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How BEPS 2.0 could impact the alternative investment fund (AIF) industry

Global asset managers are still developing approaches for base erosion and profit shifting (BEPS) initiatives and face new challenges.

In brief

  • The timeline for implementation is ambitious.
  • The scope of the Pillar One measures now covers multinational entities with global turnover above approximately $23.5 billion.
  • Pillar Two’s practical impact on global operations of MNEs may be substantial.

The new BEPS 2.0 measures initially aimed to address tax developments arising from the digitalization of the economy and have been one of the priorities of the Organisation for Economic Co-operation and Development (OECD)/G20¹ Inclusive Framework on BEPS in recent years, following the release of the BEPS Action 1 Report in 2015. They have been grouped into two proposals, referred to as pillars — one on nexus and profit allocation (Pillar One) and another on ensuring a minimum level of taxation (Pillar Two), documented in the Pillar One and Pillar Two Blueprints published in October 2020.²

The OECD/G20 Inclusive Framework on Base Erosion and Profit Shifting (IF) introduced a two-pillar solution and issued two specific statements. The most recent statement was published on October 8, 2021, (October Statement)³ and outlines the agreed key components of each Pillar. The October Statement has been agreed upon by 137 of the 141 jurisdictions participating in the IF and subsequently endorsed by the G20 finance ministers and the G20 leaders.

The implementation timeline, presented in the appendix to the October Statement, is ambitious, with the expectation that most rules will come into effect as early as 2023. Pillar Two Model Rules,⁴ containing the model legislation for jurisdictions to use when introducing elements of Pillar Two, were released in late December 2021.

This new tax development comes when governments are struggling to rebuild their budgets and the global economy is attempting to recover from the COVID-19 pandemic. Hence, it comes as no surprise that the BEPS 2.0 project has received such strong support from many G7 and G20 country leaders, and significant political urgency with respect to the measures is driving the implementation timeline.


Chapter 1

Pillar One

Nexus and profit allocation rules

Pillar One introduces a new approach to profit allocation between jurisdictions, departing from the reference to physical presence only. A fundamental goal of this pillar is to grant additional taxing rights to market/user jurisdictions.

  • Scope: Compared with the Pillar One Blueprint, the scope of the measures has been significantly revised and now covers multinational entities (MNEs) with global turnover (i.e., total income the business generates) above EUR20 billion (approximately $23.5 billion) and profitability above 10% (i.e., profit before tax/revenue) — rather than focusing on consumer-facing businesses and automated digital services. Importantly, this threshold will be reassessed after seven years with a view to decreasing it to EUR10 billion (approximately $11.8 billion). 
  • Business line segmentation could be applied in exceptional cases, so that a segment of an MNE that meets the minimum turnover and profitability thresholds on a standalone basis would be within scope of the new rules.
  • Taxation: Among various technicalities, the main practical consequence would be a new taxing right over a 25% share of residual profit (profit in excess of 10% of revenue) of in-scope MNEs (Amount A) allocated to market jurisdictions with nexus, using a revenue-based allocation key. Nexus will only exist if the in-scope MNE derives at least EUR1 million in revenue from the jurisdiction (reduced to EUR250,000 for smaller jurisdictions with a gross domestic product of less than EUR40 billion).
  • Relevant exclusions: Significant for the asset management industry, the October Statement reiterates that regulated financial services will be excluded from the scope of Pillar One.
  • Implementation: Amount A will be implemented through a Multilateral Convention (MLC) and, to the extent necessary, changes to domestic legislation. The text of the MLC supplemented by an Explanatory Statement is expected to be released in early 2022, so that the participating countries can sign and ratify it by 2023. The MLC will also require all parties to remove digital services taxes (and similar levies) on all companies and commit not to introduce such measures in the future.
  • Practical implications for alternative asset managers: As the current turnover threshold is very high, it is unlikely that investment funds or real estate investment trusts (REITs) would fall within the scope of Pillar One. Similarly, for asset managers, it is reasonable to assume that most should not be affected by Pillar One while the EUR20 billion threshold remains applicable (as noted above, it is expected to be lowered in seven years).

Furthermore, regulated investment funds as well as regulated fund managers may be able to rely on the regulated financial services exemption; however, the exact scope of the exclusion is yet to be defined.  

On the whole, it is expected at this stage that only a relatively small number of the world’s largest corporations will be subject to the core rules of Pillar One, during the first few years following its implementation. Portfolio companies are not excluded from Pillar One, so the general rules could become relevant for private equity asset managers in the future.

