5. Tax base determinations
406. Amount A is a 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. 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 standardised measure of profit as a basis for Amount A, including the extent to which harmonisation adjustments are required to address divergences in existing financial accounting standards. Second, there is the need to address the rationale for, and technical 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. This chapter sets out a comprehensive set of rules and guidance for the Amount A tax base determination, taking into account the technical work undertaken thus far on these three broad aspects. These rules and guidance have been designed to minimise, where possible, the additional compliance costs for taxpayers and administrative burdens for tax administrations.
A PBT measure based on consolidated financial accounts
407. The Amount A tax base will be quantified using an adjusted PBT measure that will be derived from the consolidated financial accounts of in-scope MNE groups. In practice, 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” – will mainly be used.1 Where necessary, other GAAP will also be allowed provided their use is permitted by the body with legal authority in the tax jurisdiction of its UPE to prescribe, establish, or accept accounting standards and that its use does not result in material competitive distortions in the application of Amount A. This approach (including the assessment of GAAP equivalence) is aligned with Pillar Two, which has adopted a similar approach.
408. Consistent with Pillar Two, no specific book-to-book harmonisation adjustments (to account for variances between different GAAP) are considered necessary at this stage given the significant additional complexity their introduction would entail; however, the Amount A tax base may incorporate an on-going monitoring process to ensure discrepancies across accounting standards do not produce materially inconsistent outcomes among Amount A taxpayers.
409. 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 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. These adjustments are consistent with the approach under Pillar Two, except potentially for income derived from joint ventures and interest expenses from transactions with related parties that do not belong to the consolidated group under the relevant accounting standard (e.g. investment entities).
410. Further work will be undertaken on the implementation of the proposed framework to use consolidated group financial accounts (e.g. introducing a monitoring mechanism), and to finalise some aspects of the standardised PBT measure (e.g. income from joint ventures).
The segmentation framework
411. The Outline recognised that for some groups it may be necessary to compute the Amount A tax base on a segmented basis, but also recognised 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 segmentation framework for Amount A aims to provide a balance of the benefits of the additional accuracy and the additional complexity and costs that segmentation would bring.
412. The framework starts from an acknowledgement that though it is feasible for taxpayers to break down their revenue between ADS, 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 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 a 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.2 Therefore, the segmentation framework will adopt this simplification as the default rule, while providing that in some circumstances, primarily to maintain a level playing field between taxpayers, the Amount A tax base will be computed on a segmented basis.
413. 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 for 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 EUR [X] billion would benefit from a “segmentation exemption” which would require them to compute the Amount A tax base on a group basis.3 For ease of administration and transition, this threshold would initially be set at EUR [X] billion and reduced over a five-year transition period.4 Alternatively, this exemption could be designed as a safe harbour, whereby MNE groups below the threshold would have the option to compute the Amount A tax base either on a group or on a segmented basis, subject to the constraints outlined in the third step below.
Third, those groups not eligible for the exemption or, if designed as a safe harbour did not elect for it, would then test whether they are required to segment their Amount A tax base and on what basis. Consideration is being given to an approach based on the following three sub-steps:
MNE groups will apply the “segmentation hallmarks” to determine whether they are required to segment their tax base. If they are not required to segment, they will compute their Amount A tax base on a group basis.
For MNE groups that do display these segmentation hallmarks, the disclosed segments in the MNE group financial statements will be tested to ascertain whether they meet the agreed hallmarks. If so, Amount A tax base will be computed on the basis of these segments. There will be an exemption for groups whose disclosed segments have similar profit margins, which will also compute the Amount A tax base on a group basis.
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. This is expected to be relevant for only a small number of MNE groups. This alternative approach would be determined based on the definition of a segment for the purposes of Amount A. It would be expected that this alternative approach would in most instances merely require a group to further breakdown the profit or loss account of an existing segment or segments and that the group may have an existing internal reporting framework on which to base this alternative segmentation.
414. Further work will be undertaken to finalise specific aspects of the different steps of this segmentation framework, including the appropriateness of the level of the global revenue thresholds (step 2), the definition of a segment based on the hallmarks (step 3) and the administration of the framework through the early certainty and dispute resolution process, and to explore potential simplifications to ease the administration of the approach.
Loss carry-forward rules
415. 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. This carry-forward regime will be kept separate from any existing domestic loss carry-forward rules, and include specific rules to deal with business reorganisations (including changes of the segmentation basis).
416. Some specific design aspects of the loss-carry forward rules will need to be refined. This will include considering a transitional regime for losses incurred prior to the introduction of Amount A (pre-regime losses), and determining whether the loss-carry forward regime should include time limitations and anti-avoidance rules. There is also a separate issue on whether this regime should apply exclusively to economic losses or be extended to cover profit shortfalls (where the profit of a group or segment falls below the profitability threshold), which will be resolved as part of the discussion of the quantum of Amount A (see section 6.2).
5.2.1. Eligible consolidated financial accounts
417. Given that Amount A is a new taxing right that is determined based on the profits of a group (rather than on a separate entity basis), it is necessary to use consolidated group financial accounts as the starting point for computing the Amount A tax base. This approach also has the advantage that the Amount A tax base is less affected by controlled transactions5 and, for large MNE groups, that it is based on financial statements that have been subject to external audit,6 thus providing a reliable source of information that is normally readily available to tax administrations.
418. In general, Amount A would not mandate MNE groups to produce consolidated accounts under a specific accounting standard. The relevant financial accounting standard for computing Amount A tax base would be the financial accounting standard used by the UPE in the preparation of its consolidated financial statements.
419. At the same time, because MNE groups prepare consolidated financial accounts under different accounting standards, this approach requires the resolution of several issues to ensure that the Amount A tax base determination produces comparable results when differing standards are used. These issues include identifying acceptable accounting standards across Inclusive Framework jurisdictions that produce sufficiently comparable and reliable results for computing Amount A, and clarifying whether specific harmonisation adjustments are required to deal with particular items of income or expenses.
Eligible GAAP
420. Although there are variations between different consolidated accounting standards, the GAAP of many Inclusive Framework members have far more commonalities than differences. To limit compliance costs, MNE groups will therefore be permitted to rely on the consolidated financial accounts produced by their UPE under any GAAP provided this standard produces equivalent or comparable outcomes to consolidated financial accounts prepared under IFRS.7 Equivalency with IFRS is to be assessed based on the work of the International Accounting Standards Board (IASB) as well as the work of securities regulators that allow other accounting standards in financial reports of publicly accountable companies, consistent with the assessment of GAAP equivalence under the Pillar Two. An initial assessment has shown the GAAP of Australia, Canada, Hong Kong (China), Japan, New Zealand, the People’s Republic of China, the Republic of India, the Republic of Korea, Singapore and the United States are eligible GAAP. As illustrated in Figure 5.1 below, these eligible GAAP already cover roughly 90% of MNE groups with consolidated revenue above EUR 750 million and profitability above 10% in 2016.
Source: Orbis - Bureau van Dijk and OECD Secretariat.
421. There will be some MNE groups in scope of Amount A whose consolidated financial reports are not prepared under eligible GAAP. Such MNE groups will however be allowed to use other GAAP as a basis for determining the Amount A tax base for ease of administration. These are GAAP permitted by the relevant body with legal authority in the tax jurisdiction of its UPE to prescribe, establish, or accept accounting standards when their use does not result in material competitive distortions in the application of Amount A. This approach needs to be consistent with the determination of acceptable accounting standards under Pillar Two.8 Further technical work is required to define and measure material competitive distortions.
