Article 3.5.1

209. Article 3.5.1 allocates the Financial Accounting Net Income or Loss of a Flow-through Entity among PEs, Constituent Entity-owners and the Entity itself. It applies after a reduction is made (if any) with respect to the Ownership Interests held by minorities (e.g., non-Group Entities) in accordance with Article 3.5.3. Article 3.5.1 first allocates the Financial Accounting Net Income or Loss of a Flow-through Entity to a PE and then allocates the remaining amount to the Entity or its Constituent Entity-owners depending on characteristics of the Entity. These rules are contained in Article 3.5.1, as follows:

Income first allocated to a PE

210. Paragraph (a) provides that if the business of the Flow-through Entity is partially or totally carried out through a PE, the Financial Accounting Net Income or Loss of the Flow-through Entity is attributed to that PE in accordance with Article 3.4. This rule ensures that the Financial Accounting Net Income or Loss of the PE is removed from the Financial Accounting Net Income or Loss of the Flow-through Entity where it is included.

211. The PE could be situated in the jurisdiction where the Entity was created or in a third jurisdiction. For example, A Co is a company located in Country A and a partner of B LP, which is a Tax Transparent Entity organised in accordance with the laws of Country B. Under Country B’s tax law, A Co has a PE in Country B because the business activities of B LP are being carried out through an office therein. Since B LP is fiscally transparent in Country B, Country B considers, for tax purposes, that A Co is carrying out business activities directly through the office, which creates the PE. In this case, B LP is the Main Entity of the PE located in Country B and therefore, the Financial Accounting Net Income or Loss of B LP has been reduced from the Financial Accounting Net Income or Loss of the Main Entity and attributed to the PE.

212. In other cases, the PE can be located in a third jurisdiction. Consider the previous example but instead of having an office in Country B, B LP has its office in Country C which creates a PE in this jurisdiction (Country C). This scenario is also covered by paragraph (a) of Article 3.5.1. It is irrelevant whether the third jurisdiction requires A Co or B LP to pay the tax with respect to the income attributable to the PE. The phrase “through which the business of the Entity is wholly or partly carried out” ensures that Article 3.5.1(a) applies regardless of whether the third jurisdiction sees the Entity as a Flow-through Entity and whether such jurisdiction requires the Entity or its Constituent Entity-owners to pay the tax with respect to the income attributable to the PE. If the Constituent Entity-owner of the Flow-through Entity is required to pay a Covered Tax with respect to the income attributable to the PE, such tax is allocated pursuant to Article 4.3.2(a).

Residual allocated to direct owners

213. Article 3.5.1(b) allocates the Financial Accounting Net Income or Loss of a Tax Transparent Entity that is not the UPE of the MNE Group. In this case, such income or loss is allocated to the Constituent Entity-owners in accordance with their Ownership Interests in the profits of that Entity to reflect the tax treatment in both the Entity’s and owner’s jurisdictions.

214. If the Constituent Entity-owners are also Tax Transparent Entities, then paragraph (b) of Article 3.5.1 applies again and allocates the residual Financial Accounting Net Income or Loss to the next Constituent Entity-owner up the ownership chain (unless the Ownership Interest holder is the UPE, in which case Article 3.5.1(c) applies). Thus, if all the Constituent Entities are Tax Transparent Entities (i.e. a Tax Transparent Structure), all of the MNE Group’s income or loss is ultimately allocated to the UPE under Article 3.5.1 (b) and (c).

215. Article 3.5.1(b) applies only after the application of the rule in Article 3.5.1(a). This means that the allocation of Financial Accounting Net Income or Loss to the Constituent Entity-owner has to be reduced by any amount already attributed to a PE in accordance with Article 3.5.1(a). This prevents allocation of the same amount of income or loss to the PE and to the Constituent Entity-owner of the Tax Transparent Entity. This also means that no Financial Accounting Net Income or Loss would be allocated to a stateless Tax Transparent Entity.

216. The phrase “in accordance with their Ownership Interests” is intended to ensure that the amount of Financial Accounting Net Income or Loss remaining after allocation to a PE is allocated among the Constituent Entity-Owners in accordance with their interest in such income. For example, the Ownership Interests of a Tax Transparent Entity are held as follows: 40% by a non-resident Constituent Entity-owner and the remaining 60% of the Ownership Interests are divided equally by two resident Constituent Entityowners. The Tax Transparent Entity has an office in the jurisdiction where it is located and under the applicable tax provisions, such fixed place of business creates a PE in that jurisdiction for the non-resident owner and 40% of the Tax Transparent Entity’s income is allocated to a PE. The remaining 60% of income is allocated to the Constituent Entity-owners in accordance with Article 3.5.1(b) (30% each).

