Article 5.3.1

27. Article 5.3.1 explains the role of the Substance-based Income Exclusion in the computation of Excess Profits and Top-up Tax under Article 5.2. The exclusion is subtracted from the Net GloBE Income in the jurisdiction in order to arrive at a measure of Excess Profit. If the exclusion determined for a Fiscal Year exceeds the Net GloBE Income of the jurisdiction for that year, there will be no Excess Profit, and thus no Top-up Tax computed for that year unless there is Additional Current Top-up Tax for that Fiscal Year. The excess of the Substance-based Income Exclusion over the Net GloBE Income of the jurisdiction for a Fiscal Year cannot be carried forward or backward to reduce the Net GloBE Income of another Fiscal Year.

28. The Substance-based Income Exclusion applies by default to each jurisdiction in which the MNE Group operates. However, an MNE Group is permitted to annually elect out of the requirement to apply the exclusion on a jurisdiction-by-jurisdiction basis. The election not to apply the exclusion is provided because some MNE Groups may consider that the burden of computing the amount of the exclusion for a particular jurisdiction outweighs the potential benefits of the exclusion in that jurisdiction.

29. The election not to apply the exclusion is made by the Filing Constituent Entity and it is made on a jurisdiction-by-jurisdiction basis. The Filing Constituent Entity makes the election by filing a GloBE Information Return that computes Excess Profits consistent with the election, i.e. by not subtracting an exclusion amount from the Net GloBE Income of the jurisdiction. An explicit affirmative statement that the election is being made for a jurisdiction is not necessary. An election not to apply the exclusion for a Fiscal Year cannot be revoked after a GloBE Information Return for that Fiscal Year has been filed consistent with the election. However, the MNE Group is not bound to make the election for the same jurisdiction in any subsequent Fiscal Year. Thus, an MNE Group that elects not to apply the Substance-based Income Exclusion for a jurisdiction in one year may apply the exclusion in the following Fiscal Year.

29.1 An MNE Group is allowed to claim only a subset of its total Eligible Payroll Costs and Eligible Tangible Assets when calculating its Substance-based Income Exclusion. The MNE Group is not required to calculate the maximum allowable amount of Eligible Payroll Costs and Eligible Tangible Assets in order to make any claim for Substance-based Income Exclusion whatsoever.

Article 5.3.2

30. Article 5.3.2 provides that the Substance-based Income Exclusion is comprised of two components – the payroll carve-out and the tangible asset carve-out. The Commentary below elaborates on these components, starting with the payroll carve-out and then turning to the tangible asset carve-out.

Article 5.3.3

31. The payroll carve-out subtracts from the Net GloBE Income of a jurisdiction a fixed return on activities performed in that jurisdiction calculated by reference to the Constituent Entity’s employment costs. The payroll carve-out design recognises a Constituent Entity’s payroll expense as an appropriate proxy for substantive activities carried out by employees of the MNE Group in the relevant jurisdiction. In applying the payroll carve-out, it is necessary to identify relevant employees (Eligible Employees), the location of those employees, and the relevant payroll expenses of those Eligible Employees (Eligible Payroll Costs).

Eligible Employees

32. For the purposes of the payroll carve-out, Article 10.1 defines Eligible Employees as employees, including part-time employees, of a Constituent Entity and independent contractors participating in the ordinary operating activities of the MNE Group under the direction and control of the MNE Group. This definition is consistent with CbCR and avoids what would otherwise be a difficult line-drawing exercise of distinguishing an employee from an independent contractor. For purposes of the payroll carve-out, independent contractors include only natural persons and may include natural persons who are employed by a staffing or employment company but whose daily activities are performed under the direction and control of the MNE Group. Independent contractors do not include employees of a corporate contractor providing goods or services to the Constituent Entity.

Jurisdiction where employee carries out its activities

33. The payroll carve-out is computed on a jurisdictional basis and is based on the Eligible Payroll Costs of Eligible Employees that perform activities in the jurisdiction where the Constituent Entity employer is located. Employees will generally perform their activity in the jurisdiction where the Constituent Entity employer is located (employer’s jurisdiction). However, in certain cases the employee may also perform work for their employer outside the employer’s jurisdiction.

