As discussed in prior blog posts, Amount A is a proposed new taxing right over a share of the residual profit of MNE groups that fall within its defined scope. The tax base is therefore determined on the basis of the profits of a group (rather than on a separate entity basis), and it is necessary to start with consolidated group financial accounts.
Comment: As discussed in prior blog posts, the reliance on consolidated financial statements in computing Amount A is a novel concept. Many taxing authorities are likely to view reliance on consolidated financial statements as a departure from the arm’s length standard, which typically looks to profits earned by individual legal entities as the basis for taxation.
This approach raises three broad categories of issues for the determination of the Amount A tax base. First, there is the need to define a standardized measure of profit as a basis for Amount A, including the extent to which harmonization adjustments are required to address divergences in existing financial accounting standards. Second, there is the need to address the rationale for, and technological feasibility of, computing Amount A using segmented accounts, on either a business line or geographic basis. Third, the design of loss carry-forward rules is required to ensure that losses are taken into account in the computation of Amount A.
Comment: As discussed in prior blog posts, the use of segmentation to determine the tax base for Amount A is again a novel concept. While segmentation is sometimes a component of GAAP financial statements, segmentation has not heretofore been the basis for taxation and, again, is likely to be perceived by some as a departure from the arm’s length standard.
A PBT measure based on consolidated financial accounts. The Amount A tax base will be quantified using an adjusted Profit Before Tax (“PBT”) measure that will be derived from the consolidated financial accounts prepared under GAAP that produce equivalent or comparable outcomes to consolidated financial accounts prepared under International Financial Reporting Standards (IFRS) – the “eligible GAAP”. Where an MNE group in scope of Amount A does not produce consolidated financial statements, it would need to prepare consolidated financial statements. Consistent with Pillar Two, no specific book-to-book harmonization adjustments (to account for variances between different GAAP) are considered necessary. For ease of administration, only a limited number of book-to-tax adjustments will apply to determine the relevant measure of PBT, and seek alignment of the tax base for Amount A with the corporate tax base of the OECD’s Inclusive Framework members. These adjustments will include exclusion of income tax expenses, exclusion of dividend income and gains or losses in connection with shares, and expenses not deductible for Corporate Income Tax (CIT) purposes in most Inclusive Framework jurisdictions for public policy reasons.
The segmentation framework. The Outline recognized that for some groups it may be necessary to compute the Amount A tax base on a segmented basis, but also acknowledged that using segmentation to determine the relevant PBT measure will create additional compliance costs for taxpayers and extra burdens for tax administrations who will need to review these segmented accounts as part of any compliance activity and within the context of the tax certainty process.
The framework starts from an acknowledgment that though it is feasible for taxpayers to break down their revenue between Automated Digital Services (“ADS”), Consumer Facing Businesses (“CFB”) and out-of-scope, it may not be possible for them to compute separately the net profits attributable to these activities (i.e. segmentation of the tax base). Nevertheless, as Pillar One applies the principle of net, rather than gross, basis taxation it will still be necessary to only reallocate profits attributable to in-scope activities. The OECD believes that the easiest way to achieve this would be to calculate the Amount A tax base on a consolidated basis and use the consolidated profit margin of the group as proxy for the in-scope profit margin, applying it to in-scope revenues to produce a proxy for in-scope profits. From this proxy, Amount A would be calculated and then allocated among market jurisdictions using the allocation formula. However, there are some circumstances where this may not be appropriate, of where doing so might fail to maintain a level playing field between taxpayers. For example, where a large group operates two substantially independent businesses, with different profit margins, computing the Amount A tax base on a segmented basis would ensure that a taxpayer cannot reduce or eliminate a potential Amount A tax liability by combining profits from high and low margin activities. In these circumstances, the segmentation framework could require a taxpayer to compute the relevant measure of PBT using segmented accounts.
The framework will be based on the following three-step process: first, all MNE groups in scope of Amount A would need to break down their revenue between ADS, CFB and out-of-scope activities, as may be required by the scope and nexus rules; second, to limit the number of MNE groups that are required to segment their Amount A tax base, MNE groups with global revenue less than a determined threshold would benefit from a “segmentation exemption” which would require them to compute the Amount A tax base on a group basis; third, those groups not eligible for the exemption, or if designed as a safe harbor, did not elect for it, would then test whether they are required to segment their Amount A tax base and on what basis.
With respect to segmentation, consideration is being given to an approach based on three steps: first, MNE groups will apply “segmentation hallmarks” to determine whether they are required to segment their tax base; for MNE groups that display segmentation hallmarks, the disclosed segments in the MNE group financial statements will be tested to ascertain whether they meet the agreed hallmarks; finally, MNE groups that are not eligible to use their disclosed segments will be required to compute the Amount A tax base on the basis of alternative segments. Possible considerations in determining segments might include, but are not limited to, the nature of the products or services, the nature of the production processes, the type or class of customer for the products or services, the methods used to distribute the products or provide the services, and, if applicable, the nature of the regulatory environment. Where a taxpayer computes the Amount A tax base on the basis of its disclosed segments, it will still need to allocate a pool of central or unallocated costs between segments in order to arrive at the relevant PBT measure for each segment. As a rebuttable presumption, these costs will be apportioned between segments using revenue as an allocation key. When applying Amount A on a segmented basis, the treatment of intersegmental transactions remains to be determined. The OECD points out that intersegmental transactions may have a direct impact on the reported profitability of different segments and could create incentives for groups to use intersegmental transactions to shift profits to segments that are primarily out-of-scope of Amount A.
Loss carry-forward rules.
Loss carry-forward rules will apply through an earn-out mechanism at the level of the group or segment (as determined by the segmentation framework). This means that losses generated over a given tax period under Amount A, unlike profits, will not be allocated to market jurisdictions. Instead, they will be pooled in a single account for the relevant segment and carried forward to subsequent years, with the result that no profit under Amount A would arise for that segment (and be reallocated to markets) until historic losses reported in that account have been fully absorbed. Where the Amount A tax base is segmented, the segmentation approach will require that losses and profits incurred by different segments within the group are computed separately, and that losses incurred by a segment are generally not available to reduce the profit of another segment. A transitional regime is being considered which would allow certain net pre-regime losses to be preserved and deducted against Amount A in-regime profits up to a certain time limit. For Amount A, specific rules would be developed to deal with the treatment of unrelieved losses in the context of business reorganizations. Some OECD members proposed that the Amount A carry-forward regime should accommodate, in addition to economic losses, “profit shortfalls”. They consider that where the Amount A profit of a group (or segment) in a given period falls below the agreed profitability threshold of the Amount A formula, the Amount A carry-forward regime should treat the difference between this profit and the level of the profitability threshold as a “loss” that can be carried forward to the next taxable periods.