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Article 7.3. Eligible Distribution Tax Systems
Article 7.3 allows certain distribution tax regimes to be accommodated within the structure of the GloBE Rules, subject to certain safeguards and recapture rules. A distribution tax regime is a tax system that generally imposes income tax on a corporation when the corporation’s income is distributed or deemed to be distributed to its shareholders, rather than when it is earned. Distribution tax regimes also impose current tax in respect of certain non-business expenses. Current taxation based on these disallowed expenditures is equivalent to disallowing a deduction for such expenses under a more traditional income tax. Because these non-business expenditures reduce distributable earnings, they cannot be subject to tax on distribution as a practical matter.
The tax rates applicable under a distribution tax regime may equal or exceed the Minimum Rate such that the income is not subject to a low rate of tax when the earnings are eventually distributed. Absent a distribution or deemed distribution, however, much of the income is not subject to tax in the year it is earned and reported in the financial accounts. Moreover, the rules in Article 4.3 generally do not permit deferred tax liabilities in respect of taxes payable upon distribution to be included in the computation of the Total Deferred Tax Adjustment Amount. This means that the Constituent Entity’s GloBE Income likely would be subject to tax under the GloBE Rules in those years in which there is not an actual or deemed distribution because the Adjusted Covered Taxes for the Fiscal Year will be very small or nil. Moreover, in years where distributions are made, the amount of the distributions may bear no relationship to the income arising in those years, which may result in low or even extremely high ETRs. Article 7.3 mitigates these differences between the time the income accrues in the financial accounts and the time it is subject to distribution tax to the extent that distributions are made within a four-year period.
7.3.1. A Filing Constituent Entity may make an annual election with respect to a Constituent Entity that is subject to an Eligible Distribution Tax System to add the amount of Deemed Distribution Tax determined under Article 7.3.2 to Adjusted Covered Taxes for the Fiscal Year. An election under this Article shall apply to all Constituent Entities located in the jurisdiction.
7.3.2. The amount of Deemed Distribution Tax is the lesser of:
a) the amount of Adjusted Covered Taxes necessary to increase the Effective Tax Rate computed under Article 5.2.1 for the jurisdiction for the Fiscal Year to the Minimum Rate; or
b) the amount of tax that would have been due if the Constituent Entities located in the jurisdiction had distributed all of their income that is subject to the Eligible Distribution Tax Regime during such year.
7.3.3. An annual Deemed Distribution Tax Recapture Account is established for each Fiscal Year in which the election in Article 7.3.1 applies. A Deemed Distribution Tax Recapture Account is increased by the amount of the Deemed Distribution Tax determined under Article 7.3.2 for the jurisdiction for the Fiscal Year for which it was established. At the end of each succeeding Fiscal Year, the outstanding balances of Deemed Distribution Tax Recapture Accounts established for prior Fiscal Years are reduced in chronological order and to the extent thereof, but not below zero:
a) first by Taxes paid by the Constituent Entities during the Fiscal Year in relation to actual or deemed distributions;
b) then by the amount of any Net GloBE Loss of the jurisdiction multiplied by the Minimum Rate; and
c) then by any amount of Recapture Account Loss Carry-forward applied to the current Fiscal Year pursuant to Article 7.3.4.
7.3.4 A Recapture Account Loss Carry-forward shall be established for the jurisdiction when the amount described in Article 7.3.3(b) exceeds the outstanding balance of the Deemed Distribution Tax Recapture Accounts. The Recapture Account Loss Carry-forward shall be in an amount equal to such excess and shall be taken into account in subsequent Fiscal Years as a reduction to Deemed Distribution Tax Recapture Accounts in such Fiscal Years. When such amount is taken into account in a subsequent Fiscal Year, the Recapture Account Loss Carry-forward must be reduced by that amount.
7.3.5. If there is an outstanding balance of a Deemed Distribution Tax Recapture Account (maintained in accordance with Article 7.3.3) on the last day of the fourth Fiscal Year after the Fiscal Year for which such account was established, the Effective Tax Rate and Top-up Tax for the Fiscal Year for which the account was established must be recalculated under Article 5.4.1 by treating the balance of the Deemed Distribution Tax Recapture Account as a reduction to the Adjusted Covered Taxes previously determined for such year.
