

The second amount in the formula is the taxpayer's "hypothetical domestic tax liability," as if the taxpayer earned no foreign-source income and had no foreign tax attributes. The notion is that these taxes are strictly attributable to domestic-source income and thus should not be allocable to a foreign PE or Entity. In practice, the taxpayer's hypothetical domestic tax liability is determined as the taxpayer's domestic taxable income minus its foreign-source income as determined in Step 1, then multiplied by the applicable domestic tax rate. If that amount would be negative, Allocable Covered Taxes are zero. If the domestic tax regime uses a progressive rate, the taxpayer's effective rate is used, as if the domestic-source income and foreign-source income were earned proportionately at each rate.

Importantly, any expenses that were excluded in determining foreign-source income in Step 1 must be added back for determining foreign-source income in Step 2. This should increase the taxpayer's hypothetical domestic tax liability, which will ultimately reduce Allocable Covered Taxes because a greater hypothetical domestic tax liability is subtracted from total current tax expense. The net effect should be a lower amount of Allocable Covered Taxes because expenses are apportioned to foreign-source income in Step 2 but greater allocation of those Allocable Covered Taxes to a foreign PE or Entity (rather than to the taxpayer) because expenses are not apportioned to foreign-source income in Step 1.

The third amount in the formula is any amount of Blended CFC Taxes, which are excluded from Allocable Covered Taxes because they are separately allocated under the February 2023 Administrative Guidance.

The fourth amount in the formula is applicable only where the taxpayer's domestic tax regime uses FTC limitations for multiple baskets of income. In that case, Allocable Covered Taxes are to be determined for one basket first by excluding taxes related to all other baskets, then moving to a second basket and excluding taxes related to all remaining baskets, and so on until the final basket. Implicit in that methodology is knowing the tax amount related to each basket, which presumably must be determined under domestic tax principles. In addition, if the taxpayer has any tax attributes that are relevant in determining its domestic tax liability, those tax attributes are to be allocated to each basket based on domestic tax principles, making reasonable assumptions where necessary.

Step 3: Calculate the Cross-Crediting Allocation Keys

The third step is to calculate the Cross-Crediting Allocation Key for each foreign PE or Entity and for the taxpayer. This will ultimately determine the proportion of Allocable Covered Taxes that are allocated to each foreign PE or Entity and to the taxpayer in Step 4. Where the domestic tax regime has multiple FTC baskets, a Cross-Crediting Allocation Key must be determined for each basket.

The formula for calculating the Cross-Crediting Allocation Key differs slightly depending on the context. For any foreign PE or Entity (including any Excluded Entity) except a Constituent Entity that made a distribution to the taxpayer, the formula is: Taxpayer's foreign-source income attributable to the foreign PE or Entity, multiplied by the Taxpayer's applicable tax rate and reduced by creditable foreign taxes accrued with respect to income of foreign PE or Entity.

The taxpayer's foreign-source income attributable to the foreign PE or Entity is derived from the amount determined in Step 1. In effect, it is the taxpayer's domestic taxable income attributable to the foreign PE or Entity in question. That amount is multiplied by the taxpayer's applicable tax rate, which is the same rate determined for purposes of determining the hypothetical domestic tax liability in Step 2. Finally, the product of those two amounts is reduced by any FTCs the taxpayer claimed for foreign taxes (including any QDMTT liability) imposed on the income of the foreign PE or Entity.

A similar formula applies for allocating taxes to a foreign PE or Entity that made a distribution to the taxpayer (i.e., for purposes of Article 4.3.2(e) of the GloBE Model Rules), except that it considers only the taxpayer's taxable income from the distribution and any FTCs claimed for foreign taxes imposed on the distribution. The formula is: Taxpayer's taxable income from the distribution, multiplied by Taxpayer's applicable tax rate and reduced by creditable foreign taxes accrued with respect to the distribution.