422. Where an MNE group in scope of Amount A does not produce consolidated financial statements, it would need to prepare consolidated financial accounts and to compute the Amount A tax base under the accounting standards permitted by the body with legal authority in the tax jurisdiction of its UPE to prescribe, establish, or accept accounting standards for financial reporting purposes, provided that those standards qualify as eligible or, otherwise, do not result in material competitive distortions in the application of Amount A.
Book-to-book harmonisation adjustments
423. The Amount A tax base will not involve any specific harmonisation adjustments to account for differences between different GAAP that could affect the computation of the Amount A tax base.
424. It is recognised that designing and administering harmonisation adjustments would be extremely complex, as the significance of discrepancies across standards varies widely across industries, and even from one MNE group to the next.9 Examples of such, adjustments could be:
Reversal of impairments: IFRS requires impairment adjustments to be reversed when the reasons for the impairment no longer pertain, except for impairments of goodwill. On the contrary, other GAAP may not allow for the reversal of certain impairments (e.g. inventory, long-lived assets). This could give rise to timing differences, which could be nearly permanent ones depending on the expected time that the underlying items remain in the balance sheet. This issue might be more relevant for industries with particularly long business cycles.
Financial assets classification: Accounting standards may resort to different criteria for classifying financial assets that can lead to permanent differences in profit measurement because classification affects recognition of income. For instance, under certain GAAP, the legal form of a debt instrument primarily determines classification. On the contrary, under IFRS the legal form does not determine classification of debt instruments. Rather, the nature of the cash flows of the instrument and the MNE group’s business model for managing the debt instruments are the key considerations for classification.
425. Therefore, not requiring any book-to-book harmonisation adjustment will thus significantly facilitate compliance and administration, as well as be consistent with Pillar Two, and the existing CbCR requirement.
426. Instead of making book-to-book adjustments, the Amount A tax base may however incorporate some safeguards to ensure that discrepancies across accounting standards do not produce materially inconsistent outcomes among MNE groups after the introduction of Amount A. For example, an ongoing monitoring mechanism of these discrepancies could be introduced as part of the implementation of Amount A. This ongoing monitoring could include performing comparisons across MNE groups in scope subject to different standards to identify and assess the actual impact of accounting differences on the Amount A tax base over time, and identify any material competitive distortions derived from existing or future differences across accounting standards that would require specific adjustments. Further technical work will be undertaken to design and explore appropriate mechanisms.
5.2.2. The standardised PBT definition
427. Consistent with the decision to use a standardised PBT figure, the computation of the Amount A tax base will start from the total profit or loss figure from the “profit or loss” (P&L) statement of the MNE group’s consolidated accounts. A number of adjustments will then be applied, including the elimination of income tax expenses, to address potential issues that might otherwise arise given the different objectives of Amount A and accounting rules (i.e. book-to-tax adjustments). These adjustments will be consistent with the approach adopted under Pillar Two, except potentially for income derived from joint ventures and interest expenses from transactions with related parties that do not belong to the consolidated group under the relevant accounting standard (e.g. investment entities).
PBT as the selected measure of profit
428. A PBT measure will be used as the basis for determining Amount A as it approximates the measure of profit on which CIT is normally levied. Profit before tax is a comprehensive figure that generally comprises all income and expenses of an MNE group except the income tax expenses. It takes into account all the real costs of doing business, both operating and non-operating expenses (such as finance costs), and is unaffected by the classification of specific items in different sections of the “profit or loss” statement. This makes it the most appropriate metric for use in the calculation of Amount A. Further, its resemblance to the existing CIT base has the advantage of minimising the risk of determining profit for Amount A purposes that is substantially different from the aggregated taxable profit reported by the members of the group under existing rules.
429. PBT is not defined in most GAAP, which typically provide guidance on how various income and expense items should be recognised for accounting purposes. This means that MNE groups have some discretion over which items to include in PBT, and the development for Amount A purposes of a standardised definition (with adjustments) will be necessary to ensure a consistent computation of the tax base across all in-scope groups, which is discussed in the next section.
The determination of a standardised PBT measure
430. As a starting point, all items within the consolidated P&L statement10 will be taken into consideration. 11 This means the computation of the Amount A tax base will start from the bottom line figure of the P&L statement (i.e. the total for profit or loss). From this point, certain book-to-tax adjustments will be made (such as the deduction of certain items of income and the adding back of certain expenses) to arrive at a standardised PBT figure. For ease of administration and compliance, these adjustments will be kept to a minimum in order to limit complexity, and align with adjustments under Pillar Two.
431. The purpose of these adjustments is to align to the extent possible the Amount A tax base with the corporate tax base of Inclusive Framework jurisdictions. This will be achieved by excluding certain material items that are commonly excluded from the corporate tax base of Inclusive Framework jurisdictions. The exclusion of these items typically reflects the different objectives pursued by tax and accounting rules. .
Income tax expenses
432. Income taxes are the most obvious expense that needs to be added back to determine the standardised PBT under Amount A. Income tax expenses are usually not deductible for CIT purposes in Inclusive Framework jurisdictions.
433. Financial accounting distinguishes between income taxes and other taxes. Income taxes, as defined for financial accounting purposes,12 are typically reported separately in the P&L statement. Taxes that are not considered income taxes are treated like operating expenses and may not be separately identified in the income statement. Only taxes covered by the definition of income taxes for accounting purposes would be extracted from the “profit or loss” statement, and added back in to compute the Amount A tax base.13
Dividend income and gains or losses arising in connection with shares, including income under the equity method
434. In many Inclusive Framework jurisdictions, dividend income and gains or losses from the disposal of shares are excluded, in whole or in part, from the CIT base or benefit from tax relief (such as indirect credit for taxes paid). In some jurisdictions, the exclusion is conditioned on certain ownership and holding period requirements. In other jurisdictions, the exclusion applies without restrictions. These exclusions are often referred to as participation exemptions, and generally seek to eliminate the double taxation that otherwise would occur if the profit of the investee (i.e. the distributing entity or the entity whose shares are transferred) were to be taxed again at the level of the investor upon the distribution or disposal.
435. Recognising the broad nature of the participation exemptions of many Inclusive Framework jurisdictions, dividend income and gains or losses in connection with shares will be excluded from the Amount A tax base, consistent with the approach adopted under Pillar Two.14 This exclusion will also apply where, in the absence of any disposal, the P&L statement accounts for gains (or losses) attributable to changes in the value of shares using the fair value method. Some aspects of this adjustment are still under discussion, however, such as the option of introducing some conditions or restrictions to this exclusion (e.g. specific percentage of ownership, holding period). As part of this, the treatment of expenses incurred in connection with dividend income or the generation of gains or losses from shares is also under discussion. This issue will require balancing the challenges associated with tracing these expenses in the financial accounts and the risk of erosion of Amount A tax base (e.g. financial expenses related to funding acquisitions of shareholdings).
436. As a corollary, any profit or loss derived from using the equity method of accounting will also be excluded, consistent with the approach adopted under Pillar Two.15 Generally, the equity method applies to investments in entities or arrangements in which the investor owns a substantial interest (generally between 20% and 50%) that are not consolidated under financial accounting standards. These ownership interests are effectively treated as transparent, recognising the investor’s proportionate share of the entity or arrangement’s after-tax income or loss.16 The Inclusive Framework is, however, discussing whether this adjustment should not apply to income derived from joint ventures, in particular where that income does not represent retained earnings that have already been (or will be) subject to Amount A at the level of the entity or arrangement (e.g. because the revenue of the joint venture falls below the scope revenue thresholds).
