Article 7.1.1

7. Article 7.1.1 permits the UPE to reduce its GloBE Income for a Fiscal Year in the three situations described in paragraphs (a) to (c).

8. The rules of Article 7.1.1 apply with respect to each Ownership Interest. The UPE will reduce its GloBE Income by the amount of GloBE Income attributable to each Ownership Interest that meets a criterion in paragraphs (a) to (c). The remainder of the income, if any, will be included in the computation of the UPE’s GloBE Income or Loss and included in the computation of the Net GloBE Income for the jurisdiction under Article 5.1.2.

Paragraph (a)

9. The general rule is described in paragraph (a).1 The paragraph sets out two tests that must be met with respect to each Ownership Interest for the reduction to apply: a taxable period test and a minimum tax test. The first test is included at the beginning of paragraph (a) and requires that the holder is subject to current taxation on such income. Specifically, the holder must be subject to tax on its share of the UPE’s GloBE Income for a taxable period that ends within 12 months of the end of the MNE Group’s Fiscal Year. The holder is not required to pay its tax liability within 12 months of the end of the MNE Group’s Fiscal Year to meet this test. It is sufficient that the holder’s share of the UPE’s GloBE Income is included in its taxable income for a taxable year that ends within 12 months of the MNE Group’s Fiscal Year end.

10. A holder is subject to tax on its share of the UPE’s GloBE Income if that income is includible in the holder’s taxable income under the laws of the jurisdiction in which the holder is tax resident or includible in taxable income of a PE of the holder.

11. The second test evaluates the holder’s level of taxation and can be satisfied if the conditions in subparagraphs (i) or (ii) are met. The conditions in subparagraphs (i) to (ii) are alternatives; thus, the conditions in only one of the subparagraphs need to be satisfied.

12. Subparagraph (i) is met if the holder is subject to tax on the full amount of its share of the GloBE Income (that is, for example, without the benefit of an exemption) and subject to tax at a nominal rate that equals or exceeds the Minimum Rate (meaning no ETR calculation is required in respect of the holder). Temporary difference (i.e. a timing difference) between the time an item of income or expense is included in the computation of GloBE Income or Loss and the UPE’s taxable income will not cause a holder to fail the requirement that it be subject to tax on the full amount of such income (as well as meeting the 12 month requirement in paragraph (a)). For example, if the UPE is allowed to use an accelerated depreciation method to compute the taxable income allocable to its holders, the difference in the timing of the income will not cause the holders to be considered subject to tax on less than the full amount of the UPE’s GloBE Income. A holder is considered subject to tax on the full amount of its GloBE Income even if its taxable income includes expenses or losses related to other investments or businesses or profit-seeking activities. For purposes of subparagraph (i), the nominal rate is the statutory rate applicable to the holder on its share of the UPE’s income. If the holder is subject to graduated rates, the nominal rate is the highest rate applicable to the holder determined as if its share of the UPE’s GloBE income were its total taxable income.

13. The conditions in subparagraph (i) are met with respect to holders that are not residents of the UPE Jurisdiction if the UPE Jurisdiction subjects them to tax at or above the Minimum Rate either because they are treated as having a PE in the UPE Jurisdiction or because the income is sourced in the UPE’s jurisdiction and subject to a withholding or similar source-based tax. In the event that the non-resident holders are not subject to tax in the UPE’s jurisdiction at a nominal rate that equals or exceeds the Minimum Rate, additional information will be required in order for the UPE to demonstrate that those holders are subject to tax on their share of the income within 12 months at a nominal rate that equals or exceeds the Minimum Rate.

14. The alternative conditions under subparagraph (ii) are met if it can be reasonably expected that the aggregate amount of Covered Taxes (paid by the UPE and other Entities that are part of the Tax Transparent Structure) and taxes paid by the holder on the income attributable to the Ownership Interest equals or exceeds the amount that results from multiplying the full amount of such income by the Minimum Rate. Whether the taxes paid can be reasonably expected to equal or exceed the tax at the Minimum Rate is determined based on all the facts and circumstances. The MNE Group bears the burden of proving that the expectations are reasonable.

15. Subparagraph (ii) does not require an ETR computation. Its conditions are met if the UPE demonstrates that it is reasonable to expect that its income will be subject to an amount of tax that equals or exceeds the tax liability on that income at the Minimum Rate. Subparagraph (ii) takes into account the net amount of taxes paid by the UPE and other Entities that are part of the Tax Transparent Structure and by the holder of the UPE’s Ownership Interest on its share of the UPE’s income. It requires that the taxes paid by the UPE and other Entities that are part of the Tax Transparent Structure are Covered Taxes and that the taxes paid by the holders are taxes on the income of the UPE. For instance, the UPE could be required to pay a local Covered Tax notwithstanding that its income is allocated to its holders under federal law. In this case, subparagraph (ii) is met if it is expected that the net amount of tax paid by the UPE itself and the holder equals or exceeds the minimum tax on that income.