Finally, a Cross-Crediting Allocation Key must be computed for the taxpayer itself. The purpose is ultimately to allocate taxes to the taxpayer corresponding to the foreign-source income that it earned "directly." The idea is that because the taxpayer did not derive this income through a foreign PE or Entity, any corresponding domestic tax liability should be allocated to the taxpayer itself. In effect, this will dilute the tax amount allocated to any foreign PE or Entity in Step 4. The formula is: Taxpayer's foreign-source income arising "directly," multiplied by Taxpayer's applicable tax rate and reduced by creditable foreign taxes accrued with respect to the foreign-source income.

Step 4: Allocate Allocable Covered Taxes based on the Cross-Crediting Allocation Keys

The final step is to allocate Allocable Covered Taxes as determined in Step 2 to each foreign PE or Entity using the Cross-Crediting Allocation Keys as determined in Step 3. This is done by multiplying Allocable Covered Taxes by the ratio of the Cross-Crediting Allocation Key for the foreign PE or Entity (or the taxpayer) over the sum of all Cross-Crediting Allocation Keys. If the domestic tax regime uses multiple FTC baskets, then the amount of Allocable Covered Taxes and the Cross-Crediting Allocation Keys are the basket-specific amounts, as determined in Steps 2 and 3, respectively.

Once the allocation is made under the steps described above, a few final adjustments are required. First, any taxes allocated to a foreign PE or Entity (including an Excluded Entity) are excluded from the taxpayer's Covered Taxes to prevent double counting. Second, if any taxes are allocated to a foreign PE or Entity that relate to income excluded from GloBE Income or Loss, then an amount of taxes must be excluded also in accordance with Article 4.1.3(a) of the GloBE Model Rules. The amount that is excluded is to be determined based on the principles of the taxpayer's domestic tax regime (i.e., not the regime of the foreign PE or Entity), making reasonable assumptions where necessary. Finally, for a CFC, Hybrid Entity or Reverse Hybrid Entity, the amount of taxes that are actually allocated under this formula must not exceed the amount computed under the Passive Income limitation of Article 4.3.3 of the GloBE Model Rules.

Allocation of cross-border deferred taxes

The June 2024 Administrative Guidance provides a five-step allocation formula for pushing down deferred taxes in specified circumstances, in accordance with Article 4.3.2 of the GloBE Model Rules. This does not apply for Blended CFC Tax Regimes.

The 2024 Administrative Guidance effectively adopts a "branch accounting" mechanism to push down an amount of deferred tax that is reflected in the financial accounts of a Main Entity or Parent Entity "with respect to the assets and liabilities" of a foreign PE or Entity that is also a Constituent Entity.

This follows a five-step formula. The first step is to separate out any deferred tax assets (DTAs) and deferred tax liabilities (DTLs) recorded in the financial accounts of the Main Entity or Parent Entity with respect to the assets and liabilities of each foreign PE or Entity. Then, deferred tax expense or benefit arising from the movement in those DTAs and DTLs must be determined and split into three categories depending on whether it corresponds to:

1. Income that is not GloBE Income
2. GloBE Income that is not Passive Income
3. GloBE Income that is Passive Income

The second step — which would apply in conjunction with the first step where applicable — is to disaggregate any "net basis" DTAs or DTLs such that the pre-FTC deferred tax expense or benefit and any creditable foreign tax amount may be separately determined. Consider a CFC that records 100 of book income in Year 1 but because of a timing difference the CFC earns zero taxable income for purposes of its Parent Entity's tax jurisdiction (which has a 20% rate) and its own tax jurisdiction (which has a15% rate). Assuming the CFC is expected to earn 100 taxable income in Year 2 for purposes of both tax jurisdictions, the Parent Entity should have a CFC inclusion but may also claim an FTC for any foreign taxes incurred by the CFC. If the MNE Group records a "net" DTL in Year 1 of 5 (i.e., a DTL of 20 for a CFC inclusion in the Parent Entity jurisdiction minus a DTA of 15 for creditable foreign taxes) that net DTL of 5 must be disaggregated into a DTL of 20 and a DTA of 15, respectively.

