- Amount A is proposed to come into effect in 2023 and will apply to MNE groups with a global turnover above EUR 20 billion (or local equivalent) and profitability above 10%, subject to some exceptions.
- The Regulated Financial Services Exclusion is set forth in Schedule G and will place revenue and profits earned from Regulated Financial Services (as well as from certain related group service entities) outside the scope of Amount A. Regulated Financial Services are defined as any services performed by a Regulated Financial Institution (RFI).
- The model rules define six types of RFIs, but each definition generally has three elements: a licensure requirement (generally that the entity is licensed to engage in enumerated activities in its operating jurisdiction), a regulatory capital-adequacy requirement, subjecting the entity to certain recognized risk-based standards, and an activity threshold requirement.
- Rules apply on an entity-by-entity basis — an entity that meets the definition of an RFI is entirely excluded from calculations relating to Amount A.
- Schedule G outlines a seven-step process, but only steps 2 and 3 are specific to the Regulated Financial Services Exclusion, and it is those steps on which the OECD has invited comments.
The Model Rules will serve as the basis for the substantive provisions that will be included in the Multilateral Convention, which is intended to implement Amount A, as well as provide a template that jurisdictions could use as the basis to give effect to the new taxing rights over Amount A in their domestic legislation.
The draft model rules subject to consultation cover Schedule G: Regulated Financial Services Exclusion. The current draft does not reflect the final views of the Inclusive Framework (IF) members at this stage and is a working document released by the OECD Secretariat for the purpose of obtaining input from stakeholders. The OECD specifically noted the disagreement of some members of the IF to the inclusion of reinsurance and asset management as activities excluded from Amount A.
The Regulated Financial Services Exclusion draft model rules are required to determine the applicability and calculation of Amount A for taxpayers operating RFIs. An explanatory commentary is yet to be released to further complement the model rules, but the draft includes several notes in which the OECD outlines what an explanatory commentary would provide.
The application of the Regulated Financial Services Exclusion can be summarized in the following seven steps:
- Step 1: The MNE group ("Group") applies the general scope rules to the entire Group (or disclosed segment where those exceptional rules apply), including financial services activities that will be subject to the exclusion. A Group that does not have at least EUR 20 billion in revenue and a profit margin of 10% is not in-scope of Amount A and does not need to progress further. The scope rules are summarized in our 6 April 2022 client alert.
- Step 2: If the revenue and profit thresholds are satisfied, reassess the EUR 20 billion thresholds using only the Group’s non-Regulated Financial Services revenue. Only Groups with greater than EUR 20 billion in in-scope revenues need to progress further.
- Step 3: Isolate Regulated Financial Services profits and reassess whether the 10% profitability threshold is satisfied by comparing the remaining in-scope profits to in-scope revenues. Where the 10% profit margin is not met, the Group is out of scope. The OECD is working on ways to simplify this step, particularly for groups that have in-scope profit margins that are consistently below 10%.
- Step 4: Apply the nexus and revenue sourcing rules using only in-scope revenues to determine if nexus thresholds are satisfied. See our 10 February 2022 client alert for a summary of these rules.
- Step 5: Apply the rules for determining and allocating taxable profits to market jurisdictions. These rules were addressed in our 23 February 2022 client alert.
- Step 6: The profits excluded by the Regulated Financial Service Exclusion will be excluded from the mechanism for eliminating double taxation arising from Amount A.
- Step 7: File necessary administration and reporting documentation. This process will be addressed later as part of the provisions on tax certainty.
Step 2: Identifying excluded activities and applying the revenue threshold to in-scope activities
The intent of step 2 is to apply the EUR 20 billion revenue threshold looking only to in-scope activities. Generally, this is done by subtracting third-party revenue derived from Regulated Financial Services from the Group’s consolidated revenue figures. Regulated Financial Services are services conducted by a RFI. As a result, step 2 is applied entity-by-entity — those entities that meet the definition of an RFI are wholly excluded from Amount A and, as a result, those that do not meet the RFI definition are effectively wholly included.
The model rules appear to state that the test is also applied by summing the non-RFI entity revenues, though whether this is an alternative to the subtractive method is not clear. One assumes that the outcome of both tests should be the same, in any event.
The rules do then provide two “simplifications” to reduce the burden of making the calculations. First, the Group can identify only its largest RFIs and subtract the third-party revenues of those entities, continuing to identify RFIs and subtracting revenue until the total falls below the EUR 20 billion thresholds. In the alternative, the Group can identify all non-RFI entities (those that would be in-scope) and add together all of their revenue without adjusting for intra-group revenue. If that total is below the threshold, the Group would not need to calculate further.
