Pillar Two Of The Inclusive Framework On BEPS

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Article 1.2 of the Model Rules establishes the definitions of MNE Group and Group. The first definition of MNE Group is set forth in Article 1.2.1, according to which an MNE Group means ...
Switzerland Tax

A.THE GROUP AND ITS UNITS

1. Definitions of MNE Group

a) Basic definition of MNE Group

1.001 Article 1.2 of the Model Rules establishes the definitions of MNE Group and Group. The first definition of MNE Group is set forth in Article 1.2.1, according to which an MNE Group means any Group that includes at least one Entity or Permanent Establishment (PE) that is not located in the jurisdiction of the Ultimate Parent Entity (UPE). This definition contains some terms requiring reference to other provisions of the Model Rules, such as Group (defined in Article 1.2.2), Entity and PE (supra 1.A.1(b)) (both defined in Article 10.1), as well as UPE (defined in Article 1.4) (infra 1.A.2); these terms will be defined in detail below. For the sake of clarity, it is worth mentioning that according to Article 10.1 the term Entity means: (a) any legal person (other than a natural person) or (b) an arrangement that prepares separate financial accounts, such as a partnership or trust. The term PE according to Article 10.1 will be defined in detail below (infra 1.1.B(b)). Finally, on the basis of Article 10.1, Group Entity, in respect of any Entity or Group, means an Entity that is a member of the same Group.

1.002 The definition of MNE Group provided by Article 1.2.1 can be appreciated for its clearer and simpler wording than that originally contained in the Pillar Two Blueprint, where an MNE Group was defined as 'any Group that includes two or more enterprises the tax residence for which is in different jurisdictions or includes an enterprise that is resident for tax purposes in one jurisdiction and is subject to tax with respect to the business carried out through a PE in another jurisdiction'.1 Despite some minor drafting changes, that definition was similar to the one set out for CbCR purposes.2 The primary objective of the MNE Group definition adopted within the Model Rules is to delineate the subjective scope of these rules. It mandates, for the Group to qualify as an MNE Group, that a UPE of the Group must have, directly or indirectly, at least one foreign subsidiary or a PE in a country other that of the localization of the UPE.3

1.003 In this sense, Article 1.2.1 of the Model Rules outlines two important requirements that need to be met before a Group of companies can be classified as an MNE Group and therefore fall within the scope of the Model Rules. These conditions mandate that the UPE of the Group must possess, either directly or indirectly, at least a subsidiary or a PE abroad. In other words, the Model Rules can only apply when an Entity has a foreign subsidiary or a foreign branch. In addition, the foreign subsidiary or branch must be considered as a member of the same Group and fall within a certain degree of ownership or control of the UPE.4

1.004 The MNE Group definition lacks any reference to the notion of tax residence, but rather includes the term 'localization', which, according to the literal wording of Article 1.2.1, refers to both the subsidiary and the PE as well as to the UPE. A Group will fall within the definition of an MNE Group if at least a subsidiary or a PE are 'located' in a jurisdiction different from that where the UPE is 'located'.

1.005 The concept of 'localization' has indeed a broader meaning, as it covers both the case where an Entity belonging to the Group is resident for tax purposes in a specific jurisdiction under the domestic tax provisions of this latter and the case where the income of this Entity belonging to the Group is produced in a foreign jurisdiction through a minimum threshold, that is, specifically qualifying as a PE situated there. According to Article 10.3.1, the location of an Entity that is not a Flow-through Entity is determined as follows: (a) if it is a tax resident in a jurisdiction based on its place of management, place of creation or similar criteria, it is located in that jurisdiction; and (b) in other cases, it is located in the jurisdiction in which it was created.

1.006 In other words, an MNE Group only exists when there is an operational business presence connecting an Entity of one country with at least another foreign country. If such an Entity does not have, directly or indirectly, at least one foreign subsidiary or a PE in a jurisdiction other than where it is tax-located (namely, tax-resident), there is no MNE Group under the Model Rules, even if such an Entity derives income from foreign sources (that is, royalties, interest, income from real estate, and so on).

1.007 The rationale behind this definition can be found in the essence of the Model Rules, which are targeted at MNEs engaged in cross-border activities and operating in multiple jurisdictions. They aim at capturing situations where differences of domestic tax laws bring about strategies of profit shifting and base erosion. The Model Rules look at the global operational presence of a Group when determining its classification under their framework.

1.008 Therefore, an MNE Group consisting in several different entities, operating in one State only, even if meeting all other requirements, cannot be considered as an MNE Group and cannot thus be subject to the Model Rules. By contrast, the mere existence of a single foreign subsidiary or a single PE, even if not generating income, is sufficient to make an MNE Group fall within the MNE Group definition.

1.009 The clarity and simplicity of this definition deserve appreciation, as it successfully identifies the international dimension of the MNE Group as a pivotal requirement for the application of the Model Rules. There is however a problem. On the one hand, it is possible to easily verify this requirement by a Group in those cases where the UPE directly or indirectly owns a foreign subsidiary or a foreign PE. On the other hand, however, to verify the requirement can be more problematic when the foreign dimension of the MNE Group has not been declared in advance by the taxpayer, but is instead ascertained as a result of inspections by the tax authority of the foreign country.