The third step is to allocate the deferred tax expense or benefit for any income that is not GloBE Income of the foreign PE or Entity. This amount is allocated to the respective foreign PE or Entity but is then excluded from Covered Taxes under Article 4.4.1(a) of the GloBE Model Rules because it relates to excluded income.

The fourth step is to allocate the deferred tax expense or benefit for any GloBE Income that is not Passive Income. The full amount of the deferred tax expense — prior to any recast in accordance with Article 4.4.1(a) of the GloBE Model Rules — must be allocated under this step to ensure that no amount of that deferred tax expense remains with the Main Entity or Parent Entity. Then, to determine the deferred tax expense inclusion for the foreign PE or Entity, any pre-FTC deferred tax liability for the foreign PE or Entity must be recast to 15. That amount is then reduced by any relevant creditable foreign taxes, which are not recast. If relevant creditable foreign taxes exceed the pre-FTC deferred tax liability, then the result is zero (i.e., the result cannot be negative).

This is illustrated by the following formula, where "DTE Inclusion" means the amount of deferred tax expense or benefit that is included for the foreign PE or Entity after the steps above: the DTE Inclusion for the foreign PE or Entity equals the movement in the recast gross DTLs and DTAs with respect to assets and liabilities of the foreign PE or Entity reduced by the relevant creditable foreign taxes (or used FTCs).

The fifth, and final, step is to allocate the deferred tax expense for any GloBE Income that is Passive Income. Generally, this step is similar to Step 4, except that the Passive Income limitation of Article 4.3.3 of the GloBE Model Rules must be applied if deferred tax expense is pushed down to a Hybrid Entity, Reverse Hybrid Entity, or CFC. Importantly, Article 4.3.3 is applied collectively to current and deferred tax expense. If the Passive Income limitation does not apply (i.e., there is excess tax expense), the excess is treated first as new deferred tax expense and then as current tax expense. Finally, if an amount of deferred tax expense is not allocated because of Article 4.3.3(b), then it is included in the Total Deferred Tax Adjustment for the Parent Entity. It is noted that Article 4.3.3 does not apply to taxes allocable to PEs.

The June 2024 Administrative Guidance addresses several other points related to pushdown of deferred taxes. First, and most importantly, the Guidance permits the MNE Group to make a Five-Year Election on a jurisdictional basis to exclude allocations of deferred tax expense or benefit under Article 4.3.2(a), (c), (d) and (e) of the GloBE Model Rules arising with respect to tax regimes applicable to Constituent Entities located in that jurisdiction. If the election is made, any allocable deferred tax expense or benefit is excluded from Covered Taxes of all Constituent Entities in the jurisdiction and from Covered Taxes of the Main Entity or Parent Entity (as the case may be).

Second, similar to the current tax pushdown rules described above, the June 2024 Administrative Guidance does not apply for purposes of Blended CFC Tax Regimes, such as the GILTI regime in the United States. In addition, the guidance states that pre-GloBE DTAs or DTLs associated with a Blended CFC Tax Regime cannot transition into GloBE under Article 9.1.1 of the GloBE Model Rules.

Third, the June 2024 Administrative Guidance extends earlier guidance on Substitute Loss Carry-forward DTAs to foreign PEs, Hybrid Entities, and Reverse Hybrid Entities. The February 2023 Administrative Guidance, which first introduced the concept of a Substitute Loss Carry-forward DTA, applied only where a Parent Entity has a domestic tax loss that offsets foreign-source income attributable to its CFC (i.e., a CFC inclusion).