33.1. Where the employee undertakes more than 50% of their activities for the MNE Group during the relevant period within the jurisdiction of the Constituent Entity employer, the Constituent Entity will be entitled to the full payroll carve-out with respect to that employee. Where the employee undertakes 50% or less of their activities for the MNE Group during the relevant period within the jurisdiction of the Constituent Entity employer, the Constituent Entity will only be entitled to the proportion of the payroll carve-out attributable to the employee’s working time spent within the jurisdiction of the Constituent Entity employer. For example, if the Eligible Employee spends only 30% of its working time in the jurisdiction of its Constituent Entity employer, then the Constituent Entity is only able to claim 30% of the payroll carve-out with respect to that Eligible Employee.

Eligible Payroll Costs

34. The payroll carve-out takes a broad approach to determining Eligible Payroll Costs based on a general test of whether the expenditure of the employer gives rise to a direct and separate personal benefit to the employee. Article 10.1 defines a Constituent Entity’s Eligible Payroll Costs to include expenditures for salaries and wages as well as for other employee benefits or remuneration such as medical insurance, payments to a Pension Fund or other retirement benefits, bonuses and allowances payable to Eligible Employees, and stock-based compensation. The amount of Eligible Payroll Cost for stock-based compensation is that included in the relevant financial accounts used to determine the Constituent Entity’s payroll carve-out and is not impacted by an election under Article 3.2.2. Eligible Payroll Costs also includes payroll taxes (or other employee expense-related taxes such as fringe benefits taxes), as well as employer social security contributions.

35. Consistent with the broad approach for determining Eligible Payroll Costs, the payroll carve-out is based on the total amount of the payroll expenditures accrued in the financial accounts for the Fiscal Year, except for payroll expenses capitalised into the carrying value of Eligible Tangible Assets subject to the Tangible Assets carve-out. Payroll expenditures capitalized into Eligible Tangible Assets will be taken into account in the Tangible Assets carve-out. Payroll expenditures that are capitalised to other Tangible Assets, including inventory, are included in Eligible Payroll Costs.

36. The payroll carve-out computation shall not include the payroll costs attributable to a Constituent Entity’s International Shipping Income and Qualified Ancillary International Shipping Income under Article 3.3. Payroll costs attributable to a Constituent Entity’s excess income over the cap for Qualified Ancillary International Shipping Income under Article 3.3.4 are included in the payroll carve-out computation (given that such excess income would not qualify for the exclusion from the GloBE Rules, allowing the associated Substance-based Income Exclusion is warranted). The amount of payroll cost attributable to International Shipping Income and to Qualified Ancillary International Shipping Income that is excluded shall be determined under the same principles set out in Article 3.3.5. The payroll which is directly allocable to the International Shipping Income and Qualified Ancillary International Shipping that is within the cap under Article 3.3.4 shall be excluded. Payroll expense that cannot be directly allocated shall be allocated between a Constituent Entity’s International Shipping Income, Qualified Ancillary International Shipping Income, and other income on a formulaic basis in proportion to its revenues from international shipping over its total revenues.

36.1 The payroll carve-out computation shall not include an amount of Eligible Payroll Cost attributable to the income excluded from the GloBE Income of the UPE under Article 7.2.1. Where the UPE of an MNE Group makes a distribution which is subject to a Deductible Dividend Regime (and other conditions are met), an amount of GloBE Income can be excluded from the GloBE Income of that UPE under Article 7.2.1. To the extent such an exclusion occurs, there will be a proportionate reduction in the Eligible Payroll Costs of the UPE. The reduction will be equal to the total Eligible Payroll Costs of the UPE multiplied by the ratio of the GloBE Income excluded under Article 7.2.1 to the total GloBE Income determined for the UPE (before the Article 7.2.1 exclusion). This adjustment will be equivalent to that made under Article 5.3.7(b). Further, the Eligible Payroll Costs of any other Constituent Entity located in the jurisdiction that is subject to the Deductible Dividend Regime shall be reduced in proportion to its GloBE Income that is excluded under Article 7.2.3 compared to its total GloBE Income.