Importantly, Pillar One introduces another concept — Amount B — which aims to standardize the remuneration of related party distributors that perform “baseline marketing and distribution activities” in a manner that is aligned with the arm’s-length principle. Amount B is not expected to be subject to the same scope limitation as Amount A — and hence Amount B could apply to a much larger number of MNEs. Work on Amount B is to be finalized by the end of 2022.


Chapter 2

Pillar Two

Minimum tax rules

The purpose of Pillar Two is to confirm that all large internationally operating businesses are subject to a minimum level of taxation regardless of where their operations are conducted or headquarters are located.

  • Scope: Pillar Two has two main components:
    • A treaty-based rule, called the Subject-to-Tax Rule (STTR)
    • Two interlocking domestic rules, referred to as the Global anti-Base Erosion (GloBE) rules

The STTR will apply before the GloBE rules. Its main objective is to allow developing countries⁵ to impose additional tax on certain payments made between connected persons (the relevant test is based on a control relationship) to countries that impose corporate income tax at nominal rates below the STTR minimum rate (9%).

The GloBE rules should, for the most part, apply to MNE groups and their Constituent Entities,⁶ which are already within the scope of the CbCR rules, i.e., having consolidated revenues exceeding EUR750 million (approximately $885 million) for two out of the four fiscal years immediately preceding the tested fiscal year.

The practical impact of Pillar Two on global operations of MNEs may be substantial, particularly as the scope of the GloBE rules may not be fully uniform across all jurisdictions. The Inclusive Framework member jurisdictions are not required to adopt GloBE rules, but they all accept the application of these rules by other Inclusive Framework members. In addition, each country is free to impose a top-up tax with respect to parent entities in such country in response to the low taxation of any of their direct or indirect subsidiaries, even if the group does not meet the EUR750 million threshold.

  • Taxation:
    • STTR: The STTR will allow source jurisdictions to impose withholding tax on certain related party payments (e.g., interest), if such payments are not subject to minimum taxation. The additional tax would be limited to the difference between the agreed minimum rate (9%) and the rate at which the corresponding income is taxed in the payee’s jurisdiction. The agreed minimum rate refers to a nominal adjusted corporate income tax rate. To avoid double taxation on certain payments, Pillar Two addresses the effective rule coordination between the GloBE and the STTR by stating that the tax under the STTR would be taken into account in the effective tax rate (ETR) computation for GloBE purposes.
    • GloBE rules: The GloBE rules are further divided into an Income Inclusion Rule (IIR), which would allow a parent company’s jurisdiction to tax on a current basis income earned through Constituent Entities that are subject to tax at low rates (i.e., ETR below 15%), which is commonly referred as a top-up tax, and an Undertaxed Payments Rule (UTPR), which serves as a backstop to the IIR and would allow jurisdictions to deny deductions (or perform an equivalent adjustment) with respect to Constituent Entities that are subject to low taxation (i.e., ETR below 15%).

The IIR is the primary rule, which, to some extent, is based on traditional controlled foreign company (CFC) rules and resembles the US Global Intangible Low-Taxed Income (GILTI) regime. Briefly, it effectively triggers additional taxation (the top-up tax) at the level of the parent entity where the MNE’s jurisdictional ETR is below the agreed minimum rate.

The UTPR is a secondary rule, so it only applies where a Constituent Entity is not already subject to an IIR. In application of the UTPR, the top-up tax would be effectively allocated to jurisdictions that are home to other members of the MNE group and that have UTPR rules, based on the relative amounts of tangible assets and employee headcount in those other group members. As highlighted by the Pillar Two Model Rules, under certain circumstances low-taxed profit of the ultimate parent entity (UPE) could be subject to top-up tax by countries where subsidiaries are located.

  • Relevant exclusions: The Model Rules provide exclusions from the GloBE rules for certain type of entities. These include:
    • Governmental entities
    • International organizations
    • Nonprofit organizations
    • Pension funds
    • Investment Funds if they are the UPE of an MNE group
    • Real Estate Investment Vehicles if they are the UPE of an MNE group
    • Entities that are owned by one or more of the Excluded Entities listed subject to certain ownership activity conditions (These entities do not need to be UPEs to benefit from the exclusion.)
  • Implementation: The STTR is expected to be implemented through changes in double tax treaties. A multilateral instrument will be developed by mid-2022 to facilitate the implementation of the STTR.

The GloBE rules are expected to be implemented through changes in domestic law by participating countries in 2022 to be effective in 2023, except that the UTPR is to come into effect in 2024.