Finally, the June 2024 Administrative Guidance does not provide further detail on the pushdown of deferred tax expense that relates to a domestic tax attribute of a Main Entity or Parent Entity. As noted, a Substitute Loss Carry-forward DTA is available where a Main Entity or a Parent Entity has a domestic tax loss that offsets foreign-source income attributable to a foreign PE or Entity. However, the OECD has not explicitly addressed circumstances where, for example, a Main Entity or a Parent Entity records deferred tax expense for the use of a domestic tax attribute (such as a net operating loss or FTC carryforward) to offset foreign-source income that is attributable to a foreign PE or Entity. The June 2024 Administrative Guidance contains a statement indicating that further consideration will be given to whether the Substitute Loss Carry-forward DTA guidance is fully effective or whether limitations are necessary.

Allocation of profits and taxes in structures including Flow-through Entities

The June 2024 Administrative Guidance clarifies specific issues that arise in applying the GloBE Model Rules to Flow-through Entities and Hybrid Entities, providing guidance intended to ensure profits and taxes are allocated appropriately and consistently between jurisdictions.

The first issue addressed by the June 2024 Administrative Guidance involves the classification of Flow-through Entities based on how they are treated under the tax laws of their owners' jurisdictions. A Flow-through Entity can be classified differently across jurisdictions, either as a Tax Transparent Entity or a Reverse Hybrid Entity. This situation arises because each jurisdiction has distinct rules for determining fiscal transparency. The complexity increases when a Flow-through Entity is owned by another Flow-through Entity, leading to uncertainty and potential double taxation because different implementing jurisdictions might attribute the profits to different jurisdictions.

To address this issue, the June 2024 Administrative Guidance proposes that the classification of a Flow-through Entity should be determined by the tax laws of the next owner up the chain who is not a Flow-through Entity. If no such owner exists, the Ultimate Parent Entity (UPE) will be considered, even if the UPE itself is a Flow-through Entity. The next owner up the chain who is not a Flow-through Entity and the Flow-Through UPE are referred to as the "Reference Entity." Additionally, because this determination is made for each Ownership Interest, an entity with multiple owners in different jurisdictions could have more than one classification for GloBE purposes, requiring that the classification be determined at the level of each owner.

The June 2024 Administrative Guidance also clarifies that a Flow-through Entity located in a jurisdiction without a corporate income tax or a similar Covered Tax cannot be considered fiscally transparent unless the jurisdiction's laws explicitly provide for such treatment. However, an Entity located in a jurisdiction without a corporate income tax may still be considered a Tax Transparent Entity in certain cases under Article 10.2.4 of the GloBE Model Rules.

The June 2024 Administrative Guidance clarifies the interaction between Article 3.5.3 and Article 3.5.4(b) of the GloBE Model Rules regarding the tax treatment of partially owned Flow-through Entities, particularly when the UPE of an MNE Group is also a Flow-through Entity. Article 3.5.4 of the GloBE Model Rules is intended to prevent the reduction of Financial Accounting Net Income or Loss (FANIL) of a Flow-through Entity due to ownership interests held by non-Group entities in the UPE, which could otherwise lead to the exclusion of an entity or the entire MNE Group from the GloBE Rules.

According to the June 2024 Administrative Guidance, stakeholders raised some concerns about the application of Article 3.5.4(b) of the GloBE Model Rules, especially in cases where Flow-through Entities are not wholly owned by the UPE. The June 2024 Administrative Guidance specifies that Article 3.5.4(b) of the GloBE Model Rules applies to the extent of the Ownership Interests owned by the UPE, whether directly or indirectly through a Tax Transparent Structure. However, Article 3.5.3 of the GloBE Model Rules continues to apply to Ownership Interests owned, directly or indirectly, by non-Group Entities, ensuring that the Financial Accounting Net Income or Loss of the Flow-through Entity is appropriately reduced and allocated.

The June 2024 Administrative Guidance provides the following example regarding the interaction between Articles 3.5.3 and 3.5.4(b) of the GloBE Model Rules:

A Co is the UPE of an MNE Group and is structured as a Flow-through Entity, holding 80% of B Co, which is also a Flow-through Entity within the same group. The remaining 20% of B Co is held by non-Group Entities. B Co's profit totals 100, and under Article 3.5.4(b) of the GloBE Model Rules, this article's provisions apply solely to the 80% of B Co's profit attributable to the UPE, equating to 80 of the profit. Consequently, Article 3.5.3 of the GloBE Model Rules remains applicable to the 20% ownership held by non-Group Entities. Thus, B Co's profit should be reduced by 20 before profit allocation in accordance with Article 3.5.1 of the GloBE Model Rules.