Article 5.3.4

37. The tangible asset carve-out subtracts from the Net GloBE Income of a jurisdiction a fixed return on the carrying value of Eligible Tangible Assets located in that jurisdiction. Eligible Tangible Assets include the carrying value of property, plant and equipment, natural resources, and a lessee’s right-of-use assets that are located in the jurisdiction in which the Constituent Entity is located. Including a broad range of tangible assets in the carve-out base recognises that all such assets are indicative of substantive activities. Moreover, it helps to level the playing field across industries that use varying types of tangible assets in their business. Including leased tangible assets neutralises the difference between owning and leasing assets and recognises that the business decision to own or lease typically has no bearing on the intensity of substantive activities. The section below provides more details on each category of included tangible assets and excluded assets.

Jurisdiction where asset is located

38. The tangible asset carve-out requires that the tangible assets are located in the same jurisdiction as the Constituent Entity that owns them or, in the situation where the tangible asset falls into categories (c) or (d), in the same jurisdiction as the Constituent Entity that holds the right-of-use of the asset. It is expected that, in most cases, the tangible asset will be located in the same jurisdiction as the Constituent Entity that owns or leases the asset. However, under specific circumstances, the nature of the asset and the way it is used may be such that it is not located in any jurisdiction or is located in multiple jurisdictions (e.g. an aircraft of an international airline) at different times during the Fiscal Year.

38.1. Where the tangible asset is located within the jurisdiction of its Constituent Entity owner (or lessee, if applicable) more than 50% of the time during the relevant period, the Constituent Entity will be entitled to the full tangible asset carve-out with respect to that asset. Where the tangible asset is located within the jurisdiction of its Constituent Entity owner (or lessee, if applicable) 50% or less of the time during the relevant period, the Constituent Entity will only be entitled to the tangible asset carve-out in proportion to the time the asset was located within the jurisdiction of the Constituent Entity owner (or lessee, if applicable).

Paragraph (a) – Property, plant and equipment

39. Property, plant and equipment are tangible assets that are held for use in the production or supply of goods or services or for administrative purposes and are expected to be used during more than one period. Assets in this category include: buildings, machinery, computers and other office equipment, motor vehicles, furniture and fixtures, and land.

Paragraph (b) – Natural resources

40. Natural resources include oil and gas deposits, timber tracts and mineral deposits. These assets are accounted for similarly to depreciable property, plant and equipment. That is, natural resources are initially recognised at cost, including acquisition, exploration-related, and restoration costs. After initial recognition, the asset is carried at its cost less any accumulated depletion and any accumulated impairment losses, i.e., the cost model.2 Depletion allocates the cost of natural resources to the extracted mineral or severed timber and has a number of similarities to depreciation accounting. Because the usefulness of a natural resource is generally directly related to the amount of resources extracted, the units of production method is widely used to calculate depletion. Service life is therefore the estimated amount of resources to be extracted, e.g., tons of minerals or barrels of oil.

Paragraph (c) – Right-of-use Tangible Assets

41. A carve-out based on the ownership of tangible assets would lead to a difference between owning and leasing assets. In order to avoid this distortion, the carve-out includes the carrying value of a leased tangible asset, including buildings and land, in the same way as property, plant and equipment owned by the Constituent Entity.

42. In a lease arrangement a lessee recognises a “right-of-use” asset on its balance sheet representing its right to use the underlying asset and a lease liability representing its obligation to make lease payments. A right-of-use asset may arise in connection with the use of an asset owned by the government or a private party. A lessee accounts for right-of-use assets similarly to an owner of property, plant and equipment. Specifically, a lessee initially recognises right-of-use assets based on the present value of the lease payments, and subsequently recognises depreciation and impairment losses i.e., the cost model.3 For purposes of Article 5.3.4, a right-of-use asset in respect of tangible asset will be treated the same as ownership of the tangible asset notwithstanding variations in the treatment of the asset in the financial accounts.

43. Financial accounting distinguishes between finance leases and operating leases. Under a finance lease the lessor is treated, in effect, as transferring the underlying assets, which may be tangible assets, to the lessee in exchange for a receivable, which is not a tangible asset. In such cases, the lessor no longer has the carrying value of tangible assets in its financial accounts. The lessee will in most cases create a “right-of-use” asset in its financial accounts, which reflects its right to use the tangible property during the term of the lease. The GloBE Rules treat a “right-ofuse” asset as tangible asset if the underlying asset itself is tangible. Thus, the lessee will be permitted to include the accounting carrying value of its right-of-use asset in calculating its SBIE. In a finance lease, the right-of-use asset will be substantially similar in amount to what the carrying value of the asset would have been if the asset had been purchased instead of leased.