The European Commission has announced plans to move quickly on implementation through an EU Directive, releasing a draft Pillar Two directive on December 22, 2021. Initially, this implementation was expected to be rather challenging given that some of EU Member States did not agree to the previous statement issued by the Inclusive Framework on July 1, 2021. However, Ireland now has signed up to the BEPS 2.0 plan. Similarly, Estonia and Hungary also joined the October Statement. Despite the fact that Cyprus is not a member of the Inclusive Framework, it welcomed the agreement reached on October 8.

  • Practical implications for alternative asset managers: The Model Rules in principle recognize that investment funds should be out of the scope of Pillar Two, in line with the Pillar Two Blueprint’s exclusion rules from the GloBE designed to preserve the tax neutrality of the fund industry. An Investment Fund will qualify as an Excluded Entity only if it meets certain specific conditions:
    • It is designed to pool assets (which may be financial and nonfinancial) from a number of investors (some of which are not connected).
    • It invests in accordance with a defined investment policy.
    • It allows investors to reduce transaction, research and analytical costs, or to spread risk collectively.
    • It is primarily designed to generate investment income or gains, or protection against a particular or general event or outcome.
    • Investors have a right to return from the assets of the fund or income earned on those assets, based on the contributions made by those investors.
    • The entity or its management is subject to a regulatory regime in the jurisdiction in which it is established or managed (including appropriate anti-money laundering and investor protection regulation).
    • It is managed by investment fund management professionals on behalf of the investors.

Real Estate Investment Vehicle is defined as an entity the taxation of which achieves a single level of taxation either in its hands or the hands of its interest holders (with at most one year of deferral), provided that that person holds predominantly immovable property and is itself widely held.

The above definitions should be broad enough to cover commonly used arrangements — regulated funds (including Luxembourg SIFs, Irish QAIFs), unregulated funds that are managed by a regulated asset manager, such as Luxembourg RAIFs or REITs.

Although at first sight the investment fund industry is believed to not be subject to the Pillar Two rules, a number of uncertainties remain.

Diving further into the details, some requirements inadvertently create uncertainties for a number of funds. As an example, the first condition (a number of investors, some of which are not connected) could impact arrangements put in place for investors belonging to the same group (i.e., insurance companies):

  • Many stakeholders in the asset management industry responded to the OECD’s call for comments on its October 2020 Blueprints and raised concerns on the proposed definition. Some of their concerns were, at least partially clarified, such as specific treatment of REITs. Other key points have not been addressed yet, for instance, whether the GloBE rules should not apply to an investment fund that is the UPE of its group. The investors and general partners typically do not consolidate with the investment funds in which they invest; there are some exceptions among investment managers but no specific carve-out was included to cover these situations.
  • If an investment fund does not meet the definition of an Excluded Entity, the UTPR could potentially apply to payments made by the fund, such as income distributions to investors and asset management fees if they are low-taxed.
  • A holding company of an investment fund would be an Excluded Entity, if, inter alia, it is wholly owned or almost exclusively owned by one or more Investment Funds or other Excluded Entities. There is still not enough clarity on the practical impact of these rules on co-investment arrangements and intra-group activities carried out by certain holding companies.

Finally, irrespective of the impact of Pillar Two on the tax neutrality of fund and holding companies, PE asset managers should consider the impact of these rules on their portfolio companies.

In conclusion, although the general expectation is that the direct impact of BEPS 2.0 on the investment fund industry should be limited, the IF is also still working on Commentary to support the Pillar Two Model Rules, which is expected to be released soon. Reviewing the model rules and relevant exclusions, together with the Commentary to come, may be important to timely addressing possible operational challenges. In addition, it may be important to monitor the conditions under which the US GILTI regime will be considered to coexist with the OECD GloBE rules.

This article is provided solely for the purpose of enhancing knowledge on tax matters. [It does not provide accounting, tax, or other professional advice.]

Views expressed in this article are those of the authors and do not necessarily represent the views of Ernst & Young LLP or other members of the global EY organization.


Looking further ahead, the EU implementation of BEPS 2.0 will have implications for existing and pending EU Directives and initiatives, such as the Interest and Royalties Directive. Thus, any EU changes related to BEPS 2.0 should be carefully examined as they might have an indirect impact on investments. As part of the wider EU tax agenda, the EU Commission introduced, among others, new anti-tax avoidance measures with respect to shell companies that could have further consequences on considerations for European investments.

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