OECD releases further Administrative Guidance for Pillar 2

What is the background?

The general transition rule under Article 9.1.1 MR enables an MNE Group to take into account, in the GloBE calculation, the deferred tax attributes at the beginning of the first year that an MNE group comes into the scope of the GloBE Rules (the “Transition Year”). Such deferred tax asset or liability must be measured using the lower of the minimum rate of 15% or the relevant domestic tax rate and must be reflected or disclosed in the financial accounts of the Constituent Entities.

The transition rules under Article 9.1.2 and Article 9.1.3 MR do feature certain exclusions or limitations to the general rule to prevent outcomes not in line with the policy objective of the rules. This is in particular the case for certain events that happened after 30 November 2021. These rules do not have retroactive tax implications but rather set out rules with respect to how certain tax attributes are taken into account in fiscal years to which the GloBE Rules apply.

The Administrative Guidance clarifies that the transition rules are not meant to be used by MNE Groups or General Governments to carry out transactions or offer tax benefits to taxpayers that create deferred tax assets, which could potentially shield a portion or all of an MNE Group’s future low-tax income from GloBE Rules.

Against this background, you will find below the key points on how the Administrative Guidance intends to preserve the integrity of the GloBE Rules and how the mentioned transition rules (in particular Article 9.1.2 MR) apply.

What elements must be met in order for Article 9.1.2 MR to apply?

The Administrative Guidance states that the special transition rule in Article 9.1.2 MR of the GloBE Rules is to prevent taxpayer from the exploitation of permanent differences between GloBE Income or Loss to taxable income through deferred tax assets that would be reflected or disclosed in the financial accounts of a Constituent Entity for the Transition Year. 

The elements that must be met in order that the deferred tax expense resulting from the reversal of such deferred tax asset shall be excluded from the GloBE computation are the following:

1. The deferred tax assets shall arise from items excluded from the computation of GloBE Income or Loss under Chapter 3, and
2. the deferred tax assets shall be generated in a transaction that takes place after 30 November 2021.

The Administrative Guidance provides further clarification on how these elements are defined:

Items excluded from computation of GloBE Income or Loss under Chapter 3

The Administrative Guidance clarifies that this includes not only deferred tax assets attributable to items expressly excluded under Chapter 3 of the GloBE Rules but also deferred tax assets associated with “non-economic expenses or losses for tax purposes”. Typical examples are tax-specific deductions that do not apply for accounting purposes (e.g. specific enhanced tax deductions such as depreciation deductions or super-deductions in excess of an asset’s cost). The guidance further specifies that the reference also includes deferred tax assets that are not attributable to the prepayment of tax or tax benefits that achieve similar effects, such as tax credits on future expenditures or activity.

Transaction that takes place after 30 November 2021

Where such deferred tax asset is created in a transaction that takes place after 30 November 2021, the deferred tax expense resulting from the reversal of the deferred tax asset is not included in the GloBE computation respectively needs to be eliminated thereof. In this respect the Administrative Guidance also confirms that Article 9.1.2 MR can apply to a deferred tax asset arising from a transaction that takes place after the Transition Year provided the deferred tax asset was reflected or disclosed in the financial accounts for the Transition Year.

On the contrary, deferred tax assets established in a transaction prior to or on 30 November 2021 are not adjusted (apart from recasting as required under Art. 9.1.1 MR).

What constitutes a “transaction” under Article 9.1.2 MR?

So far neither the GloBE Rules nor the Commentary to the GloBE Rules provided for a definition of what constitutes a “transaction” under Article 9.1.2 MR. The Administrative Guidance is now closing this gap and explaining in detail what is meant by “transaction”.

The Administrative Guidance states that the term “transaction” needs to be interpreted broadly, and it is not limited to commercial transactions. It includes “any agreement, ruling, decree, grant or similar arrangement with a General Government (hereinafter referred to as governmental arrangement), as well as any amendment or modification to a pre-existing governmental arrangement”.

Specifically, governmental arrangements that provide the taxpayer with specific entitlement to a tax credit or other tax relief (e.g. a tax basis step-up) that does not arise independently of the arrangement are covered transactions. Under the Administrative Guidance, a tax benefit arises independently if no critical aspect of the tax credit or tax relief, such as the eligibility or amount, relies on discretion exercised by the General Government.

The Administrative Guidance in particular specifies that the following tax attributes are in scope of Art. 9.1.2 MR and as such excluded from GloBE computation:

• a) Deferred tax assets related to new or amended governmental arrangements post 30 November 2021 providing specific tax benefits (tax credits or other tax relief, such as a tax basis step-up) that do not arise independently of the arrangement.
• b) Deferred tax assets from an MNE Group’s retroactive tax treatment change (e.g. because of election or choice exercised) post 30 November 2021.
• c) Deferred tax assets/liabilities arising from tax basis differences due to a new corporate income tax law that was enacted after 30 November 2021 and before the Transition Year.