Paragraph (b)

16. Paragraph (b) provides a safe harbour to a Flow-through UPE with owners that are natural persons that hold small Ownership Interests in the UPE. Determining the tax position of minority owners may be burdensome for the UPE. Because natural persons are typically not eligible for preferential tax rates on income derived through a Tax Transparent Entity, it is reasonable not to require the UPE to determine the tax position of a natural person that holds Ownership Interests that in aggregate carry rights to 5% or less of the profits and assets of the UPE. This rule means that a UPE could be required to determine the tax position of no more than 19 natural persons, and such persons would have relatively significant stakes in the UPE. This safe harbour only applies where the two conditions in subparagraphs (i) and (ii) are met.

17. Subparagraph (i) requires the natural person to be a tax resident of the UPE Jurisdiction. A natural person is tax resident in a jurisdiction only if the person is subject to individual income tax in such jurisdiction. Consequently, a natural person cannot be tax resident in a jurisdiction that does not impose an individual income tax. Therefore, there is an expectation that the UPE’s income is subject to tax in the hands of the natural person because they are both located in the same jurisdiction and therefore subject to the same tax laws regarding fiscal transparency. It is further reasonable to expect that the jurisdiction is subjecting natural persons to tax at a rate that equals or exceeds the Minimum Rate on their income derived from Flow-through Entities. Therefore, it is assumed that such persons are going to be subject to tax on the full amount of income attributable to their Ownership Interests at a rate that equals or exceeds the Minimum Rate. The UPE may use reasonable means of determining whether its owners are tax resident in the jurisdiction. For example, a UPE in a jurisdiction that imposes a withholding tax on the profits or distributions from the UPE with respect to foreign owners of the UPE may rely on an owner’s representation as to whether it is exempt from a withholding tax or eligible for a lower withholding tax rate based on a Tax Treaty.

18. Subparagraph (ii) limits the safe harbour to natural persons that each hold Ownership Interests that in aggregate carry rights to 5% or less of the profits and 5% or less of the assets of the UPE. For example, this means that an Ownership Interest giving rights to 51% of profits would fall outside the safe harbour in 7.1.1(b), despite giving rights to less than 5% of the assets. The extent of each person’s Ownership Interests is determined as of the end of the Fiscal Year. This subparagraph only applies where the Ownership Interests of the UPE are held directly by natural persons.

Paragraph (c)

19. Paragraph (c) is the last scenario in which Article 7.1.1 applies. It covers the case where the holder of the Ownership Interest in the UPE is a Governmental Entity, International Organisation, a Non-profit Organisation, or a Pension Fund. However, similar to paragraph (b), paragraph (c) only applies where two conditions are met.

20. The first condition is set out in subparagraph (i). It requires the Governmental Entity, International Organisation, Non-profit Organisation or Pension Fund to be resident in the UPE Jurisdiction. The term “resident” in paragraph (c) is not the same as “tax residence” as used in Tax Treaties, Article 10.2 or Article 10.3. For purposes of Article 7.1.1, these Entities are resident in the jurisdiction where they are created and managed. A Governmental Entity is resident only in the jurisdiction of the government (including any political subdivision or local authority thereof) of which it is a part or that wholly owns it. Whether an Entity is resident in a jurisdiction is determined based on all facts and circumstances.

21. The second condition, included in subparagraph (ii), requires that each Entity holds Ownership Interests that in aggregate carry rights to 5% or less of the profits and assets of the UPE. This is the same condition as in paragraph (b)(ii). These Ownership interests must also be directly held by the Governmental Entity, International Organisation, Non-profit Organisation or Pension Fund for the condition to be satisfied. The definitions of these Entities generally prohibit the Entity from carrying on a trade or business. This ownership limitation is designed to ensure that Article 7.1 cannot be used to circumvent the prohibition from carrying on a trade or business by carrying on a trade or business through a Tax Transparent Entity.

22. Ownership Interests in the Tax Transparent Entity held by Investment Entities are not included in paragraph (c) because Investment Entities are tax neutral whereas the Entities described in paragraph (c) are generally not subject to tax under the laws of the UPE’s jurisdiction. An Investment Entity itself may be subject to tax at a rate below the Minimum Rate and the UPE would have no knowledge of the taxability or residency of the Investment Entity’s owners. Thus it is not appropriate to extend the rule in paragraph (c) to Investment Entities.

Article 7.1.2

23. Article 7.1.2 provides a corollary to Article 7.1.1 for losses. Losses incurred by a Flow-through Entity typically flow through to the holders and are allowed as a deduction in computing the holder’s taxable income or loss, and may even contribute to a loss carry-back or carry-forward that reduces the holder’s share of prior or future income from the Flow-through Entity or other income. In some jurisdictions, however, losses of a Flow-through Entity are retained by the Entity and carried forward in the determination of the Entity’s future taxable income.