437. This issue can be illustrated through the following example. Assume MNE Group A and MNE Group B constitute a joint venture where each group owns an interest of 50%. The joint venture generates revenue below the Amount A revenue threshold and is therefore not in scope of Amount A. Assume further that the joint venture makes a profit of 100 during the first period and Group A and Group B account for 50 profit each under the equity method. There is an argument to support the view that Group A and Group B income under the equity method from the joint venture should not be excluded from the Amount A tax base given that it represents a profit that is not subject to Amount A at the level of the joint venture. However, further work is required on this point to support the rationale of this adjustment and to address potential manipulation.
Expenses that are typically non-deductible or limited for public policy reasons
438. A number of items treated as expenses under financial accounting rules are not deductible for CIT purposes in most Inclusive Framework jurisdictions for public policy reasons. Those expenses are typically associated with behaviours that governments regard as undesirable and will therefore be added back in computing the Amount A tax base. These adjustments would apply to bribes and other illegal payments, and fines and penalties that are due to a public authority for the breach of any legislation. Further work is required to explore whether the deduction of these expenses should be limited only where they exceed a certain amount to reduce the compliance burden.
5.2.3. Next steps
439. As a next step, further work will be undertaken on the implementation of the proposed framework to use consolidated group financial accounts, including:
Definition of an MNE group for consolidation purposes: the Amount A tax base will follow consolidation rules to delineate the composition of an MNE group in scope of Amount A. As a consequence, entities that benefit from consolidation exemptions, such as investment entities, will not be required to produce consolidated accounts for Amount A purposes. Including interaction with the accounting consolidation test under CbC rules and potential changes in the consolidation group derived from a decision by local accounting regulatory bodies.
Dual-headed MNE groups: this involves addressing any particular issues for the computation of the Amount A tax base raised by dual-headed structures which can be listed on different exchanges and required to satisfy the accounting and regulatory frameworks of different jurisdictions.
Changes in accounting estimates and prior period errors: this relates to clarifying the impact on the Amount A tax base of retrospective corrections of material “prior period errors” in the consolidated financial accounts and designing a simple mechanism to adjust Amount A computations.
Development of a monitoring mechanism to assess differences between GAAP that could lead to material competitive distortions.
440. Further work will also be undertaken to finalise the determination of the standardised PBT measure. Specific areas for consideration include:
Whether profit or loss derived from joint ventures using the equity method of accounting should be retained in Amount A tax base.
Whether interest expenses from transactions with related parties that do not belong to the consolidated group under the accounting standard (for example an investment entity that controls an MNE group and advances funds to the group) present a risk of base erosion material enough to consider introducing a specific measure under Amount A.
Whether gains and losses from exceptional and non-recurring items should be excluded from the Amount A tax base, noting that these items are generally not excluded from the CIT base in Inclusive Framework jurisdictions, nor under Pillar Two or the CbCR requirement.
Whether items classified in the “other comprehensive statement”17 should be included in the Amount A tax base, noting that these items are generally not added back to the CIT base in Inclusive Framework jurisdictions, nor under Pillar Two or the CbCR requirement.
Whether minority interests should be accounted for in computing the Amount A tax base.
441. Important considerations in this work will include simplicity of administration, the ease of compliance, and having a standardised and consistent approach across the two Pillars.
442. The primary reason why it may be necessary to compute the Amount A tax base on a segmented basis is because Amount A will apply only to the profits that groups derive from carrying on in-scope activities. For example, the scope requirements for ADS distinguish between standardised cloud computing services, which would be in scope, and bespoke cloud services, which would not. A group that provides both types of services therefore needs an approach to segmentation that enables it to apply Amount A only to the profits derived from in-scope activities.
443. For the scope and nexus rules, taxpayers will need to separate their revenue between that attributable to CFB, ADS and out-of-scope activities. It is reasonable to expect that a taxpayer could prepare, and tax administrations could review, a breakdown of revenue on this basis. However, it would be more complex for a taxpayer to segment these different types of activities to calculate a measure of PBT. This is because it would require groups to apportion costs between these different types of activities in a way that is unlikely to reflect their existing external or internal reporting, and the reliance on allocation keys for such an apportionment brings into question whether the segmented PBT for each of these separate activities would accurately reflect the underlying economic reality of each business.18
444. Nevertheless, as Pillar One applies the principle of net, rather than gross, basis taxation it will still be necessary to compute the profits attributable to in-scope activities. 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 a 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. Therefore, as the default a group should be able to compute the Amount A tax base on a group basis.
445. However, there are some circumstances where this would not seem appropriate, or 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.
446. The segmentation framework seeks to balance these competing pressures. In recognition of the need for an approach to Amount A that is as simple as possible, while retaining the integrity of the overall policy, a set of rules to determine whether segmentation is required, and where applicable how to arrive at a segmented PBT, is outlined below. Further work will be undertaken to develop this segmentation framework,19 and once agreement has been reached detailed guidelines will be published for taxpayers and tax administrations.
5.3.1. Overview of the different steps of the segmentation framework
447. The segmentation framework seeks to provide a balance between the additional accuracy and the additional complexity brought by the segmentation of the tax base. It establishes the following three-step process to evaluate the basis for segmentation, including providing for exemptions to the requirement to segment for ease of administration and compliance:
First, all MNE groups would break down their revenue between ADS, CFB and out-of-scope activities, as may required for the scope and nexus rules;
Second, to limit the number of MNE groups that are required to segment, MNE groups will compute the Amount A tax base on a group basis when their revenue falls below an agreed threshold; and
Third, any remaining groups will then test whether they should be required to segment and on what basis. Consideration is being given to an approach based on the following three sub-steps:
MNE groups will apply the “segmentation hallmarks” to determine whether they are required to segment – the Amount A tax base will be computed on a group basis if they are not required to segment.
For groups that do display these segmentation hallmarks, the disclosed segments in the consolidated financial accounts will be tested to ascertain whether they meet the agreed hallmarks. If so, the Amount A tax base will be computed on the basis of these segments, subject to an exemption where the disclosed segments have similar profit margins.
MNE groups that are not able to use their disclosed segments but are required to segment will be required to compute the Amount A tax base on the basis of alternative segments. This is expected to be relevant for only a small number of in-scope MNE groups, as a consequence of the application of the earlier steps.
5.3.2. Step one: Separating revenue from CFB, ADS and out-of-scope activities
449. As a simplification, the exclusion of profits arising from out-of-scope activities will in most instances be delivered through the revenue-based allocation key of the Amount A formula (see section 6.2.3), rather than by requiring an MNE group to segment its accounts between in and out-of-scope activities to arrive at the relevant PBT measure. The Amount A formula is designed to ensure that only the portion of the Amount A tax base corresponding to in-scope revenue sourced in a given market jurisdiction is allocated to that market jurisdiction. This means that even in instances where the calculation of the Amount A tax base does not distinguish between in and out-of-scope activities, market jurisdictions will be allocated a proxy Amount A profits related to in-scope revenue sourced in their jurisdiction calculated by assuming that the profitability of in-scope activity is equal to the profitability of the group as a whole. Further work will be undertaken to address potentially material distortions where, for instance, an MNE group has highly profitable or highly loss-making out-of-scope activities which could affect the reliability of the approach. This will include consideration of whether, in some circumstances, taxpayers should be required to calculate net profit for in- and out-of-scope activities (or ADS, CFB and out-of-scope activities) separately.