The June 2024 Administrative Guidance also addresses the application of Article 3.5.3 of the GloBE Model Rules in cases where minority owners hold their interests in a tested entity indirectly through another Constituent Entity. Article 3.5.3 requires the reduction of the FANIL of a Flow-through Entity by the amount attributable to non-Group Entity owners, including minority owners.

This reduction is required whether the minority interest is held directly or through a Tax Transparent Structure. The June 2024 Administrative Guidance indicates that the Inclusive Framework has agreed that the FANIL should be reduced when the minority owners' Ownership Interests in the tested Entity are held directly or are indirectly owned through a Constituent Entity-owner that is a Flow-through Entity and is closer in the ownership chain to the tested Entity than the Reference Entity.

In addition, the June 2024 Administrative Guidance addresses the issue of how to allocate taxes accrued by a Tax Transparent Entity to the Constituent Entity-owner that recognizes the income, indicating that Covered Taxes accrued by the Tax Transparent Entity should follow the profits allocated to the Constituent Entity-owner to maintain consistency in the jurisdictional ETR computation.

However, ambiguity arises when Covered Taxes, such as a Controlled Foreign Company (CFC) charge, are reallocated from one Constituent Entity to the Tax Transparent Entity under a different provision of Article 4.3 of the GloBE Model Rules. The June 2024 Administrative Guidance seeks to clarify whether these taxes should be reallocated further to the Constituent Entity-owner or treated as Covered Taxes of the Tax Transparent Entity itself.

The June 2024 Administrative Guidance modifies the allocation mechanism to ensure that CFC taxes are matched with the income they relate to and are allocated only to Reference Entities through which the Parent Entity paying the CFC tax owns its Ownership Interests in the Tax Transparent Entity. This modification also considers the Blended CFC Allocation Key, which must be computed before allocating the income of a CFC that is a Flow-through Entity to a Constituent Entity-owner.

The Commentary to the GloBE Model Rules will be updated to clarify that Article 4.3.2(b) of the GloBE Model Rules applies to both CFC tax charges allocated to a Tax Transparent Entity and Covered Taxes accrued in the financial accounts of the Tax Transparent Entity. In situations where a Tax Transparent Entity is owned by multiple Reference Entities, CFC taxes should only be allocated to a Reference Entity if the Parent Entity owns its Ownership Interest in the Tax Transparent Entity indirectly through that Reference Entity.

To illustrate this, the June Administrative Guidance includes the following example:

Consider an MNE where A Co owns B Co, and B Co owns C Co. The jurisdiction in which A Co is located, jurisdiction A, treats A Co, B Co or C Co as not fiscally transparent. The jurisdiction in which B Co is located, jurisdiction B, treats B Co as not fiscally transparent and C Co as fiscally transparent. The jurisdiction in which C Co is created treats C Co as fiscally transparent. See table below.

C Co, with a profit of 100 and an ETR of 0%, is considered a Tax Transparent Entity by Jurisdiction B. B Co, the closest non-Flow-through Constituent Entity-owner to C Co in the ownership chain, is designated as the Reference Entity. Under Jurisdiction A's CFC Tax Regime, A Co is taxed 15 on C Co's profit. This CFC tax is initially allocated to C Co in accordance with Article 4.3.2(c) of the GloBE Model Rules and subsequently reallocated to B Co in accordance with Article 4.3.2(b), aligning with the allocation of C Co's profit to B Co under Article 3.5.1.

The June 2024 Administrative Guidance identifies an issue with the definition of a Hybrid Entity. There is ambiguity regarding whether the term "owner" refers only to the direct owner or also includes indirect owners.