24. Article 7.1.2 provides that the GloBE Losses incurred by a UPE that is a Flow-through Entity must also be reduced by the amount attributable to each Ownership Interest, except to the extent that the holders of Ownership Interests are not allowed to use the loss in computing their separate taxable income. This means that the GloBE Loss is not reduced to zero only if the loss does not flow through, in its entirety, to the holders of Ownership Interests under the tax laws applicable to the Entity and to the holders so as to allow the holders to use their share of such loss in computing their separate taxable income. To the extent that the GloBE Loss is not reduced to zero, the remaining GloBE Loss stays with the Flow-through UPE. Without this rule, losses that are passed through to the holders of Ownership Interests would also be available for use in the jurisdictional ETR calculation to shield GloBE income of other Constituent Entities located in the UPE’s Jurisdiction.

25. To the extent that a GloBE loss of a Flow-through UPE is not reduced to zero pursuant to Article 7.1.2 (and thus stays with the Flow-through UPE), a Filing Constituent Entity may make a GloBE Loss Election that is limited to the UPE under Article 4.5.6, and carry forward the balance as a GloBE Loss Deferred Tax Asset to subsequent Fiscal Years. The GloBE Loss Deferred Tax Asset is computed based on the amount of the GloBE Loss remaining after application of Article 7.1.2 and may be included in the UPE’s Adjusted Covered Taxes in a subsequent year for purposes of applying Article 7.1.1(a)(ii).

26. Article 7.1.2 applies with respect to each Ownership Interest similar to Article 7.1.1. Therefore, the MNE Group is required to demonstrate that each of its holders is not able to deduct losses attributed to their Ownership Interest in the computation of their separate taxable income in order to include their share of the loss in the GloBE Loss Deferred Tax Asset computed under Article 4.5.6.

Article 7.1.3

27. Article 7.1.3 requires the UPE to reduce its Covered Taxes, if any, in proportion to the income reduction under Article 7.1.1. Thus, if the UPE reduces its GloBE Income by 80% pursuant to Article 7.1.1, the UPE must also reduce its Covered Taxes by 80%. In many cases, by virtue of the tax transparency regime, the UPE may not have any Covered Taxes. However, it is possible that Covered Taxes other than the national CIT are imposed on Flow-through Entities, such as those imposed by a local, sub-national government. Although the Covered Taxes excluded by Article 7.1.3 are not taken into account in the ETR computation for the UPE Jurisdiction, they are taken into account under Article 7.1.1(a)(ii) in determining whether the taxes on the holder’s share of the UPE’s GloBE Income equal or exceed the tax at the Minimum Rate on that income.

28. Article 7.1.1 reduces the Flow-through Entity’s GloBE Income by all of the GloBE Income (determined after adding back Covered Taxes) allocable to an Ownership Interest. Accordingly, no further adjustment is required to reduce the Entity’s GloBE Income by the related Covered Taxes as required under Article 7.2.2.

Article 7.1.4

29. Article 7.1.4 extends the treatment of Article 7.1.1 to 7.1.3 to certain PEs through which the UPE and certain other Flow-through Entities of the MNE Group conduct their business. Paragraph (a) covers the case where the business of the flow-through UPE is wholly or partly carried out through a PE.

30. Paragraph (b) covers the situations where the flow-through UPE directly holds the Ownership Interests of another Tax Transparent Entity whose business is wholly or partly carried out through a PE. This is the case where the Financial Accounting Net Income or Loss attributable to the PE is included in the financial statements of the Flow-through Entity held by the UPE.

31. Paragraph (b) is also extended to the scenario where the Flow-through UPE holds the Ownership Interest of the Tax Transparent Entity and the PE through a Tax Transparent Structure (see Article 10.2). This allows Article 7.1.4 also to apply to PEs held by the UPE through a chain of Tax Transparent Entities.

32. In all of these cases, the Financial Accounting Net Income or Loss attributable to the PE is included in the financial statements of the UPE, but liability for the tax on that income may be borne by the UPE or by the holders of the UPE. Where the tax on the income of the PE is borne by the holders, the PE’s GloBE Income is reduced to the extent the conditions of Article 7.1.1(a) or (b) are met. In such cases, Article 7.1.1(b) takes into account any tax paid or payable in the jurisdiction where the PE is located regardless of whether that tax is paid or payable by a Constituent Entity or by the holders of the UPE.

33. Furthermore, the test in Article 7.1.1 applicable to the GloBE Income of the PE is separate from the test applicable to the GloBE Income that has been allocated to the UPE. This means that the GloBE Income or Loss of the PE is not included in the GloBE Income of the UPE for purposes of applying 7.1.1 to the UPE. The PE is treated separately from the UPE under Article 7.1.4 because it is a separate Constituent Entity and its income does not flow-through to the UPE under Chapter 3 as does the income of a Tax Transparent Entity. However, to the extent that the conditions of Article 7.1.1 are met by a holder of an Ownership Interest in the UPE with respect to the income of the PE, the PE’s GloBE Income is reduced pursuant to Article 7.1.4.