7.3.6. Taxes paid during the Fiscal Year in relation to actual or deemed distributions are not included in Adjusted Covered Taxes to the extent they reduce a Deemed Distribution Tax Recapture Account under Article 7.3.3.
7.3.7. In the Fiscal Year that a Departing Constituent Entity leaves the MNE Group or transfers substantially all of its assets,
a) the Effective Tax Rate and Top-up Tax for each preceding year for which a Deemed Distribution Tax Recapture Account is outstanding is re-calculated in accordance with the principles of Article 5.4.1. by treating the balance of the Deemed Distribution Tax Recapture Account as a reduction to the Adjusted Covered Taxes previously determined for such year; and
b) any amount of incremental Top-up Tax resulting from such recalculation shall be multiplied by the Disposition Recapture Ratio to determine the Additional Current Top-up Tax for purposes of Article 5.2.3.
7.3.8. The Disposition Recapture Ratio is determined for each Departing Constituent Entity using the following formula:
Where: GloBE Income of the CE is the sum of GloBE Income of the Departing Constituent Entity determined in accordance with Chapter 3 for each Fiscal Year corresponding to the Deemed Distribution Tax Recapture Accounts for the jurisdiction; and Net Income of the jurisdiction is the sum of the Net GloBE Income of the jurisdiction determined In accordance with Article 5.1.2 for each Fiscal Year corresponding to the Deemed Distribution Tax Recapture Accounts for the jurisdiction.
Article 7.3.1
54. Article 7.3.1 allows the Filing Constituent Entity to make an annual election in respect of a Constituent Entity that is subject to a Eligible Distribution Tax System to add the Deemed Distribution Tax to the Adjusted Covered Taxes for the Fiscal Year. An election under Article 7.3.1 is subject to the other provisions of Article 7.3.
Article 7.3.2
55. Article 7.3.2 determines the amount of Deemed Distribution Tax. It is the lesser of (a) the amount necessary to increase the Effective Tax Rate computed under Article 5.2.1 for the jurisdiction for the Fiscal Year to the Minimum Rate or (b) the amount of distribution tax that would have been paid if the Constituent Entities in the jurisdiction had distributed all of their income that is subject to the Eligible Distribution Tax Regime during such Fiscal Year. Thus, if the GloBE Income for the Fiscal Year were to exceed the amount of earnings that could be distributed and subject to tax upon distribution for that Fiscal Year, the Deemed Distribution Tax would be limited under paragraph (b) to the amount of tax that would arise if all taxable earnings for the Fiscal Year were distributed.
56. The purpose of the limitation in paragraph (b) is to ensure that under ordinary circumstances the Deemed Distribution Tax does not exceed the amount of tax that could possibly arise under the relevant distribution tax system for a Fiscal Year if all earnings were distributed in the year earned. The rule is not intended to supplant or interfere with the rules in Articles 7.3.3 and 7.3.4 for establishing and using a Recapture Account Loss Carry-forward. Thus, the computation under paragraph (b) is made without regard to any negative balance in the accumulated earnings of Constituent Entities in the jurisdiction as of the end of the preceding Fiscal Year.
Article 7.3.3
57. In order to track the extent to which Deemed Distribution Tax is paid within the 4-year period, a Deemed Distribution Tax Recapture Account for each Fiscal Year in which the election was made must be maintained and available for examination by the tax authorities of jurisdictions imposing the GloBE Rules. The Deemed Distribution Tax Recapture Accounts are maintained on a jurisdictional basis. This facilitates jurisdictional blending of income. It also ensures that the adjustments to the recapture accounts accommodate a consolidation or group relief system in the jurisdiction and allows distributions from any Constituent Entity to eliminate the account.
58. A Deemed Distribution Tax Recapture Account is established for each Fiscal Year in an amount equal to the Deemed Distribution Tax. These annual accounts can be reduced in the three ways described in more detail below. The accounts are reduced in chronological order beginning with the account established for the earliest Fiscal Year and cannot be reduced below zero.
59. Deemed Distribution Tax Recapture Accounts are first reduced by distribution taxes actually paid by the Constituent Entities as a result of distributions or deemed distributions. Distribution taxes are charged against the Deemed Distribution Tax Recapture Accounts in chronological order. The accounts are maintained based on the amount of Deemed Distribution Tax rather than the amount of GloBE Income arising in the relevant Fiscal Year. Consequently, if the jurisdiction decreases the distribution tax rate, more income will need to be distributed to yield the amount of tax necessary to eliminate the potential recapture. On the other hand, if the jurisdiction were to increase the distribution tax rate, the Constituent Entities could eliminate the accounts by distributing less of their income.