43.1.1 Under an operating lease, the lessor may have a receivable in respect of the lease but continues to account for the underlying assets in its financial accounts and on its balance sheet. Depending upon the term of the lease, the lessee may still account for its interest in the leased asset as a “right-of-use” asset, which may be included in the lessee’s Eligible Tangible Assets if the underlying property is a tangible asset and located in the same jurisdiction as the lessee. Thus, for GloBE purposes, the financial accounts of both the lessor and lessee recognise an asset that could qualify as an Eligible Tangible Asset but for the rule that excludes assets held for lease from the scope of Eligible Tangible Assets. If a lessee (including a lessee that is a Constituent Entity of the same MNE Group as the lessor) does not recognise a right-of-use asset with respect to a leased asset in its financial accounts, the lessee cannot create a fictional or hypothetical right-ofuse asset for purposes of the GloBE Rules. This may happen where the lease is a short-term lease (a term of 12 months or less) or the value of the lease is not material.

43.1.2 As applied to a finance lease, this rule reflects the fact that the lessor is not actively using the underlying asset to earn income, but instead is providing financing in respect of the asset. It is therefore not a reliable measure of substantive activities of the lessor in a jurisdiction.

43.1.3 In an operating lease, however, the lease or rental period is often substantially less than the productive life of the asset. It is less clear that assets subject to consecutive operating leases over their productive life are not actively used in a business. In some cases, the assets may be used in a business that could be considered primarily a service, such as a hotel or short-term automobile rental.

43.1.4 The exclusion of property held for lease prevents two separate MNE Groups or two Constituent Entities of the same MNE Group from claiming SBIE in respect of the same item of tangible property. In a finance lease, the lessee can take the full value of the property into account based on its right-of-use asset. However, in the case of an operating lease, the lessee’s right of use asset will often be far less than the lessor’s carrying value of the asset, meaning that there would typically not be a complete duplication under an operating lease.

43.1.5 The Inclusive Framework has determined that in the case of an operating lease, the lessor will be allowed to take a portion of the carrying value of an asset subject to an operating lease into account in determining its Eligible Tangible Asset if the asset is located in the same jurisdiction as the lessor. The amount allowed is equal to the excess, if any, of the lessor’s average carrying value of the asset determined at the beginning and end of the Fiscal Year over the average amount of the lessee’s right of use asset determined at the beginning and end of the Fiscal Year. By allowing only the excess of the carrying value over the right-of-use asset, the lessor is prevented from also claiming SBIE in respect of the same asset value that is included in the lessee’s SBIE computation. If the lessee is not a Constituent Entity, the lessee’s right-of-use asset for this purpose shall be equal to the un-discounted amount of payments remaining due under the lease, including any extensions that would be taken into account in determining a right-of-use asset under the financial accounting standard used to determine the Financial Accounting Net Income or Loss of the lessor. In the case of a short-term rental asset, for example a hotel room or rental car, the lessee’s rightof-use asset shall be deemed to be nil. A short-term rental asset is an asset that is regularly leased several times to different lessees during the Fiscal Year and the average lease period, including any renewals and extensions, with respect to each lessee is 30 days or less.

43.1.6 The carrying value of Eligible Tangible Assets is determined after taking into account elimination entries for intercompany sales. The carrying value of Eligible Tangible Assets that are subject to a finance lease or an operating lease between two Constituent Entities located in the same jurisdiction is determined after taking into account elimination entries in consolidation for the intercompany lease. Consequently, the lessee in an intercompany operating lease will not have a right-of-use asset and the lessor’s carrying values for purposes of preparing the Consolidated Financial Statements are used to compute its carveout.

Dual use assets

43.1.7. When a lessor leases a substantial part of an Eligible Tangible Asset to a lessee and retains the residual part of the asset for its own use, e.g. leasing some floors or the parking lot of a headquarters building, the carrying value of the asset must be allocated between the different uses of the property. For the lessor, the carrying value of an Eligible Tangible Asset shall be allocated between the leased part and the residual part based on a reasonable allocation key in respect of the assets (e.g. surface area of the building). The lessor shall take into account the carrying value of the Eligible Tangible Assets allocated to the residual part and may apply the guidance on the treatment of property subject to an operating lease in respect of the carrying value allocated to the leased part.