1.010 This can be, for example, the case that arises when an entity of one State is present or operating in another State because it has a significant degree of stability, permanence and structural adequacy, which exceeds the activities of a preparatory and auxiliary character, or when such activities are carried out as part of a unified strategy so that the 'anti-fragmentation rule' of Article 5 of the OECD Model applies. Similarly, a PE could exist when an entity, formally acting as an independent agent, is de facto dependent on the foreign headquarters and plays a primary role in concluding contracts in the interest of the latter and this circumstance is determined ex post by the tax authorities. In these situations, therefore, the international nature of the MNE Group would only be ascertained after tax inspections. If all other requirements are met, the Model Rules should retroactively apply starting from the tax period in which the group should have been considered an MNE Group under Article 1.2.1.

(b) Definition of Group on the basis of accounting consolidation test

1.011 The definition of Group is set out in Article 1.2.2, which provides that a Group means a collection of Entities that are related through ownership or control such that the assets, liabilities, income, expenses and cash flows of those Entities:

  • are included in the Consolidated Financial Statements (infra 2.A.2(a)) of the UPE; or
  • are excluded from the Consolidated Financial Statements of the UPE solely on size or materiality grounds, or on the grounds that the Entity is held for sale.

This definition of Group is to be distinguished from the definition of MNE Group (supra 1.A.1(a)), which is crucial for the identification of the scope of the Model Rules. The definition of Group in fact is based on an accounting consolidation test: a Group is deemed to exist where more than one Entity is connected by a degree of common ownership and control based on an accounting consolidation test, and if one of the other two requirements established in paragraph (a) or (b) is alternatively met. The term Entity includes not only legal entities, but also arrangements such as partnerships or trusts that prepare separate financial accounts.5

(i) Consolidated Financial Statements of the UPE

1.012 The requirement set out in Article 1.2.2(a) mandates a comprehensive, line-by-line consolidation of the assets, liabilities, income, expenses, and cash flows (that is, the financial results) of the Entities, including those of their PEs. It looks at the representation of a Group based on the Consolidated Financial Statements prepared by the UPE, consisting of a collection of Entities, from a financial perspective6 (infra 2.A.2(a)). The absence of consolidated accounts, however, does not exempt a collection of Entities from being technically considered a Group for the purposes of the Model Rules. In fact, according to the 'deemed consolidation test' in paragraph (d) of the definition of 'Consolidated Financial Statements' in Article 10.1, the Entities would have been consolidated had an Entity been required to prepare such accounts. Such Entities are still considered part of the same Group. This 'deemed consolidation test' ensures that these Entities, though not directly consolidated, are recognized as forming part of the Group. This provision enhances the scope of the Group definition to prevent omission of Entities that should logically be included in the consolidated reporting structure.

1.013 An Entity can be considered as part of a Group only if it fits the definition of 'Entity' under Article 10.1 (supra 1.A.1(a)) and if it also meets the requirements described above set out in Article 1.2.2(a). As clarified in Commentary P2,7 for instance, a joint operation, such as partnership, conforms to the definition of an Entity in a manner that allows the portion of its assets, income, expenses, cash flows and liabilities attributable to joint operators within the same Group to be analytically integrated into the Consolidated Financial Statements; in this case such joint operation is deemed a separate Entity within the Group. This inclusion is executed on a detailed basis within the Consolidated Financial Statements. Therefore, when Entities are reported using the pro rata or proportional consolidation method, they are considered CEs of the Group. In such cases, the segment of the Entity's assets, income, expenses, cash flows and liabilities that finds representation in the Consolidated Financial Statements is factored in for the purposes of complying with the Model Rules. This is exemplified by how the consolidated revenue threshold specified in Article 1.1 takes into consideration solely the revenue amount that is reflected within the Consolidated Financial Statements.

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Footnotes

1. Blueprint P2, § 2.2. See: Vasiliki Agianni, Rene Offermanns and Marnix Schellekens, 'The Income Inclusion Rule', in Andreas Perdelwitz and Alessandro Turina (eds), Global Minimum Taxation? An Analysis of the Global Anti-Base Erosion Initiative (IBFD, 2021).

2. According to Article 1.2 of the Model legislation related to CbCR, the term 'MNE Group' means any Group that (i) includes two or more enterprises the tax residence for which is in different jurisdictions, or includes an enterprise that is resident for tax purposes in one jurisdiction and is subject to tax with respect to the business carried out through a PE in another jurisdiction, and (ii) is not an Excluded MNE Group. OECD (2015), Transfer Pricing Documentation and Country-by-Country Reporting, Action 13 – 2015 Final Report, OECD/G20 Base Erosion and Profit Shifting Project, OECD Publishing, Paris. http://dx.doi.org/10.1787/ 9789264241480-en

3. Commentary P2 § 20, Article 1.

4. § 17, ibid.

5. § 21, ibid

6. § 22, ibid.

7. § 23, ibid

Originally published by EE Elgaronline

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