60. Second, the accounts are reduced when the jurisdiction has an overall GloBE Loss, meaning the aggregate GloBE Loss of Constituent Entities exceeds the aggregate GloBE Income of Constituent Entities located in the jurisdiction. The reduction for GloBE Losses is applied to the oldest Deemed Distribution Tax Recapture Account to the extent thereof and then to newer accounts to the extent necessary to absorb the entire loss. Because the accounts are maintained in terms of Deemed Distribution Taxes rather than income, the amount of any GloBE Loss for the jurisdiction has to be translated into an equivalent negative distribution tax amount. This translation must be based on the Minimum Rate. Thus, the GloBE Loss for the Fiscal Year is multiplied by the Minimum Rate and the result is applied against Deemed Distribution Tax Recapture Accounts in chronological order. This rule effectively permits a carry-back of losses in a Distribution Tax System. Carry-back is necessary because these losses will eliminate distributable profits and thus the Constituent Entity’s ability to distribute dividends that are subject to the distribution tax.
61. Finally, the Deemed Distribution Tax Recapture Accounts are reduced by the amount of a Recapture Account Loss Carry-forward determined under, and applied to the Fiscal year, pursuant to Article 7.3.4.
Article 7.3.4
62. When there is a Net GloBE Loss for the jurisdiction that exceeds the amount in all of the Deemed Distribution Tax Recapture Accounts, a Recapture Account Loss Carry-forward is created. This account is reduced in subsequent years as the loss carry-forward is applied to reduce the GloBE Income that would otherwise be subject to the Deemed Distribution Tax. The account ensures that the MNE Group is not taxed under the GloBE Rules in excess of its economic income earned through Entities subject to a Distribution Tax Regime.3
63. When a Constituent Entity located in the jurisdiction leaves the MNE Group or when substantially all of the assets of a Constituent Entity are transferred outside the MNE Group or outside the jurisdiction, the Recapture Account Loss Carry-forward must be reduced to the extent it is attributable to such Constituent Entity. The amount attributable to a Constituent Entity is determined by multiplying the Recapture Account Loss Carry-forward by the ratio of the GloBE Loss of that Constituent Entity in the Fiscal Year(s) that produced a Net GloBE Loss in excess of the Deemed Distribution Tax Recapture Accounts to the total of the GloBE Losses of all Constituent Entities in the jurisdiction for that Fiscal Year(s).
64. The Recapture Account Loss Carry-forward may be carried forward indefinitely. However, the Filing Constituent Entity bears the burden of proof in respect of any Recapture Account Loss Carry-forward used in the computation of the Net GloBE Income of the jurisdiction for a Fiscal Year.
Article 7.3.5
65. Article 7.3.5 mandates that an election under Article 7.3.1 applies to all Constituent Entities located in the jurisdiction.
66. Article 7.3.5 requires the MNE Group to re-calculate the ETR and the amount of Top-up Tax under Article 5.4.1 for the Election Year if the Deemed Distribution Tax Recapture Account established for the year is not reduced to zero before the end of the fourth Fiscal Year after the Fiscal Year for which it was established. The re-calculations under Article 5.4.1 are done by reducing the Adjusted Covered Taxes for the Election Year by the outstanding balance (at the end of the relevant period) of the Deemed Distribution Tax Recapture Account for that year. The Substance-based Income Exclusion used to compute Excess Profits in the Article 5.4.1 re-calculations for the Election Year is computed based on the Eligible Payroll Costs of Eligible Employees arising in the Election Year and the carrying values of Eligible Tangible Assets at the beginning and end of the Election Year. Similarly, if the Election Year is a Fiscal Year covered by the Transition Rules in Article 9.2, the relevant Article 5.3.3 rate and Article 5.3.4 rate apply in the determination of the Substance-based Income Exclusion.
67. The result of Article 7.3.5 should be that the Top-up Tax liability in respect of the Election Year is the same as the Top-up Tax liability that would have been determined for the year if the distribution taxes paid in the following four Fiscal Years had been paid in the Election Year.