Paragraph (d) – Licence or similar arrangements from the government to use immovable property or exploit natural resources

44. Licences and similar arrangements from the government, such as leases or concessions, for the use of immovable property or the exploitation of natural resources are included in Eligible Tangible Assets where the use of the property entails significant investment in tangible property. These arrangements provide rights similar to right-of-use tangible assets. Accordingly, to the extent they represent rights to use immovable property or to exploit natural resources owned by a government, these assets are included in the definition of Eligible Tangible Assets for purposes of the tangible asset carve-out, irrespective of whether they are recorded, or treated, as an intangible asset in the financial accounts or under the financial accounting standard used in the Consolidated Financial Statements. However, to the extent a Constituent Entity treats the right to charge tolls or fees in connection with operation of the property that underlies the licence or similar right as an asset separate from the right to use the immovable property, for example as a separate service contract, such asset is not included in Eligible Tangible Assets.

45. National or sub-national governments may grant rights to a Constituent Entity to use immovable property owned by the government in connection with the Entity’s business or to exploit natural resources that are owned by the government. This may occur, for example, in situations where the government may not be permitted by law to sell the property or those resources to private persons or businesses, although it is not limited to these situations. This is often the case in connection with infrastructure assets. For example, a government may engage a Constituent Entity to build infrastructure assets, such as a road, a bridge, a hospital, or an airport, that will be owned by the government when complete and grant the Constituent Entity a concession licence to use those the infrastructure assets in connection with the Constituent Entity’s toll road or bridge, hospital, or airport business for a period of years. The property that underlies the infrastructure concession licence is already owned by the government or will be owned by the government once it is constructed or improved. Similarly, a government may allow a Constituent Entity to extract and sell natural resources, such as minerals, timber, or oil and gas from a deposit, forest or reserve, that are owned by the government, and these rights are included in the Eligible Tangible Assets. The land under which the deposit, forest or reserve lies will continue to be owned by the government after the rights to exploit the natural resource expire. Finally, a licence or similar arrangement from the government for the use of part of a communications spectrum is a right to use immovable property included in the scope of Eligible Tangible Assets. In all of these cases, the Constituent Entity incurs costs to acquire the licence or similar right and will need to make significant investments in tangible assets to make productive use of the acquired rights. Accordingly, in such cases, the infrastructure concession licence, mineral rights, and licence to use a communications spectrum will be considered Eligible Tangible Assets, irrespective of whether they are recorded, or treated as, an intangible asset in the financial accounts or under the financial accounting standard used in the Consolidated Financial Statements. However, if the holder of the licence or arrangement from the government does not use the right in its own business and does not make significant investments in tangible property to exploit the rights granted, but instead re-licences the rights to another person or Entity, the licence or similar arrangement is not an Eligible Tangible Asset.

Excluded assets

46. The tangible asset carve-out computation excludes the carrying value of property (including land or buildings) held for investment, sale, or lease. While the carve-out generally seeks to recognise a broad range of tangible assets, an MNE Group should not be allowed to generate a larger carve-out by purchasing investment property in a jurisdiction. This risk is particularly relevant as it relates to buildings and land, which are commonly held as investments. To neutralise this risk, buildings and land that are held to earn rental income or for capital appreciation (or both), are excluded from the carve-out. The carve-out will still, however, take into account owner-occupied property that is directly or indirectly used in production or supply of goods and services. This rule is not expected to materially increase complexity or compliance costs because many accounting standards already require that such assets be identified and accounted for separately. For example, in the case of IFRS, investment properties are separately accounted for under IAS 40 – Investment Property (IFRS Foundation, 2022).

47. Similarly, an MNE Group should not be allowed to generate a larger carve-out via tangible assets whose carrying cost will be recovered principally through a sale transaction instead of through continuing use in the business. Since such assets are held for sale, not use, they are a poor proxy for substantive activities. Consequently, assets held for sale are excluded from the carve-out. In order to be considered held for sale, the asset must be available for immediate sale in its present condition subject only to terms that are usual and customary for sales of such assets and its sale must be highly probable. This rule is also not expected to materially increase complexity or compliance costs because many accounting standards already require that such assets be identified and accounted for separately. For example, in the case of IFRS, assets held for sale are separately accounted for under IFRS 5 – Non-current Assets Held for Sale and Discounting Operations (IFRS Foundation, 2022).

