Pillar 2 and Indirect Investments – Part 2: Associates and Joint Ventures
In this publication, our experts explore the effective tax rate (ETR) considerations for indirect investments held by institutional investors under Pillar 2. Indirect investments can include private equity, real estate and infrastructure fund investments, as well as club deals and joint ventures. Such investments are typically reported under IFRS as either (1) “financial assets” or as (2) “associates and joint ventures”. This publication focuses on associates and joint ventures. Financial assets are discussed in the first part of this series: ‘Pillar 2 and Indirect Investments – Part 1: Financial Assets’.
The considerations in this publication are based on the OECD’s Pillar 2 Model Rules and Transitional CbCR Safe Harbour. This publication is relevant for investors that are in scope of Pillar 2, which typically concerns insurance companies, but can also include sovereign wealth funds, pension funds, REITs and investment funds that are not fully carved-out.
The EU is implementing Pillar 2 effective 1 January 2024. Other jurisdictions are expected to follow.
1. BASICS FIRST
Before digging into the specifics for associates and joint ventures, let’s recap the basics of the Pillar 2 Model Rules, Qualifying Domestic Minimum Top-up Taxes and Transitional CbCR Safe Harbour.
1.1 GLOBE RULES
The OECD’s Pillar 2 Model Rules - also referred to as the Anti Global Base Erosion Rules (GloBE Rules) - are in essence a system of top-up taxes to ensure that multinational enterprises (MNEs) pay at least 15% tax in the jurisdictions where their ETR is lower. An overview of the GloBE Rules is included in our publication ‘Pillar 2: REITs and Real Estate Funds’.
1.2 QUALIFYING DOMESTIC MINIMUM TOP-UP TAX
Most jurisdictions will be implementing Qualifying Domestic Minimum Top-up Taxes (QDMTTs) to safeguard against any top-up tax being levied by another jurisdiction under the charging mechanisms included in the GloBE Rules. This means that a cross-check against domestic implementations of Pillar 2 is becoming increasingly relevant. QDMTTs are allowed to have variations in design compared to the standard GloBE Rules as long as the incremental tax liability is at least the same. To ensure that QDMTTs meet this requirement, we’re seeing jurisdictions generally applying the same computation mechanics as the GloBE Rules.
1.3 CBCR SAFE HARBOUR
The OECD’s Transitional CbCR Safe Harbour is a temporary measure for fiscal years ending before 1 January 2027 aimed at excluding MNEs from the scope of the GloBE Rules in lower-risk jurisdictions. Under the CbCR Safe Harbour, the top-up tax in a jurisdiction will be deemed zero - removing the need for more detailed computations under the general GloBE Rules - when at least one of the following tests is met:
- De minimis test: The revenue of the MNE in a jurisdiction is lower than EUR 10 million and the profit before tax is lower than EUR 1 million. This assessment needs to be based on the MNE’s (qualifying) CbCR.
- Routine profits test: The MNE reports a loss before tax in its (qualifying) CbCR or a profit that does not exceed the so-called substance-based income carve-out based on the GloBE Rules. This carve-out is calculated as a mark-up percentage on eligible payroll costs and tangible assets.
- Simplified ETR test: The MNE has a jurisdictional ETR of at least 15 percent in fiscal year 2024, 16 percent in 2025 and 17 percent in 2026. The simplified ETR needs to be calculated using the profit (or loss) before tax as included in the MNE’s (qualifying) CbCR and the income tax expense reflected in the (qualifying) financial statements of the entities in that jurisdiction.
The CbCR Safe Harbour is tested based on simplified jurisdictional revenue, income and tax data included in an MNE’s (qualifying) CbCR and financial accounts. The CbCR Safe Harbour also contains specific rules to address differences and maintain a level of alignment with the GloBE Rules.
2. ASSOCIATES AND JOINT VENTURES
The Pillar 2 considerations in this section are based on indirect investments that are not consolidated under IFRS but reported as associates and joint ventures. Such investments typically concern fund and co-investments in which an investor, roughly speaking, holds a stake of at least 20%. In case an investor’s stake is below 20%, the IFRS classification typically shifts to “financial assets”. Financial assets are discussed in the first part of this Pillar 2 series: ‘Pillar 2 and Indirect Investments – Part 1: Financial Assets’.
2.1 IFRS - ASSOCIATES AND JOINT VENTURES
Under IFRS, an associate is an entity over which the investor has significant influence. Significant influence is the power to participate in the financial and operating policy decisions of the investee without the power to control or jointly control those policies. If an investor, directly or indirectly, holds 20% or more of the voting power, it is presumed that the investor has significant influence.
Under IFRS, a joint venture is a joint arrangement whereby the parties that have joint control of the arrangement have rights to the net assets of the arrangement.
Associates and joint ventures are typically reported under the equity method. On initial recognition the investment in an associate or a joint venture is recognised at cost. The carrying amount is then increased or decreased to recognise the investor’s share of the subsequent profit or loss of the investee and to include that share of the investee’s profit or loss in the investor’s profit or loss. Distributions received from an investee reduce the carrying amount of the investment. Upon disposal, a gain (or loss) is recognised broadly equal to the difference between the sales proceeds and the carrying amount of the investment.