450. To apply the Amount A formula, an MNE group would simply need to separate its revenue between that attributable to CFB, ADS and out-of-scope activities, noting that such break down would also be necessary to apply the Amount A rules on scope (see Chapter 2) and nexus (see Chapter 3).
5.3.3. Step two: Exemption or safe harbour from segmentation based on global revenue
451. The segmentation framework for Amount A includes an exemption or safe harbour to limit the number of groups that will be required to calculate Amount A on a segmented basis. This will reduce compliance costs and ease the burden for tax administrations who will need to review a business’ segmentation as part of the tax certainty process.
452. The exemption would exempt smaller groups, with global revenue below an agreed amount, from applying Amount A on a segmented basis. This means that segmentation will be required only for large groups that are more likely to operate a number of largely independent businesses, with different profits margins and different geographic profiles. It is for these businesses, which earn the highest profits, that calculating Amount A on a segmented basis will have the greatest tax impact. Consequently, MNE groups with global revenue less than EUR [X] billion would compute the Amount A tax base on a group basis (i.e. a “segmentation exemption” would apply). For ease of administration and transition, this threshold could initially be set a higher at EUR [X] billion and reduced over a transition period e.g. five years.
453. Alternatively, this exemption could operate as a safe harbour. This means that MNE groups below the threshold would have the option to compute the Amount A tax base either on a group or on a segmented basis (subject to the constraints outlined in the third step below). Such optionality could however substantially increase the number of MNE groups that could compute the Amount A tax base on a segmented basis, including potentially situations where the costs of this segmentation process would largely outweigh the tax revenue at stake.
454. The Inclusive Framework will consider the development of exceptions or safeguards to limit access to the segmentation exemption or safe harbour in certain circumstances. For example, this could include excluding groups that have out-of-scope revenue in excess of [x%] of total revenue and a group profit margin below the agreed profitability threshold or where a group below the threshold has two disclosed operating segments, one that falls within scope of Amount A and one that falls out-of-scope.
5.3.4. Step three: Determining the relevant PBT measure on a segmented basis
455. Businesses that are not eligible for the segmentation exemption or safe harbour (under Step Two) may be required to compute the Amount A tax base on a segmented basis, though it is recognised that this will not be appropriate in all instances. Step Three will determine whether a taxpayer is required to compute the Amount A tax base on a segmented basis, and, where it is, define the relevant segments for which the relevant measure of profit or loss will be computed separately.
Step 3(a): Testing whether segmentation is required
456. It is expected that in most instances, it will be appropriate for a group that is required to segment its Amount A tax base to do so based on the operating segments it discloses for financial reporting purposes (see below). However, it is also recognised that the objectives of segmentation for financial reporting purposes differ from the objectives of applying Amount A on a segmented basis. In a financial reporting context, segmentation should enable the users of financial statements to better understand a group’s business. In contrast, segmentation for Amount A purposes should ensure the new taxing right delivers acceptable outcomes and ensures a level playing field for businesses in comparable circumstances. In addition, concerns have been raised that applying Amount A to disclosed operating segments could allow groups to influence or alter the application of Amount A by changing the way information is communicated to the chief operating decision maker, which under IFRS and US GAAP determines how segments should be disclosed.
457. Consequently, specific tests are being developed to determine if a group is required to compute its Amount A tax base on a segmented basis, or whether it would be more appropriate to compute its tax base on group basis. These tests will establish an objective and standardised definition of a segment for the purposes of Amount A based on “segmentation hallmarks”. Under one possible approach, this definition of a segment could be based on International Accounting Standard (IAS) 14, which preceded IFRS 8.20 This previous accounting standard provides a useful starting point for defining a segment for the purposes of Amount A, as it is based on the nature of a group’s business, rather than the basis on which the chief operating decision maker reviews a business.
458. IAS 14 defines a business segment as “a distinguishable component of an entity that is engaged in providing an individual product or service or a group of related products or services and that is subject to risks and returns that are different from those of other business segments. Factors that shall be considered in determining whether products and services are related include:
c) the type or class of customer for the products or services;
d) the methods used to distribute the products or provide the services; and
e) if applicable, the nature of the regulatory environment, for example, banking, insurance, or public utilities.”21
459. For some businesses, notably those that are primarily managed on a regional basis, it may be appropriate to calculate the Amount A tax base on a regional basis. In order to permit this the “segmentation hallmarks” could also include an alternative or supplementary definition of a “geographical segment”.22 However, it could also be argued that it is inconsistent with the nature of Amount A as an allocation of group-wide profits, with an agreed allocation key based on relative in-scope revenues in in each jurisdiction, to sub-divide in-scope businesses on a regional basis.
460. For some MNE groups, particularly those that have a relatively homogenous business, the “segmentation hallmarks” may show that it would be most appropriate to compute the Amount A tax base on a group basis. For other groups, the “segmentation hallmarks” will show that they should calculate the Amount A tax base on a segmented basis, and further will define the most appropriate approach to segmentation.
461. As part of the implementation of this framework, and to help taxpayers applying this definition in practice, this definition will be supported by a commentary, including examples, in order to clarify areas that may create uncertainty or give rise to dispute.
Step 3(b): Computing Amount A based on disclosed segments
Using disclosed segments as a rebuttable presumption
462. It is expected that the vast majority of groups that are required to compute the Amount A tax base on a segmented basis will rely on the disclosed operating segments included in their financial statements. This reflects the fact that most groups will disclose operating segments in their financial statements that meet the “segmentation hallmarks” outlined above. Hence, there will be a rebuttable presumption that Amount A will be applied on this basis. This presumption could be rebutted by either the group itself or a tax administration (e.g. through the tax certainty process) and therefore when an MNE groups disclosed segments do not meet the “segmentation hallmarks” it would not be able to calculate its Amount A tax base on this basis.
463. This approach means that where a group does not disclose any operating segments in its financial statements, there would be a presumption that Amount A should be applied on a group basis. Though these groups would still need to show this approach is consistent with the “segmentation hallmarks”. Similarly, where a group discloses business line segments, there would be a presumption that Amount A should be applied on that basis. There remains an important outstanding question whether there will be a presumption that a group disclosing regional segments should apply Amount A in all instances, particularly for groups that also have large pools of unallocated central research and development (R&D) or other costs. The final design of the definition of a segment for the purpose of Amount A will be particularly relevant for these businesses, which could allow businesses that operate on a regional basis to calculate their Amount A tax base on a regional basis.
Exemption for segments with comparable profit margins
464. There may be some situations, notably where profit margins vary little across the segments of a group, where the tax impact of applying Amount A either on a group or segment basis will be minimal. In these instances, in order to minimise the compliance costs and administrative burdens associated with segmentation, taxpayers could be required to apply Amount A on a group basis. This exemption would apply where the profit margin of the disclosed segments (at the profit level shown in the financial accounts, which may be at a gross or operating level) varies by less than an agreed number of percentage points. As with the exemption for segmentation based on global revenue, this exemption could be turned into a safe harbour and become optional.
