Article 3.4.1

188. Article 3.4.1 refers to cases where a PE exists for purposes of the GloBE Rules by virtue of paragraphs (a), (b), and (c) of the definition included in Article 10.1. These paragraphs refer to cases where a PE exists in accordance with a Tax Treaty or domestic law, and in cases where it would have existed if a jurisdiction without a CIT had a Tax Treaty with the jurisdiction of the Main Entity.

189. In these situations, the first sentence of Article 3.4.1 provides that Financial Accounting Net Income or Loss of the PE is the net income or loss reflected in its financial accounts (if they exist). This ensures that Constituent Entities that are PEs and subsidiaries are treated in the same way for the purposes of computing the ETR. However, following the principle in the GloBE Rules, such accounts have to be prepared in accordance with an Acceptable Financial Accounting Standard or an Authorised Financial Accounting Standard subject to adjustments to prevent any Material Competitive Distortions.

190. However, in some cases the PE will not have separate financial accounts. In that scenario, the second sentence of Article 3.4.1 provides that the Financial Accounting Net Income or Loss is the amount that would have been reflected in its separate financial accounts if they existed. Therefore accounts or reports will need to be prepared in such a scenario to compute the amount that would have been reflected in the financial accounts. Article 3.4.1 requires this determination to be based on the accounting standard used in preparation of the Consolidated Financial Statements of the UPE.

Article 3.4.2

191. Article 3.4.2 adjusts the amount and items of income and expenses that can be attributed to the PE for the purposes of determining its Financial Accounting Net Income or Loss under Article 3.4.1. Given that a PE is a tax concept, there are no specific accounting rules for determining which items and amounts of income and expenses are taken into account by the Main Entity or the PE for purposes of determining the Financial Accounting Net Income or Loss.

192. Article 3.4.2(a) provides that the amount and items of income and expenses are those being attributed to the PE in accordance with the Tax Treaty or domestic law of the source jurisdiction. The phrase “regardless of the amount of income subject to tax and the amount of deductible expenses in that jurisdiction” is intended to distinguish between the tax rules for attributing income to the PE and the tax rules, including timing rules, for computing its taxable income.

193. For example, A Co is a Constituent Entity of the MNE Group located in Country A that has a PE in Country B in accordance with the A-B Tax Treaty. Assume that 100 of business profits are attributable to the PE which are derived from royalties payments (assume there are no deductible expenses). Country B exempts 50% of the royalties. In this case, the amount of income considered for purpose of determining the financial accounting net income of the PE is 100, notwithstanding that the PE is taxed only with respect to 50.

194. If the PE in Country B had separate financial accounts that reflected a greater amount because it also includes other items of income that were not attributable to the PE under tax rules, then such items would not be taken into account in accordance with the first sentence of Article 3.4.2.

195. On the other hand, if the PE in Country B had separate financial accounts that reflected a greater or lesser amount of income or expense because of a difference between the timing rules for that income under local tax rules (e.g. due to accelerated depreciation for tax purposes in Country B), the amount of income reported in the financial accounts for each relevant Fiscal Year would be used to determine the income attributable to the PE, rather than the amount of income calculated under the tax rules.

196. Article 3.4.2(b) provides that where a PE exists in accordance with paragraph (c) of the definition in Article 10.1, then the income or expenses for determining the Financial Accounting Net Income or Loss would be the amounts and items that would have been attributed in accordance with Article 7 of the OECD Model Tax Convention. This sentence accounts for the scenario in paragraph (c) of the definition of PE, which is based on activities in a jurisdiction that would hypothetically create a PE under Article 5 of the OECD Model Tax Convention.

Article 3.4.3

197. Article 3.4.3 describes the attribution of income to a PE that arises under paragraph (d) of the PE definition in Article 10.1. Article 3.4.3 attributes to the PE the income that the Main Entity jurisdiction exempts from tax and that is attributable to activities occurring outside the jurisdiction. Similarly, Article 3.4.3 allocates to the PE any expenses that are not taken into account in the jurisdiction of the Main Entity because they are attributable to activities occurring outside the jurisdiction.

