GloBE Rules Series

ITQ G-

036

November 11, 2022

Question

XCo is a Constituent Entity located in jurisdiction X, which imposes a corporate income tax with a 20% rate.

100% of the shares in XCo are owned by X Holdco, which is also located in jurisdiction X.

XCo is a limited liability company (LLC) formed under jurisdiction X corporate law.

XCo changes its legal form to a corporation, also under jurisdiction X corporate law.

LLCs and corporations are both taxable entities for the purposes of the jurisdiction X corporate income tax, and they are both subject to the 20% rate.

Under the jurisdiction X corporate law, the change in legal form: (1) automatically causes all of the assets and liabilities of XCo (LLC) to be the assets and liabilities of XCo (corporation), for no consideration; (2) the issued shares of XCo (LLC) are automatically treated as the issued shares of XCo (corporation); and (3) XCo (LLC) and XCo (corporation) are deemed to be the same legal entity.

The change in legal form does not trigger the recognition of a gain or loss, or any adjustment to the carrying value of assets and liabilities, in XCo's financial statements.

Under the jurisdiction X tax law, the excess of (1) the fair value of XCo's assets and liabilities, over (2) the tax basis of the assets and the amount of the liabilities, at the time of the change in legal form, is treated as a taxable gain for XCo. That gain is subject to a special tax rate of 10%. Also, under the jurisdiction X tax law, after the change in legal form, the tax basis of the assets and the amount of the liabilities, are treated as equal to that fair value.

What will be impact, under the GloBE rules, of XCo's change in legal form?

Answer

1. GloBE Reorganisation:

A threshold issue is whether the change in legal form is a "GloBE Reorganisation", as defined in Art. 10.1.1. If it is not a "GloBE Reorganisation", then Arts. 6.3.2 & 6.3.3 can be ignored.

The opening words and para. (a) in the definition should be satisfied: the change in legal form is a "transformation", and no consideration is provided.

In applying para. (b) to a transformation, the "disposing Constituent Entity" presumably means XCo (LLC). Para. (b) seems to assume that the disposing Constituent Entity has a "gain or loss". However, it's not clear what the “gain or loss” in para. (b) is referring to, in the context of a transformation (where no consideration is provided). As noted in the question, XCo does not record a gain or loss in its financial statements. Moreover, if XCo does have a "gain", the whole of that gain is subject to tax, albeit at a reduced tax rate (10%). For these reasons, para. (b) is probably not satisfied.

Para. (c) is also probably not satisfied. Although XCo derives a taxable gain on the transformation, that taxable gain is not a "Non-qualifying Gain or Loss", as defined in Art. 10.1.1 – because XCo's financial accounting gain or loss arising on the transformation is nil.

Thus, IMHO: the change in legal form is not a "GloBE Reorganisation".

2. XCo: continuity of identity for GloBE rules:

The jurisdiction X corporate law deems XCo (LLC) and XCo (corporation) as the same legal entity.

The GloBE rules, as implemented in the various jurisdictions where XCo's MNE Group has Constituent Entities, should accept that jurisdiction X corporate law treatment.

3. Adjusted Covered Taxes:

XCo's Adjusted Covered Taxes will increase (ceteris paribus) in the Fiscal Year it changes legal form (due to the taxable gain); and will reduce (ceteris paribus) in subsequent Fiscal Years, due to tax depreciation on a higher tax basis.

4. GloBE Income:

The impact on GloBE Income will depend on whether an election is made under Art. 6.3.4:

i. If election is not made, then the transformation will have no impact on XCo’s GloBE Income. Thus, XCo's ETR will be higher (ceteris paribus) in the Fiscal Year it changes legal form, and will be lower (ceteris paribus) in subsequent Fiscal Years.

ii. If election is made: (a) a gain is recognised in the Fiscal Year it changes legal form (equal to the difference between fair value and carrying value immediately before the change in legal form); and (b) higher amounts of depreciation will be recognised in subsequent Fiscal Years, due to using fair value as the new base for depreciation. In regard to (a), the MNE Group can choose to spread the gain over 5 Fiscal Years.

Do you agree?

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