217. The term Ownership Interests is defined in Article 10.1 as any equity interests that carries rights to the profits, capital or reserves of the Entity. In the context of Flow-through Entities, it shall take into account the rights on income or profits attached to the equity interests, including any agreements or contracts that derive from such interests, because Article 3.5.1 is a profit and loss allocation rule.

218. In some situations, however, there could be a mismatch between the amount of profits allocated to the Constituent Entity-owner under the fiscal transparency rules of its jurisdiction and the amount of profits to which the Constituent Entity-owner is entitled in accordance with the rights attached to the equity interests. Article 3.5.1(b) applies to the extent that the Entity is treated as a Flow-through Entity and a Tax Transparent Entity in accordance with Article 10.2.1. Therefore, Article 3.5.1(b) follows the treatment under tax law which aligns the allocation of income, expenses, profits or losses under GloBE Rules with the outcome provided by the domestic tax laws of the Constituent Entity-owner and the Flow-through Entity.

219. For example, A Co is an Entity located in jurisdiction A that holds 60% of the equity interests of B Co, a Flow-through Entity created under the domestic law of jurisdiction B. A Co and B Co are Constituent Entities of the same MNE Group, while the holders of the remaining 40% of the equity interests are not part of the Group. A Co has an agreement with the other equity interest holders that provides A Co with an additional right attached to its equity interest entitling A Co to 70% of B Co’s profits (instead of 60%) for a five-year period starting after B Co’s incorporation. Jurisdiction A treats B Co as fiscally transparent but does not recognise the effect of the agreement between A Co and the rest of the equity interest holders and therefore does not treat the agreement as giving A Co any additional 10% entitlement to the profits of B Co. This means that under jurisdiction A’s domestic tax law, only 60% of B Co’s profits are considered as being derived by A Co during the five-year period referred to above.

220. Under the GloBE Rules, A Co holds 70% of the Ownership Interests of B Co during the five-year period of the agreement. Under Article 3.5.3, 30% of the Financial Net Income of B Co is reduced because it is the amount allocated to owners that are not Group Entities based on their Ownership Interests. The remaining 70% of the Financial Net Income is allocated to A Co under Article 3.5.1(b) because jurisdiction A considers that B Co is entirely fiscally transparent such that all of the profits of B Co are being derived by its owners (including A Co). The fact that jurisdiction A does not treat the agreement between A Co and the other equity interest holders as giving A Co an additional entitlement to 10% of the profits of B Co is not relevant to the income allocation under Article 3.5.1(b) as long as jurisdiction A treats B Co as entirely fiscally transparent (i.e. a Tax Transparent Entity).

Exception for UPEs and Reverse Hybrids

221. Article 3.5.1(c) allocates the Financial Accounting Net Income or Loss of two types of Entities: (i) a Tax Transparent Entity that is the UPE of the MNE Group, and (ii) a Reverse Hybrid Entity. In both cases, the residual Financial Accounting Net Income or Loss is allocated to the Entity itself and not to its Ownership Interest holders. For purposes of applying Article 3.5.1(c), a Tax Transparent Entity shall be treated as the UPE of the MNE Group if that Entity would be the UPE of the MNE Group but for the fact that its Controlling Interests are held by an Excluded Entity.

222. Where the Tax Transparent Entity is the UPE of the MNE Group, the Financial Accounting Net Income or Loss is allocated to the Entity instead of the owners, because the owners are not Constituent Entities of the MNE Group required to apply the GloBE Rules. Article 7.1 provides additional rules that apply when a Flow-through Entity is the UPE of a MNE Group.

223. In the case of a Reverse Hybrid Entity, the Financial Accounting Net Income or Loss remains attributable to the Entity and it is not allocated to its owners, because according to the owner’s tax legislation, the Entity is not fiscally transparent and its income or loss is not directly taxed in the hands of its owners.

224. As in Article 3.5.1(b), the allocation of Financial Accounting Net Income or Losses to the UPE Tax Transparent Entity or Reverse Hybrid Entity has to be reduced by any amount already attributed to a PE in accordance with Article 3.5.1(a) to prevent double-counting.