Defining Regulated Financial Institution
The model rules define six types of RFIs: Depositary Institution, Mortgage Institution, Investment Institution, Insurance Institution, Asset Manager, and Mixed Financial Institution. In each case, the institution must be licensed in its jurisdiction to carry out stated activities, must be subject to risk-based capital adequacy requirements that meet certain internationally recognized standards and must meet a certain threshold in relation to the stated activities. However, all six definitions exclude an intra-group entity that primarily provides the stated financial services to non-RFI members of the same group. The seventh type of entity, an RFI Service Entity, may also be excluded.
- Depositary Institution: 1) licensed to accept deposits in the ordinary course of banking business; 2) subject to capital adequacy requirements that reflect the Core Principles for Effective Banking Supervision laid out by the Basel Committee on Banking Regulation; and 3) has at least 20% of its liabilities consist of deposits.
- Mortgage Institution: 1) licensed to engage in mortgage lending; 2) subject to capital adequacy conforming to the Basel Committee; and 3) derives at least 75% of its income from mortgage lending activities.
- Investment Institution: 1) licensed to perform a) dealing, broking, or trading in financial assets for its own account, b) holding securities in inventory, c) hedging customer transactions, d) participating in underwriting, mergers and acquisitions, syndication, and securitization and providing financial services related to those activities, or e) holding, transferring, administering, controlling, or distributing financial assets for others’ accounts; 2) subject to capital adequacy reflecting either the Basel Committee principles or the Securities Regulation Principles adopted by the International Organization of Securities Commissions; and 3) derives at least 75% of its income from the listed activities.
- Insurance Institution: 1) licensed to issue insurance or annuity contracts; 2) subject to solvency standards that incorporate a risk-based capital measure; and 3) either derives at least 75% of its income from insurance and annuity contracts or holds greater than 75% of its assets in order to manage the risk of such contracts.
- Asset Manager: 1) licensed to administer, manage, or distribute interests in an investment fund or real estate investment vehicle, financial assets, or money on behalf of others; 2) subject to risk-based capital adequacy requirements; 3) derives at least 75% of its income from the listed activities.
- Mixed Financial Institution: An institution engaged in activities that fall into more than one of the above definitions. To the extent that a Mixed Financial Institution engages in certain activities that fall within one of the previous definitions, it must meet all the requirements applicable to an institution of that type.
- RFI Service Entity: An entity that is wholly owned by the ultimate parent of the Group and that provides services exclusively to RFI members of the Group, which services are necessary to carry out the activities of the RFI.
Step 3: Identifying in-scope and excluded profits
The purpose of step 3 is to calculate profits by treating the non-RFI entities within the Group as a standalone businesses. This should be done by identifying all in-scope entities in the Group to the extent they were not identified as part of the step 2 process and then combining those entities into a consolidated bespoke segment solely for Amount A purposes.
The rules set out two methods to accomplish this: A “top-down” approach and a “bottom-up” approach.
The top-down approach requires the Group to “back out” from the consolidated group financials any third-party revenue and costs of the RFI members of the Group and then include related-party revenue and costs deriving from transactions between the non-RFI segment and the RFI segment.
The bottom-up approach would require the Group to recombine the non-RFI entities into a consolidated bespoke segment using segment accounting and/or management accounting principles that would have applied had the Group decided to publish the in-scope entities as a combined disclosed operating segment. This would involve recognizing both third-party transactions by the non-RFI segment and recognizing transactions with the RFI segment, but no account needs to be taken for intra-group transactions between entities in the non-RFI segment.
After this segregation of the in-scope non-RFI entities, the Group would make any necessary tax base adjustment according to the rules for tax base determination and use the resulting Adjusted Profit Before Tax as the numerator in the threshold profitability calculation.
If the reapplied threshold profitability test results in profit greater than 10%, the Group would apply the average test and the profitability test to the bespoke non-RFI segment. In addition, the Group would calculate historic and carry-forward losses in the same way. However, the model rules explicitly recognize that these further tests and calculations will be difficult given that the bespoke non-RFI segment is created solely for Amount A purposes and notes that further consideration is being given as to how to apply these rules.
The OECD will collect public comments on the Regulated Financial Services Exclusion draft model rules until 20 May 2022. It is then expected that more detailed commentary on a number of technical items (as described in this alert) will be released.
Furthermore, the OECD has announced that it will release more details on the remaining building blocks of Amount A. The remaining building blocks of Amount A concern measures to eliminate double taxation, the definition of unilateral measures, withholding taxes, safe harbors and segmentation and administration. Consultations on these building blocks are expected soon.
We will continue to closely monitor and provide client alerts on these future developments around Pillar One.