48. The tangible asset carve-out computation shall not include the carrying value of tangible assets attributable to the generation of a Constituent Entity’s International Shipping Income and Qualified Ancillary International Shipping Income that is within the cap under Article 3.3.4 (i.e. ships and other maritime equipment and infrastructure). The carrying value of tangible assets used in the generation of Qualified Ancillary International Shipping Income must be excluded in proportion to the excluded income, i.e. based on the ratio of Qualified Ancillary International Shipping Income within the cap to the total Qualified Ancillary International Shipping Income.

48.1 The tangible asset carve-out computation shall not include the carrying value of Eligible Tangible Assets proportionately attributable to the income excluded from the GloBE Income of the UPE under Article 7.2.1. Where the UPE of an MNE Group makes a distribution which is subject to a Deductible Dividend Regime (and other conditions are met), an amount of GloBE Income can be excluded from the GloBE Income of that UPE under Article 7.2.1. To the extent this occurs, there will be a proportionate reduction in the carrying value of the Eligible Tangible Assets of the UPE. The reduction will be equal to the total carrying value of Eligible Tangible Assets of the UPE multiplied by the ratio of the GloBE Income excluded under Article 7.2.1 to the total GloBE Income determined for the UPE (before the Article 7.2.1 exclusion). This adjustment will be equivalent to that made under Article 5.3.7(b). Further, the Eligible Payroll Costs of any other Constituent Entity located in the jurisdiction that is subject to the Deductible Dividend Regime shall be reduced in proportion to its GloBE Income that is excluded under Article 7.2.3 compared to its total GloBE Income.

Article 5.3.5

49. Article 5.3.5 sets out the rules for determining the carrying value of Eligible Tangible Assets for purposes of the tangible asset carve-out. The Article requires the MNE Group to determine the carrying value for purposes of the carve-out in conformity with the carrying value of the asset as recorded for purposes of preparing the Consolidated Financial Statements (i.e. after taking into account purchase accounting adjustments and elimination adjustments attributable to inter-company sales). The carrying value of each asset for purposes of the carve-out is the average of the beginning and end of year carrying values. Thus, if an asset is acquired or disposed during the Fiscal Year, its carrying value at the beginning or end of the Fiscal Year will be zero. Because the zero carrying value is included in the computation of the average, the carve-out for assets acquired or disposed during the year will be based on half of the carrying value of asset at the end or beginning of the year. The consequence of taking into account purchase accounting adjustments in respect of Eligible Tangible Assets and ignoring inter-company sales adjustments is that the tangible asset carve-out is based on the cost of acquiring the assets from unrelated persons and reflects the MNE Group’s actual investment in the relevant assets. Failure to include purchase accounting adjustments would understate the actual investment and including inter-company sales could overstate or understate the actual investment.

50. For financial accounting purposes, assets included in property, plant and equipment generally are initially recognised on the financial accounting balance sheet at their acquisition cost, including their purchase price and any costs directly attributable to bringing the asset to the location and condition necessary for it to be capable of operating in the manner intended by management. After initial recognition as an asset, an item of property, plant and equipment is carried on the balance sheet at its cost less any accumulated depreciation and any accumulated impairment losses (referred to as the “cost model”). Depreciation refers to the systematic allocation of the cost of an asset, less its residual or “salvage” value, over its useful life. An impairment loss is the amount by which the carrying amount of an asset exceeds its recoverable amount. Natural resources are also accounted for similarly to property, plant and equipment, except that the carrying value of natural resources is reduced by an allowance for depletion rather than depreciation.

