GloBE Rules Series

ITQ G-

075

October 27, 2023

Question

ACo, a company located in jurisdiction A, is a Constituent Entity in an MNE Group which is “within scope” of the GloBE rules.

ACo conducts a manufacturing business in jurisdiction A. ACo uses its own patents in its manufacturing business.

ACo also owns 100% of the shares in BCo, a company located in jurisdiction B. Jurisdiction B is a “developing country”, as defined in the July 2023 Subject to Tax Rule (STTR) Report.

At the beginning of Year 20X1, ACo licenses its patents to BCo for 10 years, for a royalty of EUR 3 million per annum. The royalty is due and payable on the last day of each year.

The jurisdiction A corporate income tax law does not tax foreign source income unless and until it is repatriated (or deemed to be repatriated) to jurisdiction A. Knowing this, and on the basis that the BCo royalties would be characterised as foreign source income under jurisdiction A law, ACo includes in the terms of the licence agreement a requirement that BCo pay the royalties into ACo’s bank account in jurisdiction C. Due to ACo’s control over BCo, BCo agrees to that requirement. It is ACo’s intention that the royalties will never be repatriated (or deemed to be repatriated) to jurisdiction A.

The A/B treaty is identical to the 2017 OECD model treaty, with the addition of the STTR.

Under the jurisdiction B corporate income tax law, outbound royalties are subject to a 10% final withholding tax.

With respect to the EUR 3 million royalty to be paid in 20X1:

Does the treaty permit jurisdiction B to impose withholding tax on the royalty?
If the answer to (1) is yes: (a) what will be the amount of withholding tax?; and (b) when will that withholding tax be required to be paid?
Also if the answer to (1) is yes: how will the withholding tax be treated under the GloBE rules?

Answer

Q (1)

Art. 12(1) provides an exemption from jurisdiction B tax on the royalty.

However, does the STTR apply?

The key issue is whether the exemption from jurisdiction A tax (for as long as the royalty is not repatriated or deemed to be repatriated to A) is a "preferential adjustment", as defined in Art. 1(6)(a). That in turn raises the issue of whether that exemption is a "permanent reduction", which is defined in Art. 1(6)(b)(ii).

ACo "has control over the point at which that income is recognised for tax purposes" in A, and (I assume) the royalty is not repatriated (or deemed repatriated) within 3 years following the end of 20X1. Therefore, Art. 1(6)(b)(ii) will deem the exemption to be a "permanent reduction", at the expiration of 20X4.

[Two other points to note on the "permanent reduction" definition:

1. The fact that ACo controls the terms of the licence agreement is irrelevant: para. 82 of STTR Report.

2. The fact that ACo's intention is that the royalties will never be repatriated (or deemed repatriated) to jurisdiction A might allow an argument that the reduction is "not expected to reverse over time" – which would mean that the definition is satisfied in 20X1. What do you think?]

The other 2 conditions in Art. 1(6)(a) will be satisfied: there is a full exemption from income, that is directly linked to the item of covered income (i.e., the royalty).

Thus, the "tax rate" on the royalty will be 0% (Art. 1(5)(a)), and the “materiality threshold” is satisfied (Art. 1(12)(a)).

Therefore, Art. 1(1) allows jurisdiction B to impose tax on the royalty.

Q (2)(a)

The rate will be 9%: Art. 1(2). Thus, the jurisdiction B tax will be EUR 270,000.

Q (2)(b)

The treaty conditions allowing the jurisdiction B tax to be imposed will not be satisfied until the expiration of 20X4: see above.

Therefore, I expect that the tax will be paid in 20X5, pursuant to the administrative arrangements agreed between the 2 competent authorities under Art. 1(14).

Note, however, that for jurisdiction B domestic law purposes, the tax is imposed for 20X1.

Q (3)

The jurisdiction B tax will qualify as ACo's "Covered Tax" for GloBE purposes.

In regard to timing, the tax should relate to 20X1. However, as the adjustment is an increase in ACo's liability for Covered Taxes for a previous Fiscal Year, it should be treated as ACo's "Covered Tax" in 20X5: Art. 4.6.1 (GloBE rules).

Do you agree?

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