Determining profit before tax on a segment basis
465. 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. In many instances, it may prove difficult, if not impossible, to allocate these costs directly between segments. Therefore, again as a rebuttable presumption, these costs will be apportioned between segments using revenue as an allocation key. To prevent this rebuttable presumption giving rise to distortions, a safeguard rule could be introduced with the effect that the option of using a revenue-based allocation of costs would be available only where the proportion of central costs to be allocated between segments falls below a given percentage of total group or segment costs. Above this threshold, there would be a requirement to allocate costs using a more accurate, less approximate method. Where taxpayers compute their Amount A tax base on a segmented basis there will also be a requirement to reconcile the aggregated PBT (as calculated for the purposes of Amount A) at a segment level, with the PBT reported at a consolidated level.
466. When applying Amount A on a segmented basis, the treatment of intersegmental transactions remains to be determined. There may be instances where groups recognise intersegmental transactions in their segmented financial statements, or where a specific approach to segmentation requires the recognition of intersegmental transactions. Intersegmental transactions will be eliminated as part of the preparation of consolidated financial accounts. However, these transactions may have a direct impact on the reported profitability of different segments. This could, where Amount A is applied on a segmented basis, create incentives for groups to use intersegmental transactions to shift profits to segments that are primarily out-of-scope of Amount A (or conversely losses to segments that are primarily in scope of Amount A).
467. The simplest way to guard against this risk would be to exclude all intersegmental transactions for the purposes of Amount A. However, in some instances this would result in the misallocation of profits between segments – e.g. where one segment incurs substantial costs in developing an intangible that is then profitably exploited in another segment. To address the challenges associated with intersegmental transactions, consideration is being given to requiring a group to combine relevant segments where intersegmental transactions exceed a given percentage of the revenue attributable to a segment.
Step 3(c): Computing Amount A based on alternative segments
468. The few groups that are not able to compute the Amount A tax base on a group basis or based on their disclosed segments could be required to perform that computation on the basis of alternative segments. This alternative approach would be determined based on the definition of a segment for the purposes of Amount A, as outlined above. It would be expected that this alternative approach would in most instances merely require a group to further break down the profit or loss account of an existing segment or segments and that the group may have an existing internal reporting framework on which to base this alternative segmentation.
469. A taxpayer could determine (or tax administrations, through the tax certainty process could require) that Amount A should be applied on the basis of an alternative segmentation. Hence, this option should deter taxpayers that may otherwise seek to use their approach to segmentation as a tool for tax planning.
5.3.5. Next steps
470. As a next step, further work will be undertaken to finalise the following specific areas of the segmentation framework:
The exemption from segmentation (step two), especially:
The appropriateness of the level of the global revenue thresholds, including the threshold that would apply for the transitional period, informed by the data and analysis of the impact of the different global revenue thresholds on the number of groups required to segment their tax base (see Table 2.1).
The regime of this exception, and whether it should be mandatory (exemption) or optional (a safe harbour).
Possible additional exceptions or safeguards to override the exemption in some circumstances (e.g. in the case where a group that has out-of-scope revenue in excess of [x%] of total revenue and a group profit margin below the agreed profitability threshold or a group below the threshold has two disclosed operating segments, one that falls within scope of Amount A and one that falls out-of-scope).
The definition of a segment based on the hallmarks (step three), especially:
Whether to include a third-party revenue requirement to prevent groups from using segments that consist primarily of revenue and costs generated by inter-group transactions.
Whether to include a materiality threshold to ensure that the definition does not lead to a proliferation of small, low-value segments (as this substantially increases the compliance costs and administrative burden associated with applying Amount A). For example, this materiality threshold could require a group to aggregate identified segments that generate less than an agreed percentage of the group’s consolidated revenue and/or an absolute amount of revenue.
The computation of the PBT measure on a segmented basis (step three), especially the treatment of regional segments disclosed in financial accounts, the use of a revenue-based allocation keys for indirect costs, and the treatment of intersegment transactions.
471. In this work, important considerations will include simplicity of administration (and compliance costs) and ensuring a level playing field between taxpayers.
472. To account for losses, the Amount A tax base rules will apply consistently at the level of the group or segment (where relevant) irrespective of whether the outcome is a profit or loss. Any losses arising from a taxable period will be preserved and carried forward to subsequent years through an “earn-out” mechanism. This means that Amount A losses will be reported and administered through a single account for the relevant group or segment, and kept separate from any existing domestic loss carry-forward regime.
5.4.1. Objectives
473. Consistent with the legislation of many Inclusive Framework member jurisdictions, the loss carry-forward regime will seek to ensure that Amount A is based on an appropriate measure of net profit.23 It is necessary to offset tax losses of earlier years against current year taxable profits to enable all businesses to recoup losses reflecting costs of their investment, and place businesses with volatile profit in the same position as those with more stable profit. This is consistent with the objective of taxing only economic profit (or ability to pay principle),24 and improves the neutrality of Amount A by ensuring a proper matching of revenues and expenses for all types of business activities.25
474. Loss carry-forward is also a way to preserve the taxing rights of residence jurisdictions, for example because they have already accepted (and will continue to accept) the deduction of losses generated by a business under the existing ALP-based system. Accounting for losses ensures that the residence jurisdiction of a business bearing the initial downside of a business activity (e.g. at a start-up level) will be able to recover these losses before a portion of the profit generated by the same activity is allocated to another jurisdiction under Amount A.
5.4.2. Calculation of losses
475. The Amount A tax base will be computed consistently whether a business earns profits or incurs losses (symmetry). This means that the calculation of “in-regime” losses (losses incurred after the introduction of Amount A) will be derived from the consolidated financial accounts after making the relevant book-to-tax adjustments (see section 5.2.2). This may apply to the level of the adjusted group PBT as a whole or, where the segmentation framework applies and Amount A will be measured at the level of the segment, to each segment (see section 5.3).
476. Where there is no segmentation26, all profits and losses linked to different business activities (including potentially out-of-scope activities) within the group will be mixed within the same tax base for Amount A purposes.27 In contrast, 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 (i.e. there will be no cross-segment blending of profits and losses). Additional work will be required to finalise specific aspects of these computation rules, such as identifying exceptions for business reorganisations (see section 5.4.4), specific requirements to address the effects of inter-segment transactions (typically, to prevent abusive shifting of profits and losses, see section 454), and other implications of symmetry in the application of the Amount A tax base rules.
477. Consistent with the Outline and guiding principles established by the Inclusive Framework (see above section 1.1), a transitional regime is being considered which would allow certain net pre-regime losses (losses incurred before the introduction of Amount A that exceed profits earned during that pre-regime period) to be preserved and deducted against Amount A in-regime profits up to a certain time limit. To avoid complexity, no distinction would be made between pre-regime losses and in-regime losses under the carry-forward regime, i.e. the features of the carry-forward regime (including potential restrictions) would apply similarly to pre-regime and in-regime losses. This transitional regime would seek to allow groups to recover the costs of investment undertaken before the introduction of Amount A (i.e. distortions arising from the timing of introduction of the new taxing right), and prevent a reallocation of profit under Amount A where there is no economic profit. But it is recognised that this approach would also treat pre-regime losses and pre-regime profits differently, creating an asymmetry in the calculation of losses which would reduce the Amount A profit potentially reallocated to market jurisdictions. Some members of the Inclusive Framework consider that profit and losses should apply symmetrically and therefore, in principle are opposed to accommodating any pre-regime losses. They argue that in case pre-regime losses are considered, pre-regime profits of the relevant period must also be brought forward for distribution. In addition, retroactive identification and calculation of Amount A losses based on past financial accounts could present practical challenges. To address these challenges and to reduce compliance and administrative costs, a time limit beyond which pre-regime losses would no longer be considered could be introduced. Along with other considerations regarding this approach, further work and discussion will be required to determine this duration.28
478. Depending on the length of this period for pre-regime losses, and the availability of historical data, some simplifications to the Amount A tax base rules (e.g. book-to-tax adjustments, segmentation rules), or to the rules developed for business reorganisations, may also need to be considered to facilitate administration. For example, if a lengthy period of pre-regime losses is accepted then it will be necessary to devise rules which deal with the impact of changing approaches to segmentation throughout such a period to ensure that an appropriate measure of pre-regime losses is available for offset against in-scope profits (e.g. using an allocation key based on revenue).
