Global Minimum Tax : 16 – Permanent Establishments under GloBE

[Amit Jalan]

Friends

Time is ticking away ahead of these new GloBE rules being implemented starting 2024, and countries everywhere are coming up with draft legislation to implement them. Most tax teams in MNEs know that they need to make a change. Challenges are understanding, evaluating, and modelling the impacts across the organization.

We bring this edition to highlight one key aspect talked about within the GloBE Rules, i.e., Permanent Establishments and all the rules around it as contained within the Model Rules.

We hope this bulletin adds Value in your professional Sphere.

In broad terms, the Pillar 2 GloBE Rules determines the Effective Tax Rate (“ETR”) of all jurisdictional Entities within an MNE Group and compare this to the 15% minimum rate, whereby any shortfall is subjected to a top-up tax. It achieves this by allocating income and tax to ‘constituent entities’ in a jurisdiction and then blending all of the income and tax together to calculate a jurisdictional effective tax rate (ETR).

Article 1.3 of the GloBE Rules treats a Permanent Establishment (“PE”) of a Constituent Entity as a separate “Constituent Entity” from the Main Entity of which it is a part.

Further, under Article 1.2 of the GloBE Rules, an MNE Group is any Group that includes at least one Entity or Permanent Establishment that is not located in the jurisdiction of the Ultimate Parent Entity. Thus, an Entity located in one jurisdiction together with its PE located in another jurisdiction will form an MNE Group for the purposes pr the GloBE Rules, provided only that the Entity is not part of any other MNE Group or an Excluded Entity under Article 1.5 of the GloBE Rules and that the PE is not a Stateless-PE.

Thus, under the GloBE Rules, each PE is treated as a separate constituent entity, both from the Main Entity of which it is a part as well as any other PEs (other than Stateless PEs). Therefore, the GloBE Rules provide rules to allocate Globe income and covered taxes separately to PEs for the purpose of calculating the jurisdictional ETR.

The GloBE Rules include a number of specific provisions relating to PEs. The key ones are:

• Meaning and types of PEs
• Location of PEs
• Allocation of Global income and covered tax to a PE
• Special rule for losses of PEs 

Meaning and types of PEs

Like the OECD Model Convention, the GloBE Rules adopt the concept of a “Permanent Establishment” (“PE”) to define the level of presence that an Entity may have in a jurisdiction outside its country of residence. However, the definition of a PE within the GloBE Rules, under Article 10.1 differs from the definition within Article 5 of the OECD Model Convention. There can be four types of PEs under Article 10.1 of the GloBE Rules, which basically provides that an Entity that has a place of business (or deemed place of business) in a jurisdiction (i.e. the source-jurisdiction) other than the place in which it is located/resident (i.e. resident-jurisdiction), will have a PE in the following circumstances: a) Treaty PE: if there is an applicable Tax Treaty in force between such jurisdiction and the state of residence, provided that such jurisdiction (the source-jurisdiction) treats it as a PE and taxes the income attributable to it in accordance with a provision similar to Article 7 of the OECD Model Tax Convention on Income and on Capital.

