OECD Issues Additional Administrative Guidance for Pillar Two
The OECD on June 17 released additional administrative guidance on the Pillar Two GloBE model rules. The fourth set of administrative guidance follows three rounds of administrative guidance that were issued in February 2023, July 2023, and December 2023. This guidance covers a number of issues under the GloBE rules including:
- The application of the recapture rule applicable to deferred tax liabilities (DTL), including how to aggregate DTL categories and methodologies for determining whether a DTL reversed within five years.
- Clarification on how to determine deferred tax assets and liabilities for GloBE purposes when the rules result in divergences between GloBE and accounting carrying value of assets and liabilities.
- The cross-border allocation of current and deferred taxes, allocation of profits and taxes in certain structures involving flow-through entities, and the treatment of securitization vehicles.
The new guidance provides additional detail on how the GloBE rules are intended to operate for multinational enterprises. This administrative guidance will be incorporated into the commentary to the GloBE model rules.
DTL Recapture
Article 4.4.4 of the GloBE model rules provides that the accrual of a DTL that is claimed in adjusted covered taxes for the relevant year is subject to recapture if it does not reverse within the subsequent five years. The DTL recapture rule does not apply to DTLs that qualify as recapture exception accruals, under Article 4.4.5 or to an unclaimed accrual under Article 4.4.7.
Generally, the DTL recapture rule requires the adjusted covered taxes and the effective tax rate (ETR) for the year in which the DTL was accrued and claimed to be recomputed without such DTL, which may result in an additional top-up tax if the recomputed ETR is below the minimum rate. The DTL recapture rule generally applies to certain categories of DTLs, and compliance with the DTL recapture rule requires each constituent entity to (i) identify categories of DTLs that are in scope of the DTL recapture rule and (ii) determine the year in which, and the extent to which, each identified DTL accrual reverses.
The main objectives of the administrative guidance on DTLs are (i) to clarify how to manage the DTL recapture rule in a practical way that is in line with the policy objective of the rule, and (ii) to minimize the administrative and compliance burden for tax administrations and multinational enterprise (MNE) groups. The guidance provides rules on the criteria for determining the scope of a DTL category and methodologies for determining whether the DTL accruals in a category have reversed within five years. The guidance also provides a roadmap to determining whether DTL reversals are attributable to recaptured DTLs or pre-GloBE DTLs (that is, DTLs that originated before the transition year) that are not subject to the recapture rule.
Additionally, the guidance provides that a constituent entity may make an unclaimed accrual five-year election for a DTL category that it does not expect to reverse within five years. This simplifying approach allows a constituent entity to not claim DTL accruals in determining its adjusted covered taxes. If this election is made, the constituent entity will not need to determine when a DTL reverses.
Divergences Between GloBE and Accounting Carrying Values
The June 2024 administrative guidance provides rules on how MNE groups should account for adjusted covered taxes of constituent entities when there is a divergence between GloBE and accounting carrying values. Divergences between GloBE and accounting carrying values may result from a number of the provisions under the GloBE rules. When there is a divergence between the carrying value of assets and liabilities for GloBE and accounting purposes, the total deferred tax adjustment amount is determined on the basis of the GloBE carrying value rather than the accounting value.
The administrative guidance also provides that a cross-border, intragroup asset transfer is subject to the GloBE arm’s length price, which is relevant for calculating the GloBE income or loss of the disposing entity and determining the GloBE carrying value of assets and liabilities and related deferred taxes at the level of the acquiring entity.
Allocation of Cross-Border Taxes
The June administrative guidance provides a four-step process for allocating a parent entity’s current taxes to its permanent establishments when its domestic tax system allows for cross-crediting of taxes. This process is intended to apply to allocations related to permanent establishments, hybrid entities, controlled foreign corporation (CFC) taxes (excluding blended CFC taxes such as global intangible low-taxed income (GILTI)), and taxes on distributions. The guidance also provides a five-step process for allocating cross-border deferred taxes. Further, the guidance provides that the substitute loss carryforward DTA rules also apply to hybrid and permanent establishment regimes.
Other Issues
The administrative guidance also provides commentary on the allocation of profits and taxes in certain structures involving flow-through entities, and the treatment of securitization vehicles.
Next Steps
The release by the OECD provides additional guidance on the implementation and impact of Pillar Two. The additional administrative guidance will be incorporated into the commentary to the GloBE model rules.
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