Article 3.5.2

225. Article 3.5.2 states that Article 3.5.1 applies separately with respect to each of the Ownership Interests in the Flow-through Entity in accordance with the applicable tax rules. It recognises that the same Flow-through Entity can be treated as a Tax Transparent Entity by some of its owners and a Reverse Hybrid Entity by its other owners. In such cases, the rules in Article 3.5.1 are applied separately from the perspective of each Constituent Entity-owner. In other words, Article 3.5.1 applies the Tax Transparent Entity treatment with respect to Constituent Entity-owners that treat the entity as tax transparent, and applies the Reverse Hybrid Entity treatment with respect to the other Constituent Entity-owners.

Article 3.5.3

226. Article 3.5.3 deals with the situation where the Flow-through Entity has non-Group owners. The provision reduces the Financial Accounting Net Income or Loss of the Flow-through Entity by the amount that belongs to the non-Group owners. This ensures that the jurisdictional ETR of the Constituent Entities is properly computed because it does not take into account any taxes paid by non-Group members.

227. The reduction made in accordance with this provision is made prior to the application of Article 3.5.1. Therefore, Article 3.5.3 impacts Article 3.5.1 as follows:

a) the Financial Accounting Net Income or Loss of a PE referred in Article 3.5.1(a) will reflect only the portion that belongs to Group Entities; b) the full amount of the remaining Financial Accounting Net Income or Loss of the Flow-through Entity is allocated to Constituent Entities in accordance with Article 3.5.1(b) and (c).

228. For example, Hold Co is an Entity located in Country A and the UPE of an MNE Group. It holds 60% of the Ownership Interests of B LP, a Tax Transparent Entity created in Country B. The remaining 40% of the Ownership Interests of B LP are held by non-Group Entities (the “minorities”), which are also located in Country A. B LP has a store in Country B. Country B considers that this store constitutes a PE for Hold Co and the minorities. The Financial Accounting Net Income of B LP is 200. Only 100 of the Financial Accounting Net Income of B LP is attributable to the PE and taxed in Country B.

229. Under Article 3.5.3, the Financial Accounting Net Income of B LP is reduced by 80 because that is the amount that is attributable to the minorities (200 x 40%). The remaining amount (120) is allocated in accordance with Article 3.5.1. First, 60 is allocated to the PE in accordance with Articles 3.5.1 (a) and 3.5.2 because, after backing out the minorities’ share, this is the amount that remains of the PE income which is attributable to the Ownership Interests held by the Group Entities. The other 60 is allocated to Hold Co under Articles 3.5.1(b) and 3.5.2 because B LP is a Tax Transparent Entity whose income is allocated to its Constituent Entity-owners.

230. If the Consolidated Financial Statements of the MNE Group include a Covered Tax that is associated with the Financial Accounting Net Income that has been reduced by Article 3.5.3, then the amount of such Covered Tax has to be reduced in the same proportion in accordance with Article 4.1.3(a). That Article provides that Covered Taxes shall be reduced by the amount of current tax expense with respect to income excluded from the GloBE Income or Loss. This could be the case, for example, where the Flow-through Entity is subject to source taxation in a third jurisdiction that imposes the tax directly on the Entity and such taxes are reflected in its financial statements and in the Consolidated Financial Statements of the MNE Group. In the example included in the previous paragraphs, the amount of Covered Tax that would be reduced would be 40%, in accordance with the proportion of income that has been reduced.

231. This provision also applies where the Ownership Interests of the Flow-through Entity are held by non-Group members through a Tax Transparent Structure (i.e. a chain of Tax Transparent Entities). A Tax Transparent Structure is define in Article 10.2.3.

Article 3.5.4

232. Article 3.5.4 sets out two cases where Article 3.5.3 does not apply. The first one is included in paragraph (a) which covers the case where the UPE is a Flow-through Entity. Paragraph (b) covers the situation where the Flow-through Entity is held by a Flow-through UPE through a Tax Transparent Structure. These cases are not contemplated in Article 3.5.3 because all of the owners of the Flow-through Entity are non-Group owners, which is covered by Article 7.1.

Article 3.5.5

233. Article 3.5.5 requires a Flow-through Entity to reduce its Financial Accounting Net Income or Loss by the amount of its income allocated to other Constituent Entities (Constituent Entity-owners or PEs). This is necessary to avoid double-counting that income or loss under the GloBE Rules.