50.1. Where an impairment loss is recognised under the financial accounting standard used to prepare the Consolidated Financial Statements with respect to an Eligible Tangible Asset, the carrying value of that asset will be reduced at the end of the Reporting Fiscal Year to reflect that impairment loss. If a reversal of that impairment loss is recognised under that financial accounting standard, the carrying value of the Eligible Tangible Asset will be increased at the end of the Reporting Fiscal Year to reflect that reversal, but the reversal cannot increase the carrying value of the asset above the amount which would have been determined had there been no impairment loss recognised in prior years. Ordinarily, the adjustments described in this paragraph will be reflected in the carrying value of the relevant asset in the Constituent Entity’s financial accounts used to determine the Constituent Entity’s tangible asset carve-out. If they are not reflected in these financial accounts, the adjustments must be made to the carrying value of the relevant assets for purposes of determining the Substance-based Income Exclusion.

51. Land is not subject to an allowance for depreciation. However, like property, plant and equipment, land is tested for impairment. In the case of land, an impairment could arise when, for example, the area where the land is located experiences a natural disaster such as flooding, an earthquake or a tornado. If the land is in fact impaired, an impairment loss is recognised and the carrying value of the land is reduced.

52. As described in the Commentary to Article 3.2.1(d), certain accounting standards allow depreciation of property, plant and equipment based on the revaluation model. See, for example IAS 16 (IFRS Foundation, 2022[2]). Under the revaluation model, assets are periodically re-valued and their carrying value increased or decreased accordingly in the financial accounts. Thus, such assets may be reflected in the financial accounts at a value above their acquisition cost. Absent a corrective measure the revaluation model would impact the quantum of the carve-out because carrying value of the assets is determined based on the revalued amount. This result is not appropriate because revaluation increases/decreases have no connection to substantive activities. Therefore, to eliminate the effect of the revaluation model for purposes of the carve-out, any increase in the value of an asset and any subsequent incremental increase in depreciation resulting from revaluation increases are disregarded. The result of this rule is that the carrying value of the asset never exceeds what it would have been without the revaluation. Such a result recognises that revaluation increases have no connection to incremental substantive activities. It also eliminates a key difference across accounting standards: those that allow the revaluation model and those that do not.

Article 5.3.6

53. Article 5.3.6 provides rules applicable to the computation of the amount of Eligible Payroll Costs and Eligible Tangible Assets of a PE that is a Constituent Entity. This provision states that the Eligible Payroll Costs and the Eligible Tangible Assets of the PE are those included in its separate financial accounts.

54. This provision follows the same mechanics as Articles 3.4.1 and 3.4.2. The Eligible Payroll Costs and Eligible Tangible Assets are those included in the financial accounts of the PE provided that such accounts are prepared in accordance with an Acceptable Financial Accounting Standard. If the PE does not have separate financial accounts or they are not prepared in accordance with an Acceptable Financial Accounting Standard, the amount of such Eligible Payroll Costs and Eligible Tangible Assets shall be computed as if a PE had separate financial accounts prepared in accordance with the accounting standard used in preparation of the Consolidated Financial Statements of the UPE.

55. Furthermore, similar to Article 3.4.2, the Eligible Payroll Costs and Eligible Tangible Assets have to be adjusted to those that would have been attributed to a PE in accordance with the Tax Treaty or domestic tax law. In the case of PEs as defined by paragraph (c) of the definition in Article 10.1, the Eligible Payroll Costs and Eligible Tangible Assets have to be those that would have been attributed to the PE in accordance with Article 7 of the OECD Model Tax Convention and related provisions (OECD, 2017).

56. A condition included in this Article is that the employees and assets have to be located in the jurisdiction in which the PE is located. This condition is similar to the condition that applies to other Constituent Entities, and which is provided in Article 5.3.3 and Article 5.3.4. See Commentary under those articles for purposes of determining, respectively, the jurisdiction where the employees of a PE perform their activity and the jurisdiction where the tangible assets of a PE are located. Where the employees and assets attributed to the PE are not located in the jurisdiction in which it is located, the costs of such employees and assets are excluded from the computation of the Substance-based Income Exclusion.

57. Furthermore, no Eligible Payroll Costs and Eligible Tangible Assets are attributed to a PE described in paragraph (d) of the definition in Article 10.1.

58. The second sentence of Article 5.3.6 states that the Eligible Payroll Costs and Eligible Tangible Assets that are attributed to a PE are not taken into account in the Eligible Payroll Costs and Eligible Tangible Assets of its Main Entity. This ensures that such costs are not taken into account twice for purposes of computing the Substance-based Income Exclusion. Furthermore, where the GloBE Income or Loss of a PE is allocated to the Main Entity in accordance with Article 3.4.5, the Eligible Payroll Costs and Eligible Tangible Assets attributed to such PE remain in the jurisdiction where it is located and therefore are not attributed to the Main Entity.