It is required to recognise a deferred tax asset (DTA) or liability (DTL) for temporary differences between the tax and IFRS carrying value (if any). Temporary differences can, for example, exist when the investment is valued at cost for tax purposes. When a future gain (or loss) is tax-exempt, this does not constitute a temporary difference and therefore should not lead to the recognition of a DTA or DTL.
2.2 GLOBE RULES – ASSOCIATES AND JOINT VENTURES
Fund and co-investments that are reported under the equity method as associates or joint ventures are not consolidated and would generally follow the same Pillar 2 considerations as indirect investments reported as financial assets. These considerations are outlined in our publication ‘Pillar 2 and Indirect Investments – Part 1: Financial Assets’.
Absent a special rule, joint ventures would be fully excluded from Pillar 2 as they are not consolidated on a line-by-line basis at the level of the investor. For this reason, the GloBE Rules include a special regime that requires MNEs to nevertheless determine the top-up tax of a qualifying joint venture (JV). A qualifying JV is defined as an entity whose financial results are reported under the equity method in the consolidated financial statements of the ultimate parent entity (UPE) provided that UPE holds an ownership interest, directly or indirectly, of least 50% in the JV.
Under the GloBE Rules, the GloBE ETR and top-up tax need to be determined as if the JV and its subsidiaries are a separate MNE of which the JV-entity is the UPE. When having to treat a qualifying JV as a separate MNE, this means that the JV’s GloBE ETR cannot be blended with the GloBE ETR of the main MNE (i.e., the investor). The top-up tax of the JV is subsequently allocated to the MNE that holds a qualifying interest in the JV and is in principle levied in accordance with the regular income inclusion rule (IIR) and undertaxed profits rule (UTPR) mechanisms.
There are some exclusions to consider in this respect:
- Investor-MNE fully carved-out: A qualifying JV does not include an entity that is held by an MNE that is exclusively composed of entities that are carved-out from the scope of the GloBE Rules (e.g., qualifying governmental entities, pension funds or investment funds and their qualifying subsidiaries).
- Investor-entity carved-out and JV-entity with qualifying activities: A qualifying JV also does not include an entity that is held by an investor that is carved-out from the scope of the GloBE Rules (e.g., a qualifying governmental entity, pension fund or investment fund) provided the JV-entity itself performs certain qualifying asset-holding, investment, ancillary or shareholding activities.
- JV-entity carved-out: A qualifying JV also does not include an entity that is excluded from the scope of the GloBE Rules by virtue of being carved-out as, for example, a qualifying investment fund or real estate investment vehicle.
- JV already subject to Pillar 2: A qualifying JV also does not include a UPE of an MNE that is already subject to the GloBE Rules in its own right (i.e., amongst others by virtue of exceeding the EUR 750 million revenue threshold).
- JV subsidiary: For completeness, a qualifying JV cannot be the subsidiary of a JV.
2.3 QDMTT – ASSOCIATES AND JOINT VENTURE
Jurisdictions that have introduced a QDMTT could choose not to impose the QDMTT tax liability on JVs and their subsidiaries located in that specific jurisdiction (and any top-up tax computed in respect of such JV would then be subject to the standard GloBE Rules). Alternatively, a jurisdiction could impose the QDMTT tax liability computed with the inclusion of JVs and their subsidiaries to the extent located in that specific jurisdiction. The implementation of QDMTTs and design thereof will need to be monitored on a jurisdiction-by-jurisdiction basis.
2.4 CBCR SAFE HARBOUR AND FINANCIAL ASSETS
The provisions of the CbCR Safe Harbour apply to a qualifying JV and its subsidiaries as if they are a separate MNE similar to the GloBE Rules. The data points would need to be derived from qualifying financial statements of the JV (opposed to an existing CbCR, as a qualifying JV would not be in scope of the CbCR rules).
3. A&M SAYS
The JV regime in the GloBE Rules and CbCR Safe Harbour aims to capture entities that are not included in the consolidated financial statements of the UPE. This brings with it extended data-gathering challenges for MNEs.
When it comes to fund investments, club deals and joint ventures that qualify as a JV, various escapes can nevertheless apply. The most notable being that investor-MNEs that are fully carved-out from Pillar 2 should also not be required to apply the JV regime.
Examples of such investor-MNEs could be pension funds, sovereign wealth funds and investments (fund of) funds that are carved-out from the scope of the GloBE Rules.
This demonstrates the importance for such investors to complete the carve-out analysis for their structure. If the investor MNE is not fully carved-out, escapes would namely need to be tested at the level of the JV on a JV-by-JV basis which is more burdensome.
For insurance companies, performing a JV-by-JV analysis will always be required as insurance companies are not carved-out from Pillar 2. This means each JV-entity would typically need to be tested against the carve-outs for qualifying investment funds and real estate investment vehicles. These carve-outs are discussed in our publication ‘Pillar 2: REITs and Real Estate Funds’. An important consideration in this respect is that qualifying investment funds require regulatory oversight.
HOW CAN A&M HELP?
A&M can help with assessing, modelling and managing the impact and practical implications of the GloBE Rules and CbCR Safe Harbour for your structure(s). For more information, please feel free to get in touch with your usual A&M adviser, Roel de Vries or Nick Crama.