Further, the Administrative Guidance states that also deferred tax assets from losses arising more than five fiscal years prior to the effective date of a newly enacted corporate income tax need to be excluded under Article 9.1.2 MR.

Where do the affected tax benefits need to be excluded?

The Administrative Guidance confirms that the affected tax benefits do not only need to be excluded from the full detailed GloBE calculation (i.e. from the Total Deferred Tax Adjustment Amount under Article 4.4 MR) but also from the Simplified Covered Taxes under the Transitional CbCR Safe Harbour.

Is there a Grace Period and what is the Grace Period Limitation?

The Administrative Guidance provides the implementing jurisdictions with a Grace Period of basically two years. Depending on the category of deferred tax asset, the two year Grace Period applies as follows:

• Deferred tax assets described above in subparagraph (a) or (b): all Fiscal Years beginning on or after 1 January 2024 and before 1 January 2026 but not including a Fiscal Year that ends after 30 June 2027.
• Deferred tax assets described above in subparagraph (c): all Fiscal Years beginning on or after 1 January 2025 and before 1 January 2027 but not including a Fiscal Year that ends after 30 June 2028.

Because subparagraph (c) does not apply to Switzerland, the Grace Period for Swiss entities in scope is in most of the cases limited to FY24 and FY25 for calendar-year tax payers, respectively FY 25 and FY26 for non-calendar year tax payers. 

During the Grace Period and as an exception, a portion of the deferred tax expense attributable to the reversal of a deferred tax asset (i.e. Grace Period Limitation) as listed above can be taken into account in the GloBE calculation and for the Simplified Covered Taxes under the Transitional CbCR Safe Harbour. The maximum of such Grace Period Limitation shall be 20% of the originally recorded deferred tax asset (taken into account at the lower of the Minimum Rate or the applicable domestic tax rate). The total deferred tax expense attributable to the reversal of such deferred tax asset in the Grace Period cannot exceed this cap of 20%. 

In addition, the Administrative Guidance specifies that the exception is not designed to allow acceleration of the reversal so that the reversal is limited to the amount that would have reversed under the law in effect, any election (or choice) in effect, the accounting methodology used for the deferred tax asset and the terms of the governmental arrangement on 18 November 2024.

Following the first example in the Administrative Guidance, a Constituent Entity accrues in 2023 a disallowed deferred tax asset of 1’000 and this deferred tax asset will be reversed linearly over 10 years in the financial accounts (i.e. deferred tax expense of 100 is recorded each year from 2024 to 2033). In this example the maximum Grace Period Limitation is 200 (i.e. 20% of 1’000). The Grace Period Limitation of 200 is then allocated to the deferred tax expense (resulting from the reversal of the deferred tax asset) recorded in the financial accounts of Fiscal Years 2024 and 2025 (Grace Period). The total 200 deferred tax expense recorded in Fiscal Years 2024 and 2025 (i.e. 100 each year) can fully be taken into account in the Simplified Covered Taxes computation respectively in the full GloBE calculation (if applicable) because the sum of both years does not exceed the maximum Grace Period Limitation of 200. From Fiscal Year 2026 onwards (i.e. after the Grace Period ended) the deferred tax expense recorded in the financial accounts will need to be excluded from the Simplified Covered Taxes as well as the full GloBE calculation.

The Administrative Guidance also includes a second example. The facts are the same as for the above example except that the MNE Group records deferred tax expense of 200 in 2024 (i.e. the full amount up to the cap). Consequently, the MNE Group is unable to qualify for the Transitional CbCR Safe Harbour for 2025 and the reversal of the disallowed deferred tax asset cannot be included in the MNE Group’s GloBE computations in 2025 because the Grace Period Limitation cannot be exceeded. Hence, the deferred tax expense attributable to the reversal of the disallowed deferred tax asset in 2025 is excluded from the Total Deferred Tax Adjustment Amount under Article 4.4.

What happens when a QDMTT jurisdiction decides not to apply the mentioned limitations?

According to the Administrative Guidance, if a QDMTT jurisdiction allows to take into account the above-mentioned tax attributes for the full GloBE calculation or the Simplified Covered Taxes under the Transitional CbCR Safe Harbour for QDMTT purposes, an affected MNE Group will become subject to the Switch-off Rule. The Switch-off Rule does not disqualify a jurisdiction for the QDMTT but prevents the MNE Group from applying the QDMTT Safe Harbour to all Constituent Entities in such QDMTT jurisdiction. As a consequence, the MNE Group is required to switch to the credit method for such jurisdiction and additional information (e.g. information concerning the original amount of covered deferred tax assets, etc.) must be filed together with the GloBE Information Return to allow the assessment under the GloBE Rules.

It is expected that Switzerland will adopt the mentioned limitations to Article 9.1.2 MR under the Swiss QDMTT, and therefore the Switch-off Rule does not apply to affected Swiss Constituent Entities.