59. The last sentence of Article 5.3.6 states that the Eligible Payroll Costs and Eligible Tangible Assets of a PE whose income is excluded in accordance with Articles 3.5.3 and 7.1.4 are excluded from the Substance-based Income Exclusion. If the income is partly excluded, then a reduction to the Eligible Payroll Costs and Eligible Tangible Asset has to be made in the same proportion. This ensures that the Eligible Payroll Costs and Eligible Tangible Assets that are used to produce income that is excluded from GloBE Income are not taken into account to shelter income that is included in GloBE income.

Article 5.3.7

60. Article 5.3.7 explains how Eligible Payroll Costs and Eligible Tangible Assets that are included in the financial statements of a Flow-through Entity are allocated properly among Constituent Entities. This provision follows the same mechanics as Article 3.5.1.

61. As a preliminary step, the Eligible Payroll Costs and Eligible Tangible Assets attributed to a PE in accordance with Article 5.3.6 are removed and excluded from the allocation under Article 5.3.7. This is achieved by the phrase “not allocated under Article 5.3.6”. Article 5.3.7 then sets three different rules for different scenarios.

Paragraph (a)

62. Paragraph (a) covers the case where the Flow-through Entity (other than the UPE) is a Tax Transparent Entity. In this scenario, the Financial Accounting Net Income or Loss of the Flow-through Entity has been allocated to the Constituent Entity-owner under Article 3.5.1(b). Article 5.3.7(a) follows the same mechanics by allocating the Flow-through Entity’s Eligible Payroll Costs and Eligible Tangible Assets to its Constituent Entity-owner in the same proportion as the income or loss allocation. The phrase “in the same proportion” means that the same percentages apply with respect to the Financial Accounting Net Income or Loss, and the Eligible Payroll Costs and Eligible Tangible Assets when allocating them between a Flow-through Entity and its Constituent Entity-owners. This paragraph only applies if the Constituent Entity-owner and the employees and assets are located in the same jurisdiction.

Paragraph (b)

63. The second scenario is where the Flow-through Entity is the UPE of the MNE Group. In this case, the Financial Accounting Net Income or Loss of the UPE is allocated to such Entity in accordance with Article 3.5.1(c). However, Article 7.1.1 excludes such income or loss provided that certain conditions are met. In this case, paragraph (b) allocates the Eligible Payroll Costs and Eligible Tangible Assets included in the UPE’s financial statements to the extent that they are not excluded from the GloBE income or loss in accordance with Article 7.1.1. In effect, there will be a proportionate reduction in the Eligible Payroll Costs and carrying value of the Eligible Tangible Assets of the UPE. The reduction will be equal to the total Eligible Payroll Costs and carrying value of Eligible Tangible Assets of the UPE (including any Eligible Payroll Costs and carrying value of Eligible Tangible Assets allocated to the UPE pursuant to Article 5.3.7(a)) multiplied by the ratio of the GloBE Income excluded under Article 7.1.1 to the total GloBE Income determined for the UPE (before the Article 7.1.1 exclusion). Stated differently, the amount of Eligible Payroll Costs and Eligible Tangible Assets associated with the income excluded under Article 7.1.1 is not allocated to the UPE and is excluded from the Substance-based Income Exclusion computations in accordance with the next paragraph.

Paragraph (c)

64. The third rule states that all other Eligible Payroll Costs and Eligible Tangible Assets of the Flowthrough Entity not allocated under paragraphs (a) and (b) are excluded from the Substance-based Income Exclusion. This rule applies to the Eligible Payroll Costs and Eligible Tangible Assets associated with the Financial Accounting Net Income or Loss allocated to a Reverse Hybrid Entity. It also applies to the portion of the Eligible Payroll Costs and Eligible Tangible Assets associated with the Financial Accounting Net Income or Loss that has been excluded from the GloBE Income or Loss under Article 3.5.3 (attributable to non-members of an MNE Group) and under Article 7.1.1 (UPE Flow-through Entities).