5.4.3. Carry-forward regime
479. Unlike profits, losses generated over a given period will not be allocated to market jurisdictions through a formula. Allocating these losses to market jurisdictions would be complex and burdensome to administer,29 and could produce outcomes that are difficult to rationalise. For example, Amount A could be allocated to new markets that a group has recently entered in profitable years, even if in previous years the losses incurred (e.g. in developing a digital platform) were allocated to other markets in which the group has been operating for a longer period. Similarly, losses might be allocated to a market jurisdiction that cannot be offset later against any future profits of the group due to changes in the activity of the group in that market jurisdiction (e.g. lower sales activity in that jurisdiction, termination of the activity in that jurisdiction).
480. To avoid such difficulties and with a view to simplifying the process of dealing with losses, Amount A losses will be preserved and pooled in a single account at the level of the group (or segment where relevant) and carried forward to subsequent years through an “earn-out” mechanism. 30 This means that a positive tax base for Amount A (in excess of the profitability threshold determined under the formula) would arise only after all historic losses accumulated in the loss account of the group (or segment where relevant)31 have been absorbed through an earn-out mechanism.
5.4.4. Potential restrictions
481. Although loss carry-forward rules are an essential feature to tax net profits and avoid distortions, many Inclusive Framework jurisdictions restrict the deduction of some carry-forward losses for a number of reasons such as addressing tax planning strategies or ease of administration of the system. For Amount A, further work is required to assess the possibility of including time restrictions, and to develop specific rules for business reorganisations. In this work, relevant considerations will include the impact of these rules on complexity and administration, as well as on the allocation of taxing rights.
Time limitations
482. In the legislation of many Inclusive Framework members, the period over which carry-forward losses can be used is limited; after a certain period, the taxpayer’s right to offset losses against profits may lapse, wholly or in part. Beyond revenue concerns, time limitations are imposed for practical and administrative reasons, such as the difficulty of retaining information over a long period and to simplify tax administration arrangements.
483. For Amount A losses, a trade-off exists between the practical and administrative constraints that may justify the introduction of a time limitation, and the adverse impact that any limitation may have on appropriately measuring net profit (e.g. costs of investments made before the time limitation), delivering neutrality (e.g. business models with volatile profit) or on the allocation of taxing rights (e.g. residence jurisdictions that have accepted the deduction of unrelieved losses under the existing ALP-based system at an entity level). Further work is therefore required to assess the best approach to deal with this trade-off, interactions with provisions on statute of limitations (and tax audit), and determine whether unlimited carry-forward could be retained without creating excessive administrative challenges.32
Business reorganisations
484. In legislation across the membership of the Inclusive Framework, loss carry-forward regimes include specific rules for business reorganisations within an MNE group or between different groups.33 These rules generally seek to prevent avoidance opportunities by ensuring that the business claiming the loss deduction is not economically different from the business that sustained the loss. Some of these restrictions are focused on changes of ownership, for example by providing that the right of a company to carry forward losses is forfeited in the event of a change in identity of its controlling shareholder (e.g. share transactions leading to a transfer of control). Other restrictions are focused on changes in business activity, and impose what is essentially a “continuity of business enterprise” test by denying loss relief when the profit against which the deduction is claimed is not produced by substantially the same business activity that incurred the loss. Finally, some legislation includes a combination of both approaches. In all cases, these rules are complex and burdensome for taxpayers and tax administrations alike, with substantial variations in scope and impact (e.g. the definition of what constitutes a “change of ownership” or “change of business activity”). Such rules create a rich source of disputes and uncertainty.
485. For Amount A, specific rules will be developed to deal with the treatment of unrelieved losses in the context of business reorganisations (e.g. creation of a new business, modification of an existing business, sale (or purchase) of whole or part of a business to a third party). These rules would seek to ensure that unrelieved losses are transferred to (and carried forward in) the relevant group (or segment where relevant) where the relevant business activity is continued. They would also seek to prevent the trading of losses and related tax avoidance arrangements. Important considerations in the development of these rules will include: complexity (and administration) issues; definitional issues; interactions with segmentation rules (including changes over time of the segmentation basis) and the need to guard against tax avoidance arrangements; and possible impact on the allocation of taxing rights. Accordingly, a number of simplifications will be considered to deliver these results, including, for example, the use of allocation keys to allocate unrelieved losses.
5.4.5. Interactions with domestic carry-forward regimes
486. Consistent with the features described above, and the fact that Amount A has its own tax base, the Amount A carry-forward regime will be kept separate from any existing domestic loss carry-forward regime. This means that losses generated at entity level under the ALP-based profit allocation system (“entity-level losses”) would not alter the Amount A tax base, nor would Amount A unrelieved losses affect the separate tax base of an MNE group entity determined in accordance with the ALP. In practice, this means that:
A group entity liable to pay Amount A (or part of it) would not be able to reduce or eliminate that liability with entity-level losses;
Amount A losses of a group (or segment where relevant) would not be offset against the profit of an entity determined under the ALP-based profit allocation system; and
Entity-level losses under the ALP-based profit allocation system would generally not be affected by Amount A profit (or tax).34
487. There is a separate question whether entity-level losses, if not considered for computing the Amount A tax base, could be taken into account for determining the identity of the entity or entities in the group (or segment) that would bear the Amount A tax liability (for the purpose of eliminating double taxation). The mechanism to eliminate double taxation arising from Amount A is based on different steps (e.g. activity test, profitability test), and including in one of these steps the consideration of entity level losses is under consideration as part of the work on elimination of double taxation (see section 7.2.6.).
5.4.6. Profit shortfalls
488. Some Inclusive Framework 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 (i.e. profit shortfalls) as a “loss” that can be carried forward to the next taxable periods. Profit shortfalls would thus be preserved and potentially give rise to a tax relief in subsequent profitable years for Amount A purposes (see illustration in Annex C, Box C.1.).