Article 3.4.4

198. Article 3.4.4 provides that the Financial Accounting Net Income or Loss of a PE as adjusted by Articles 3.4.2 and 3.4.3 should not be taken into account in determining the GloBE Income or Loss of the Main Entity. Thus, if the Financial Accounting Net Income or Loss of a PE is reflected in the financial accounts of a Main Entity, it must be subtracted from the Financial Accounting Net Income or Loss of the Main Entity. This Article is intended to prevent double counting or omission of Financial Accounting Net Income or Loss in the computation of the GloBE Income or Loss of the Main Entity and the PE.

Article 3.4.5

199. Article 3.4.5 provides a rule relating to the allocation of losses of a PE. Some jurisdictions include the income or loss of a PE in the computation of the domestic taxable income of its Main Entity (e.g., jurisdictions with a worldwide tax system with a foreign tax credit system). However, GloBE Rules calculate the ETR of the Main Entity without taking into account the GloBE Income or Loss of the PE. Absent a special rule, the ETR of the Main Entity may be understated in a Fiscal Year when a PE loss is taken into account for domestic tax purposes but not for GloBE Income or Loss purposes. Under Article 3.4.5 this domestic treatment can be preserved, with the necessary corresponding adjustments.

200. A GloBE Loss of a PE shall be treated as an expense of the Main Entity for purposes of computing its GloBE Income or Loss, to the extent that the loss of the PE is treated as an expense in the computation of the domestic taxable income or loss of such Main Entity. This provision applies irrespective of whether the tax base of the Main Entity takes into account the net loss of the PE or each of its items of income and expense. Thus, if the Main Entity takes into account only 80% of a PE loss in computing its domestic taxable income, then the same percentage of the PE’s GloBE Loss is treated as an expense in the computation of the Main Entity’s GloBE Income or Loss and the remaining 20% is treated as a loss in computing the PE’s GloBE Income or Loss. However, if a PE loss produces a time-limited loss carryforward for the Main Entity it is treated as an expense in the computation of the Main Entity’s domestic taxable loss irrespective of whether such carry-forward expires before it is used in full.

201. The last part of the first sentence requires a PE loss not to be set off against an item of income that is subject to tax under the laws of both the jurisdiction of the Main Entity and the jurisdiction of the Permanent Establishment. The limitation on the loss reattribution to the Main Entity is illustrated by the following example.

202. A Main Entity (ME1) has a PE (PE1) and another Main Entity (ME2) has another PE (PE2). Both Main Entities are located in jurisdiction A and both PEs are located jurisdiction B. Jurisdiction A has a worldwide tax system that taxes foreign PE income and provides a foreign tax credit for taxes paid on such income. Both jurisdictions allow sharing of income and losses among tax residents and PEs located in their jurisdiction if they are under common control (e.g., tax consolidation regime). PE1 has a tax loss of 100 and PE2 has taxable net income of 100. In both jurisdictions, the tax loss of PE1 is set off against the taxable net income of PE2 so that there is no tax to pay in either jurisdiction with respect to PE1 and PE2. While the loss of PE1 is treated as an expense of ME1 in jurisdiction A, it is not reallocated to jurisdiction A under Article 3.4.5 on the basis that it is set off against an item of income that is subject to tax under the laws of both jurisdiction A and jurisdiction B. In this scenario, it is unnecessary to allocate the loss of PE1 to ME1 and jurisdiction A since its ETR is not being understated due to such loss, and the allocation of the loss to jurisdiction A would in fact understate the ETR of jurisdiction B.

203. The second sentence of Article 3.4.5 requires a corresponding adjustment which treats GloBE income subsequently earned by the PE as GloBE Income of the Main Entity (and not of the PE) up to the amount of the GloBE Loss that previously was treated as an expense for purposes of computing the GloBE Income or Loss of the Main Entity. This rule applies to the full extent of the amount of loss treated as an expense in the computation of the Main Entity’s domestic taxable income or loss. Thus, even if the loss became part of a loss carry-forward in the Main Entity’s jurisdiction that expired before it was used in full, the PE’s income to the extent of that loss is treated as GloBE Income of the Main Entity. This rule avoids difficult tracing issues and complex rules that would be needed to administer a tracing rule.