GloBE Rules Series

ITQ G-

085

January 19, 2024

Question

XCo (a company located in jurisdiction X) and YCo (a company located in jurisdiction Y) are Constituent Entities in an MNE Group which is "within scope" of the GloBE rules. Each of XCo and YCo is the only Constituent Entity located in its respective jurisdiction. XCo, YCo and the MNE Group use the calendar year as their Fiscal Year.

In January 2022, the UPE injected EUR-denominated share capital into XCo, XCo made a EUR-denominated loan to YCo, and YCo used the borrowed funds for working capital purposes in its business. This was done to allow YCo to claim a tax deduction on the interest expense, and to allow XCo to use its carryforward tax losses to avoid a tax liability in jurisdiction X.

The loan is repayable on demand, carries an interest rate of €STR (Euro Short-Term Rate) + 300 basis points, and the interest is payable (in cash) quarterly in arrears. Please assume that the interest rate satisfies the arm's length principle. The €STR is an overnight (i.e., floating) rate.

In 2024, the loan is still outstanding. In 2024, it is expected that the interest on the loan will be EUR 0.3 million.

It is expected that, in the MNE Group's CbC Report for 2024, these financial numbers will apply:

XCo: (i) Total Revenue: EUR 5 million; (ii) Profit (Loss) before Income Tax: EUR 0.5 million (this includes the EUR 0.3 million of interest income).
YCo: (i) Total Revenue: EUR 8 million; (ii) Profit (Loss) before Income Tax: EUR 0.9 million (this is after deducting the EUR 0.3 million interest expense).

At the beginning of 2024, XCo has EUR 2 million of carryforward tax losses. Tax losses can be carried forward indefinitely in jurisdiction X, subject to compliance with ownership and business continuity tests. A deferred tax asset for the tax losses is not recognised in XCo's financial statements or in the MNE Group's consolidated financial statements.

Based on this limited information, will jurisdiction X and jurisdiction Y each qualify for the Transitional CbCR Safe Harbour in 2024?

Answer

Subject to one issue (see below), both jurisdiction X and jurisdiction Y will satisfy the "de minimis test" and therefore the Transitional CbCR Safe Harbour in 2024.

The issue concerns whether the loan is a Hybrid Arbitrage Arrangement which was entered into after 15 December 2022: see paras. 74.25 to 74.31 of the "Safe Harbours and Penalty Relief" report, as added by the December 2023 AG.

That raises 2 sub-issues.

(1) Is the loan a Hybrid Arbitrage Arrangement?

Probably yes. It is probably a "deduction / non-inclusion arrangement": para. 74.27. The critical question is whether the Constituent Entity counterparty (i.e., XCo) "is not reasonably expected over the life of the arrangement [i.e., loan] to have a commensurate increase in its taxable income".

Under para. 74.30(d)(i), that assessment is to be made by ignoring any amount of taxable income which is offset by XCo's tax losses. Having regard to the fact that the loan is repayable on demand, the expected quantum of the interest income and XCo's other profits in 2024, and the quantum of XCo's carryforward tax losses, XCo should not be reasonably expected over the life of the loan to have a commensurate increase in its taxable income.

(2) Was the loan entered into after 15 December 2022?

Prima facie: no – it was entered into in January 2022.

But does para. 74.30(c) deem the loan to have been entered into after 15 December 2022?

The only relevant provision in para. 74.30(c) is clause (ii): "the performance of any rights or obligations under the arrangement differs from the performance prior to 15 December 2022".

What does "performance … differs" mean in this context? Does it mean that the rights and obligations remain the same, but the result (i.e., performance) of those rights and obligations "differs"?

Note that the interest rate is a floating rate, on a daily basis. Thus, the interest rate each day will generally "differ" (be higher or lower) than the interest rate for the day earlier. Therefore, the quantum of interest payable each quarter would generally "differ". Is this sufficient to conclude that clause (ii) is satisfied?

I don’t know the answer. It would be surprising if the loan in the present case were caught by clause (ii) – however, what does "performance … differs" mean?

What do you think?

I should add: if clause (ii) is satisfied, then jurisdiction Y will fail the "de minimis test" (the Profit (Loss) before Income Tax would not be less than EUR 1 million), and therefore would fail the Transitional CbCR Safe Harbour; however, there would be no adverse impact on jurisdiction X.

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