489. For the proponents of this approach, a carry-forward regime that includes profit shortfalls would improve neutrality by ensuring that Amount A does not apply differently to taxpayers with volatile profits from one period to the next (see Group X and Y in the example in Annex C, Box C.1.).35 They note that in conventional tax systems which tax the first unit of profit above zero, zero profitability (where losses begin) is the "pivot point" for carryovers. They suggest that in a system like Amount A that only reallocates residual profits above a fixed positive profit threshold, neutrality requires that the pivot point for carryovers be the residual profit threshold. In addition, this approach would also allow Amount A to better adapt to unpredictable economic situation. Some of these members note that transfer pricing methods, such as the TNMM, rely on average financial data over a number of years; and that a carry-forward rule for profit shortfalls is consistent with this approach, but without the administrative difficulties of an averaging method. In addition, they consider that this approach would improve the accuracy of the measure of residual profit subject to the Amount A formula, by ensuring that only profit in excess of the profitability threshold calculated over a longer period (and business cycle) is reallocated to market jurisdictions. It would thus contribute to preserving the taxing rights of residence jurisdictions over Amount A profits not only by recovering previously deducted losses, but also by improving the measure of the profit that remains subject to the existing ALP-based allocation system (so-called “deemed” routine profit of the business, see section 6.2.1). The residence jurisdiction where the business is bearing costs and taking risks would benefit for longer from its taxing right under existing rules on the approximation of routine profit. These members also generally consider that the same rules should apply to losses and profit shortfalls – a single carry-forward system (including for potential time restrictions) – and that this approach would not add any complexity and be easy to administer.
490. In contrast, for another group of members, accounting for profit shortfalls would not be justified in principle, and would also introduce a source of complexity and increase compliance and administrative burdens. From a policy standpoint, these members note that most existing income tax rules do not average profits over multiple years (including where there is a progressive tax rate), and also suggest that loss carry-forward regimes are designed only to enable taxpayers to recoup losses reflecting costs of their earlier investments. Because profit shortfalls are not a cost that impairs the ability of a group to recoup its past investments, they see them as fundamentally different from losses, and take the view that there is no justification for allowing their carry-forward. These members also take the view that disregarding profit shortfalls has no or a limited impact on the tax burden of the taxpayer (depending on income tax rate differentials), and hence on neutrality, as it only changes the allocation of profit (and the jurisdiction where the taxpayer needs to pay its income tax). In addition, they consider this proposal inconsistent with the rationale of the Amount A profitability threshold, which is a simplified convention introduced to limit interactions between Amount A and existing profit allocation rules, and simplify the calculation of Amount A profit. In their view, this threshold does not seek to replicate the concept of residual profit used in transfer pricing rules, is not intended to apply to the profit of an MNE group (or segment where relevant) over multiple years, and involves an accepted degree of approximation. Finally, these members are concerned that this proposal would present practical difficulties. In their view, the different policy objective of “income averaging” would require a separate treatment of losses and profit shortfalls, and create the complexity of dealing with two distinct carry-forward regimes. Specifically, they consider that stricter time limits would need to apply to profit shortfalls compared with losses, on the basis that accounting for profit shortfalls over an excessively long period would lead to inappropriate results. For example, a business with a low profit margin could accumulate unrelieved profit shortfalls over 10 or 15 years which would not be justified from a policy standpoint, and would create opportunities for tax planning. These members also note that profit shortfalls would increase the amount of losses administered by the Amount A carry-forward system, and hence the need for strict and complex anti-avoidance rules to prevent the trading of these losses (including in case of business reorganisations).
491. A decision will be necessary to determine whether the Amount A carry-forward should be extended to profit shortfalls. To facilitate this decision, further work will be conducted to estimate the impact of accounting for profit shortfalls on the amount of losses administered by the Amount A carry-forward regime (and on the Amount A profit of in-scope MNE groups), and in turn on reducing the quantum of Amount A. Relevant considerations will include possible implications and spill-overs of this proposal on other features of this carry-forward regime or of Amount A, such as time limitations for the use of losses (see section 5.4.4), or the level of the profitability threshold in the Amount A formula (see section 6.2.1).
5.4.7. Administration
492. The approach under consideration requires potentially all MNE groups in scope of Amount A to compute their Amount A tax base to identify and preserve losses incurred over a given period, including in periods where MNE groups may not foresee profit in the near or medium term that would be relevant for Amount A purposes (in excess of the profitability threshold).36 To manage the loss account(s), these groups will also be subject to specific filing and documentation requirements, such as keeping records at group level (or segment where relevant) of carried-forward losses (including pre-regime losses) for each period from the introduction of the new taxing right. This compliance burden could, however, be substantially mitigated by the development of a simplified and centralised compliance framework for Amount A (including standardised filing requirements), where one entity in the group would be responsible for administration and compliance with Amount A (see section 10.2.1). Further, other procedures developed to facilitate the administration of Amount A are likely to be relevant for the proposed loss carry-forward regime, such as the opportunity to obtain early certainty (e.g. calculation and allocation of pre-regime losses, impact on unrelieved losses of a business reorganisation).
5.4.8. Next steps
493. As a next step, further work will be undertaken on the specific aspects of the loss carry-forward regime that need to be finalised, including:
The issue of pre-regime losses, and what specific time limit, if any, would be needed to limit administration and compliance costs.
The impact of business reorganisations (including changes over time of the segmentation basis), and the specific rules that need to be developed to prevent the trading of losses and related tax avoidance arrangements.
The question of time limitations, and the implications of adopting unlimited carry-forward.
494. In this discussion, important considerations will include simplicity of administration (and compliance costs), ensuring net-basis taxation, neutrality and the possible impact on the allocation of taxing rights.
495. Separately, as part of the discussion on the quantum of Amount A (see section 6.5), a decision will be necessary to determine whether this regime should apply exclusively to economic losses or be extended to cover profit shortfalls.
Notes
← 1. These include, in addition to IFRS, the generally accepted accounting principles of Australia, Canada, Hong Kong (China), Japan, New Zealand, the People’s Republic of China, the Republic of India, the Republic of Korea, Singapore and the United States.
← 2. The quantum of Amount A profits allocable to an eligible market jurisdiction will result from applying the Amount A formula (including the allocation key based on in-scope revenue) to the consolidated tax base. This would mean that even though the calculation of the Amount A tax base would not distinguish between in and out-of-scope activities, market jurisdictions would still not be allocated Amount A profits for out-of-scope activities. In effect, the group or segment profit margin would be used as a proxy for the profit margin of in-scope activities.
← 3. This safe harbour approach could, however, substantially increase the number of MNE groups that would elect to compute the Amount A tax base on a segmented basis, with ensuing administrative burdens for tax administrations. The safe harbour approach would be to the benefit of taxpayers, as it would allow a group with a high profitability out-of-scope business and a low profitability in-scope business to elect to calculate its Amount A tax base on a segmented basis, thereby reducing its potential Amount A tax liability.
← 4. Where an MNE group is within the segmentation exemption but has one disclosed segment in scope of Amount A and one segment out of scope, it may be preferable to exclude the MNE group from the exemption. Further work will be undertaken on this issue.
← 5. Not all transactions between associated enterprises as defined in Article 9 of the OECD Model Tax Convention (MTC) will necessarily be eliminated through the process of consolidation. The reason for that is that the definition of “control” for accounting purposes is typically narrower than the definition of associated enterprises under Article 9 of the OECD MTC.
← 6. Even where MNE groups are not required to prepare audited consolidated financial accounts, there are also a number of constraints associated with the financial reporting process (e.g. incentives, checks and balances) that contribute to the reliability of the information provided by the financial accounts.
← 7. IFRS is a set of accounting standards issued by the IFRS Foundation and the IASB. It is the most commonly used and accepted financial accounting standard worldwide (see https://www.ifrs.org/use-around-the-world/use-of-ifrs-standards-by-jurisdiction/). This widespread use across the world makes it a useful and pragmatic reference point for assessing differences between local GAAP when computing the Amount A tax base.
← 8. See chapter 4 (section 4-7) of GloBE rules.