Article 7.3.6
68. Article 7.3.6 ensures that payments of distribution taxes, whether as a result of actual or deemed distributions, are not counted once as a reduction to a Deemed Distribution Tax Recapture Account and a second time as Adjusted Covered Taxes. Only distribution taxes paid after all Deemed Distribution Tax Recapture Accounts have been reduced to zero are treated as Covered Taxes for the Fiscal Year. Taxes paid under an Eligible Distribution Tax Regime in respect of non-business expenses, however, are Covered Taxes and taken into account as such under the rules of Chapter 4.
Article 7.3.7
69. When a Constituent Entity located in the jurisdiction leaves the MNE Group or when substantially all of the assets of a Constituent Entity are transferred outside the MNE Group or outside the jurisdiction, the ETR and Top-up Tax for the jurisdiction must be re-calculated under Article 5.4.1 by reducing the Covered Taxes by the balance of the Deemed Distribution Tax Recapture Account at the end of that Fiscal Year. If the re-calculation under Article 5.4.1 results in Top-up Tax, that amount is multiplied by the Disposition Recapture Ratio and the result is included in the Additional Top-up Tax for the Fiscal Year. This rule recaptures the Deemed Distribution Tax when the Constituent Entity ceases to be in a position to distribute assets that would yield distribution tax to eliminate the balance in the recapture accounts. Article 7.3.7 does not impose tax on gains attributable to a transfer of assets. Accordingly, the rule is not dependent upon whether the transaction is eligible for treatment as a GloBE Reorganisation under Article 6.3.
70. Under Article 7.3.7, the MNE Group applies Article 5.4.1 to all of its Deemed Distribution Tax Recapture Accounts in the Fiscal Year that the Departing Constituent Entity leaves the MNE Group or disposes of substantially all of its assets. The re-calculations under Article 7.3.7 are done in the same manner as under Article 7.3.5. The incremental Top-up Tax computed for each Deemed Distribution Tax Recapture Account is then multiplied by the Disposition Recapture Ratio determined under Article 7.3.8 to determine the amount of Additional Top-up Tax to include for the Fiscal Year under Article 5.2.3. If the Departing Constituent Entity had a GloBE Loss for a Fiscal Year, the Disposition Recapture Ratio for that year will be zero and there will be no recapture amount for that Fiscal Year.
71. After application of Article 7.3.7, the Deemed Distribution Tax Recapture Account, the Net GloBE Income of the jurisdiction, the Adjusted Covered Taxes for the jurisdiction, and the Substance-based Income Exclusion for each Fiscal Year for which there was a Deemed Distribution Tax Recapture Account must be reduced in proportion to the Disposition Recapture Ratio. This can be done by multiplying the amount of each item by the Disposition Recapture Ratio and reducing it by the result or by multiplying the item by the difference between 1.0 and the Disposition Recapture Ratio expressed as a decimal). This will ensure that subsequent adjustments to the Deemed Distribution Tax Recapture Accounts pursuant to Article 7.3.3 are given full effect in the computation of the ETR and Top-up Tax at the end of the four-year period under Article 7.3.5.
Article 7.3.8
72. The Disposition Recapture Ratio is set out in Article 7.3.8. In conjunction with Article 7.3.7, it recaptures the outstanding balance of the Deemed Distribution Tax Recapture Accounts based on the ratio of the sum of the GloBE Income of the Departing Constituent Entity in the Fiscal Years for which a Deemed Distribution Tax Recapture Account is outstanding to the sum of the Net GloBE income of the jurisdiction for those Fiscal Years. Thus, if there are two annual recapture accounts outstanding, the Constituent Entity’s GloBE Income or Loss for those two years is compared to the total Net GloBE Income for those two years and the resulting ratio is multiplied by the incremental Top-up Tax computed for each Deemed Distribution Tax Recapture Account under Article 5.4.1 to determine the amount of Additional Top-up Tax to include for the Fiscal Year under Article 5.2.3. If the Departing Constituent Entity had a GloBE Loss in a Fiscal Year for which a Deemed Distribution Tax Recapture Account was established, that GloBE Loss and the account for that Fiscal Year is ignored in the computation of the Disposition Recapture Ratio because the account for that Fiscal Year was not attributable to GloBE income of the Departing Constituent Entity
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