According to the June 2024 Administrative Guidance, the Commentary to Article 10.2.5 of the GloBE Model Rules will be modified to clarify that the word "owner" refers to both the direct and indirect Constituent Entity-owner of the Entity. As such, Covered Taxes reflected in the financial accounts of both direct and indirect Constituent Entity-owners will be allocated to the Hybrid Entity, subject to the limitations in Article 4.3.3 of the GloBE Model Rules.

The June 2024 Administrative Guidance addresses the treatment of Flow-through Entities located in jurisdictions without a corporate income tax or similar Covered Tax. Typically, a Flow-through Entity's profits are allocated to its owners for tax purposes if the entity is considered fiscally transparent. However, if an entity is in a jurisdiction without a corporate income tax, it cannot be considered fiscally transparent under the standard definition because there are no laws treating the entity's income as the owners' income. This creates a challenge in ensuring that taxes are matched with the related income in the GloBE calculations.

To resolve this issue, the June 2024 Administrative Guidance extends the definition of a Hybrid Entity to include entities in jurisdictions without a corporate income tax, provided they are treated as fiscally transparent in the jurisdiction where their owners are located and are not considered fiscally transparent under Article 10.2.4 of the GloBE Model Rules. This ensures that the tax paid by the owners on the entity's profits is allocated to the entity for GloBE purposes, maintaining the principle of matching taxes with the income to which they relate.

The June 2024 Administrative Guidance addresses the challenge of aligning profits and taxes for Flow-through Entities when different jurisdictions classify these entities inconsistently. This inconsistency can lead to mismatches where an indirect owner pays taxes on an entity's income, but the Reference Entity does not recognize this income, resulting in double taxation and inaccurate ETR computations.

To resolve this, the June 2024 Administrative Guidance clarifies that taxes paid by indirect owners on a Reverse Hybrid Entity's income should be allocated to the entity itself. This ensures that both the income and the corresponding taxes are included in the same jurisdictional ETR computation.

The following example is included in the guidance to illustrate this:

Consider an MNE Group in which A Co in Jurisdiction A owns B Co in Jurisdiction B, which owns C Co in Jurisdiction C. Jurisdiction A treats C Co as transparent, taxing A Co on C Co's income. Jurisdiction B treats C Co as opaque. See table below.

The June 2024 Administrative Guidance ensures that taxes paid by A Co on C Co's income are allocated to C Co.

Securitization vehicles

In a classical securitization transaction, assets like loans or mortgages are transferred from the creditor (the originator) to a Special Purpose Vehicle (SPV) or multiple SPVs, which could be a company, trust, or similar arrangement. Where the SPV is a company, it is often owned by an unconnected third party. It typically issues debt instruments on the bond market to finance the asset pool acquisition or to enter into a synthetic securitization transaction in which the SPV becomes party to a derivative contract or guarantee and assumes the risk of the underlying asset pool's performance, while also owning highly secure assets such as government debt. The SPV's asset pool (and/or derivatives or other instrument) generate income to service the debt, with any excess returned to the originator or related entity through a defined cash-extraction mechanism, under which payments are commonly made on a monthly or quarterly basis so surplus cash is typically not retained in the SPV for a significant period of time.

The SPV structure ensures bankruptcy remoteness from the originator and isolates the risk of the asset pool from the wider credit risk associated with the originator.

Many securitization vehicles are not consolidated and are, therefore, not subject to Pillar Two. However, in certain situations a securitization vehicle may be consolidated into the same group as the originator, and consequently may be a Constituent Entity in the originator's MNE Group under the GloBE Model Rules. This may be due to the originator's ownership interest in the SPV or to a servicing agreement or other arrangement with the SPV, under which the originator takes responsibility for the day-to-day management of the asset pool. This (together with the cash-extraction mechanism) can lead to the originator being treated as having control over the SPV under some financial accounting standards.