Thus, if based on the Tax Treaty, the PE-jurisdiction cannot tax the profits of the PE, a PE does not exist for GloBE purposes although it would exist under the Tax Treaty. For example, the profits of airlines in international traffic are taxed in the place of effective management, whereby there will be a PE under the Tax Treaty but no PE under the GloBE Rules, as the source state does not tax the income under a provision similar to Article 7 of the OECD Model Tax Convention) and the profits and tax would be allocated to the main entity. Say, a Constituent Entity resident in Country R is dedicated to the operation of aircraft in international traffic and has an office in Country S through which it carries on part of its business. Assume that the R-S treaty follows the OECD Model Tax Convention. In accordance with Article 5 of the treaty, this Constituent Entity has a PE in Country S. However, by virtue of Article 7(4) and Article 8 of the treaty, Country S is not able to tax the profits of the PE. In that case, a PE does not exist for purposes of the GloBE Rules regardless that it meets the definition of a Treaty PE. b) Domestic PE: if there is no applicable Tax Treaty in force, and such jurisdiction (the source-jurisdiction) taxes, under its domestic law, the income attributable to such place of business on a net basis (i.e. allow credit for any applicable withholding taxes that are generally charged on the gross income) similar to the manner in which it taxes its own tax residents. Stated differently, it refers to the case where jurisdictions have adopted a definition and taxation rules for a PE (or a similar concept) into their domestic law and no Tax Treaty applies, and the GloBE Rules recognize their existence and treatment under domestic law. c) Deemed PE: if such jurisdiction (the source-jurisdiction) has no corporate income tax system, and the place of business would have been treated as a PE under the terms of a Tax Treaty based on the OECD Model Convention (i.e. Article 5), provided that such jurisdiction (the source-jurisdiction) would have had the right to tax the income attributable to it in accordance with Article 7 of the that Model (a “DeemedPE”); or www.vilgst.com Page - 3 - of 5 d) Stateless PE: if none of (a), (b) or (c) above applies, and operations are conducted from outside the state of residence or location of the Entity, provided that the state of residence exempts the income attributable to such operations, i.e. exempts the income generated through foreign operations (a “Stateless-PE”). Note that the phrase “deemed place of business” in the definition of PE within the GloBE Rules was included for situations in which the non-resident does not have a place of business but its activities in the source jurisdiction are deemed to be a PE under the terms of the Treaty, e.g. a dependent agent PE.

Location of PEs

The location of the PE is of key importance as this determines the jurisdiction to which Globe income and covered tax are attributed for the purpose of calculating the jurisdictional ETR. Under Article 10 of the GloBE Rules, the location of a PE is as follows:

• Treaty PE is treated as located in the jurisdiction in which it is treated as a PE under the applicable treaty.
• Domestic PE is treated as located in the jurisdiction where it is taxed on a net basis.
• Deemed PE is treated as located in the jurisdiction where it is situated.
• Stateless PE is treated as precisely that i.e. “stateless”.