← 9. Furthermore, many of the potential differences between GAAP are of a qualitative nature, which would impede the quantification and the adjustment of such divergences in a reliable manner to compute Amount A tax base.
← 10. The statement of “profit or loss” is one of the five inter-related statements that comprise an MNE group’s consolidated financial accounts. It contains at the bottom a total for “profit or loss” that includes, in principle, all income and expenses of an MNE group for a given period. The only exception being income and expenses presented in the “other comprehensive income” statement.
← 11. For instance, an unrealised accrued gain may be relevant for a group’s shareholders, but would typically not give rise to an income tax charge until it is realised and, accordingly, would not be included in the Amount A tax base. Most unrealised accrued gains are accounted for in the “other comprehensive income” statement and, therefore, not reflected into the “profit or loss” statement until the realisation of the gain. Therefore, MNE groups recognising unrealised accrued gains in the “other comprehensive income” statement would not need to make adjustments to compute the Amount A tax base, which would make the approach relatively simple to apply.
← 12. IFRS defines “income taxes” for these purposes as including “all domestic and foreign taxes which are based on taxable profits. Income taxes also include taxes, such as withholding taxes, which are payable by a subsidiary, associate or joint arrangement on distributions to the reporting entity.” For instance, in the specific case of partnerships that are not subject to CIT, the tax expense would merely account for the withholding tax levied upon distribution of the profits to the partners.
← 13. This includes income taxes on excluded income for the purposes of computing the Amount A tax base.
← 14. See chapter 4 (section 4-7) of GloBE rules.
← 15. See chapter 4 (section 4-7) of GloBE rules.
← 16. For more details on the equity method of accounting, see chapter 4 (section 4-7) of GloBE rules.
← 17. Under IFRS and a number of GAAP, income and expenses are classified and included either in the statement of “profit or loss” or in the “other comprehensive income” statement. As a general rule, non-realised income or expenses are recognised in the “other comprehensive income” statement in the period where they are accrued. These items are subsequently reclassified (“recycled”) from the “other comprehensive income” statement into the statement of “profit or loss” in a future period, usually when they are realised.
← 18. To calculate the PBT attributable to standardised and bespoke cloud computing services would require a group to apportion substantial shared costs between these activities using allocation keys (likely including revenue). The reliance on allocation keys to apportion a potentially broad range of different costs brings into question whether the PBT that would be determined for each of these separate activities would accurately reflect the underlying economic reality of each business. It would also be challenging to verify such allocations.
← 19. This will include consideration of whether it may be appropriate to only require a taxpayer to segment its tax base between in and out-of-scope activities, in line with the scope of Amount A.
← 20. An operating segment is defined under IFRS 8 as the “component of an entity a) that engages in business activities from which it may earn revenues and incur expenses (including revenues and expenses relating to transactions with other components of the same entity), b) whose operating results are regularly reviewed by the entity’s chief operating decision maker to make decisions about resources to be allocated to the segment and assess its performance, and for which discrete financial information is available.” International Accounting Standards Board, International Financial Reporting Standard 8: Operating Segments, paragraph 5.
← 21. International Accounting Standards Board, International Account Standard 14: Segment Reporting, paragraph 9.
← 22. International Account Standard 14: Segment Reporting, paragraph 9 includes a definition of a “geographical segment” which may be relevant in developing this aspect of the “segmentation hallmarks”.
← 23. Although some jurisdictions’ CIT legislation includes loss carry-back rules, whereby losses can be transferred to reduce or eliminate the CIT paid in a prior tax year, such rules are not considered in the context of Amount A because of their complexity and uncertainty. Loss carry-back regimes have proven difficult to administer as they require reopening a taxpayer’s assessment for prior tax periods. They also make it difficult for jurisdictions to forecast tax revenue as they require the refunding (possibly in years of economic decline) of taxes paid in previous years.
← 24. In this Report, ability to pay refers to the ability of a taxpayer to pay its income tax without impairing its original investment.
← 25. For example, this is relevant for high-risk business activities requiring heavy investments in innovation and technology, where the risk of making losses is greater than for other (low-risk) business activities. Many highly digitalised businesses start their business cycle with a “scale up” period during which they undertake substantial investment to develop their business model and launch their international growth to capture new markets. During this period, they can experience large losses even if in the long term they become efficient and highly profitable. Loss carry-forward is necessary to ensure that those risk-taking businesses with high fluctuations in profit can recoup the costs associated with their initial investments, and hence not be subject to a relatively higher income tax burden than other business activities with a faster route to profit.
← 26. As a result of the different exemptions available to determine whether segmentation is required, it is expected that only a limited number of MNEs in scope of Amount A would be required to segment their consolidated accounts for the purpose of computing the Amount A tax base (see section 5.3.3).
← 27. This means that if a profit margin-based approach is adopted (see section 6.2.4), the MNE group will calculate the quantum of losses for Amount A purposes by multiplying its consolidated negative profit margin by its total in-scope revenue.
← 28. This time limit on the calculation and reporting of losses incurred before the introduction of Amount A would not necessarily apply to the carry-forward of these pre-regime losses to subsequent years (see section 5.4.4).
← 29. An approach allocating losses to market jurisdictions would require the development in each market jurisdiction of loss carry-forward rules for Amount A purposes, presumably in accordance with some harmonised standards to ensure that market jurisdictions are not able to render the loss allocation ineffective (e.g. through prohibitive time limits on relief). Taxpayers would need to administer the allocated losses in each market jurisdiction separately, and submit in each market jurisdiction a claim for tax relief once profit is allocated to that same jurisdiction under Amount A in subsequent years.
← 30. Comparable mechanisms are used in the legislation of different Inclusive Framework jurisdictions, such as for the treatment of certain investment vehicles (typically, to offset profit and losses generated by a portfolio of assets over multiple years before redistributing profit to the investors).
← 31. If the Amount A carry-forward regime is extended to certain pre-regime losses, the loss account would also include those pre-regime losses.
← 32. Some members of the Inclusive Framework consider the taxation of Amount A profit net of any losses as the priority, and support unlimited carry-forward (typically, jurisdictions with no time limitations in their domestic carry-forward regimes). Other members are concerned about the administrative challenges created by unlimited carry forward, including the opportunities for manipulation and abuse. They therefore favour a time limit. These members also generally consider that the need for time limitations is proportionate to the amount of losses at stake, and hence that the possible inclusion of profit shortfalls should be considered in deciding this issue.
← 33. A business reorganisation here means any situation where one or more members of the MNE group, or one or more business asset or branch within the group, are transferred and become part of another group, or another business or branch within the same group. This includes therefore changes to the organisation of a business that leads to changes to the segmentation basis (see section 5.3).
← 34. Members of the Inclusive Framework will remain free as a matter of domestic tax policy to reduce an Amount A allocation to their jurisdiction by entity-level losses that the same MNE has incurred through an entity in that jurisdiction.
← 35. Volatility of profits may be the result of different factors in the context of Amount A, including timing differences in the treatment of revenue and expenses between different accounting standards (see section 5.2.1).
← 36. The treatment of losses incurred by MNE groups that are not in scope of Amount A because they fall below one of the two revenue thresholds (see section 2.3) will also need to be considered. For example, the transitional regime developed to accommodate pre-regime losses (see section 5.4.2) could be extended and apply similarly to losses incurred during periods where the MNE falls below the scope revenue thresholds.