Although SPVs are designed to make only a negligible profit (at most) over the life of the transaction, they can recognize significant profits or losses in their FANIL in a given financial year (e.g., due to hedging arrangements used to mitigate risks like currency fluctuations or interest rate changes). If hedge accounting is not applied, fair value accounting of these instruments can create a mismatch if the hedged asset or liability is not also subject to fair value accounting. As many SPVs do not account for deferred tax, there will not be a deferred tax amount in the Adjusted Covered Taxes to offset the impact of the GloBE Income or Loss attributable to the hedge. This can result in a top-up tax under the GloBE Rules in years where fair value profits (e.g., from hedging) occur, despite the SPV's negligible profit from the overall transaction.

Levying top-up-tax on such SPV would significantly undermine the viability of securitization transactions and could result in the SPV no longer being isolated from the originator's Group, potentially affecting its solvency and credit rating (even before any actual tax liability arises).

To address these issues, the June 2024 Administrative Guidance foresees that jurisdictions adopting a QDMTT may exclude SPVs used in securitization transactions (Securitization Entities) as defined by the June Guidance from QDMTT or impose the top-up-tax liability relating to Securitization Entities on other Constituent Entities (if any) within the jurisdiction without forfeiting the Consistency Standard required for a jurisdiction to be eligible for the QDMTT Safe Harbor. Where Securitization Entities are excluded from QDMTT, the MNE Group will have to apply the Switch-off Rule with respect to the jurisdiction where the Securitization Entity is located. Where a jurisdiction opts for the inclusion of Securitization Entities within the scope of its QDMTT but decides to impose any top-up tax liability on other Constituent Entities of the MNE group in the jurisdiction (or the Securitization Entity in absence of any other Constituent Entity), the Switch-off Rule will not apply and the MNE Group would be allowed to apply the QDMTT Safe Harbor for the QDMTT jurisdiction.

A "Securitization Entity" is defined as an Entity which is a participant in a Securitization Arrangement (as defined), and which satisfies all of the following conditions:

• The Entity only carries out activities that facilitate one or more Securitization Arrangements.

• It grants security over its assets in favor of its creditors (or the creditors of another Securitization Entity).

• Annually or more frequently, it pays out all cash received from its assets to its creditors (or the creditors of another Securitization Entity), other than cash retained to meet an amount of profit required by the documentation of the arrangement, for eventual distribution to equity holders (or the equivalent), or cash reasonably required under the terms of the arrangement for either (or both) of the following purposes:
  • To provide for future payments that the Entity is required, or will likely be required, to make under the terms of the arrangement
  • To maintain or enhance the Entity's creditworthiness
• Any profit that the arrangement's documentation requires eventually be distributed to equity holders (or equivalent) must be negligible relative to the revenues of the entity.

Implications

The June 2024 Administrative Guidance provides important additional information on the interpretation and operation of technical aspects of the GloBE Rules.

Companies should monitor ongoing developments with respect to Administrative Guidance to identify all items relevant to the operation of the GloBE Rules in their circumstances. It also will be important for companies to monitor how the jurisdictions where they operate reflect the June 2024 Administrative Guidance and all other agreed Administrative Guidance in their domestic Pillar Two legislation.

Contact Information

For additional information concerning this Alert, please contact: Ernst & Young Tax Services Limited, Hong Kong · Matt Andrew Ernst & Young, LLP, India · Vinod Ramachandran Ernst & Young Tax Advisory Services S.à r.l., Luxembourg City Anja Taferner Katia Agazzini Ernst & Young Belastingadviseurs LLP, Netherlands Ronald van den Brekel Oana Popescu Ernst & Young Ltd, Switzerland · Alain Horat Ernst & Young LLP, United States Barbara M. Angus Adam Becker Jose A. (Jano) Bustos Roberto Aviles Gutierrez Craig Hillier Jeffrey M. Michalak Jason Yen

Published by NTD’s Tax Technical Knowledge Services group; Carolyn Wright, legal editor For a full listing of contacts and email addresses, please click on the Tax News Update: Global Edition (GTNU) version of this Alert.