Allocation of Global income and covered tax to a PE

GloBE Income Where a PE has been identified, the Globe income would be allocated to the PE under the GloBE Rules (and not to the Main Entity of which it is part). The Globe income allocated to a PE is then aggregated with the Globe income allocated to other constituent entities located in the same jurisdiction as the PE in determining that jurisdiction’s ETR. Article 3.4 of the GloBE Rules includes specific provisions to allocate income between an entity and its PEs, the allocation primarily depending on the nature of the PE as follows: i) For Treaty-PEs, Domestic-PEs and Deemed-PEs, the financial accounting net income or loss of the PE is used - as reflected in the separate financial accounts of the PE prepared in accordance with the accounting standard used in the preparation of the Consolidated Financial Accounts of the Ultimate Parent Entity (“UPE”) or, where no financial accounts of the PE, accounts would need to be prepared to ascertain the net income or loss of the PE. ii) This accounting profit is then adjusted as follows, under Article 3.4.2 of the GloBE Rules: a. in the case of Treaty-PEs and Domestic-PEs, to reflect items of income and expense taken into account in determining profit attributable to the PE under the applicable Tax Treaty or under the Domestic Law of the jurisdiction where it is located regardless of the amount of income subject to tax and the amount of deductible expenses in that jurisdiction; and www.vilgst.com Page - 4 - of 5 b. in the case of a Deemed-PE, to reflect items of income and expense that would have been attributed to it under Article 7 of the OECD Model Tax Convention iii) The amount of Globe income allocated to a Stateless-PE is, in essence, the taxincome as well as any expense not accounted for by the Main Entity of which the PE is part (Article 3.4.3), because they are attributable to foreign operations conducted outside that jurisdiction. This would mean that the income of a Stateless-PE would be subject to the GloBE Rules on a standalone basis without the ability to blend with other Constituent Entities located in a jurisdiction. iv) If there is a loss in a PE, this will be treated as an expense of the main entity to the extent that the loss of the PE is treated as an expense for domestic tax purposes. Pillar Two GloBE income that is subsequently earned by the PE is treated as income of the main entity up to the amount treated as an expense by the main entity. This has the effect of increasing the ETR of the main entity in the year of the loss (as Pillar Two income is reduced) and reducing it in future years. This ties in with the potential cash-flow issues that may arise from a loss-making PE. v) Article 3.4.5 of the GloBE Rules provides a special treatment of a GloBE Loss of a PE which is treated as an expense of the Main Entity (and not of the PE) for GloBE purposes to the extent that the loss is treated as an expense under domestic tax law of such Main Entity. GloBE Income subsequently arising in the PE shall be treated as GloBE Income of the Main Entity (and not the PE) up to the amount of the GloBE Loss pf the PE that was previously treated as an expense of the Main Entity for GloBE purposes. This has the effect of increasing the ETR of the Main Entity in the year of the loss (as GloBE income is reduced) and reducing its ETR in future years. This ties in with the potential cash-flow issues that may arise from a loss-making PE in the early years at the cost of a reduced ETR (and so potentially increased top-up tax) in later years. Therefore, given income or losses are attributable to PEs, if the same are included in the financial accounts of the Main Entity, they would need to be separated when calculating the GloBE income. Covered Taxes Covered taxes are allocated to a PE under Article 4.3 of the GloBE Rules. In summary, the amount of covered tax within the financial accounts of the Main Entity that is attributable to GloBE income allocated to a PE, is the covered tax that is allocated to the PE. This amount will include corporate income tax paid on the profit allocated to the PE in both the jurisdiction in which the PE is located and the jurisdiction in which the Main Entity of which it forms part is located. This amount is then blended with the covered tax allocated to other constituent entities located in the same jurisdiction as the PE, as part of the calculation of that jurisdiction’s ETR. In jurisdictions where relief from double taxation on profits of PEs to the Main Entity is given by exemption from tax under an applicable Tax Treaty (i.e. Exemption Method), the allocation of Globe income and covered tax under the GloBE Rules will broadly align with the allocation of taxing rights under applicable Tax Treaties. www.vilgst.com Page - 5 - of 5 However, jurisdictions that taxes companies on all of their profits wherever arising (including profits of PEs) and provide relief from double taxation by giving credit for tax paid in the jurisdiction in which PEs are located (i.e. Tax Credit Method), the Commentary to the GloBE Rules (Chapter 4, paragraphs 46 to 54), provides a mechanism by which the covered tax that is allocated to the PE should be ascertained: i) Determine the amount of the PE income that is included in the Main Entity’s domestic taxable income. This should be readily available from the Main Entity’s tax return or the work-papers used to prepare the return. ii) Determine the Main Entity’s tax liability arising from inclusion of the PE’s taxable income. This is straightforward if the PE is subject to a separate tax rate. In other cases, the Main Entity’s tax liability (before any foreign tax credit) needs to be allocated to the PE. iii) Determine the amount of any tax credit allowed in the Main Entity in respect of the taxes paid by the PE. The tax determined using these steps is deducted from the covered tax for the Main Entity and allocated to the PE for inclusion in the standard jurisdictional blending calculation. However, in case where the income of the PE is allocated to the Main Entity to offset a PE loss of an earlier year that was treated as expense of the Main Entity in that earlier year, Article 4.3.4 of the GloBE Rules provides that any adjusted covered taxes associated with such income are also allocated to the Main Entity up to the maximum corporate income tax on the income in the jurisdiction. Note that in this case, any deferred tax asset on the PE loss created and subsequently unwound within the financial accounts of the Main Entity is not taken into account in adjusted covered taxes by either the PE or the Main Entity for GloBE purposes.