Pillar One consultation: exclusion of regulated financial services

The OECD has published a public consultation document in relation to the provisions that will be needed to exclude regulated financial services from the scope of the Pillar One measures. The consultation is open for a short window until 20 May and affected MNEs should carefully consider the scope of the proposed exclusion set out in the consultation.

It is also important to note, however, that whilst the consultation has been approved for release, it is done so on a without prejudice basis. Some significant disagreements exist amongst members as to the final scope of the exclusion and changes may be made to the final version of the to be incorporated in Model Rules.

Background

In January 2020, the OECD published, "Statement by the OECD/G20 Inclusive Framework on BEPS on the Two-Pillar Approach to Address the Tax Challenges Arising from the Digitalisation of the Economy", setting out the progress that had been made in relation to the problems of applying international tax rules to the digital economy and this was followed in October 2020 by the publication of blueprints for Pillar One and Pillar Two. Formal political agreement was reached in June 2021 on the two pillar approach and this was followed by the publication of a "Statement on a Two-Pillar Solution to Address the Tax Challenges Arising From the Digitalisation of the Economy".

Pillar One will, broadly, allow market jurisdictions to tax the profits (Amount A) of the largest MNEs (with consolidated profits in excess of £20bn per annum) and profitability (profits before tax) above 10%. Following agreement on this principle, the Inclusive Framework has mandated a Task Force on the Digital Economy (TFDE) to advance the work needed to agree and implement the details of the calculation of Amount A and the scope of Pillar One. This work includes developing a multilateral convention and model rules and commentary on Amount A. As part of this work, the OECD has now published a consultation on the proposed exclusion from Amount A of regulated financial institutions.

Financial services exclusion

The Two Pillar Solution agreed by the Inclusive Framework contemplates that the Pillar One provisions will not apply to regulated financial services. This is on the basis that the defining character of this sector is that it is subject to a form of regulation, in the form of capital adequacy requirements, which generally helps to align the location of profits with the market (making this sector a significantly lower risk for base erosion and profit shifting).

The consultation proposes that the exclusion of regulated financial services will involve two steps in the calculation of Amount A:

• Firstly, following the MNE calculation of its group-wide profits and profit margin to determine if it prima facie comes within scope, it will be necessary to recalculate the total group-wide profits excluding regulated financial services activities. This will involve subtracting third party revenue derived from regulated financial services (based on an entity by entity approach, such that an entity that meets the definition is wholly excluded).

  It is contemplated that the test might be simplified in the sense that it is not necessary to make an accurate calculation if it can be shown that by subtracting the revenues from its largest regulated financial services entities, it falls below the €20bn threshold. Alternatively, the MNE might simply calculate the revenues of any non-regulated entities.

• Secondly, it will be necessary to determine if the 10% profitability threshold is met by isolating any regulated financial services entities and testing the profit margin of the remaining in-scope entities. Work is ongoing to determine if there is a way in which the application of this test can be simplified, particularly where groups exceed the revenue threshold but consistently fall below the profitability threshold.

The consultation contemplates that the definition of regulated financial services entities may encompass the following activities:

• Depositary Institutions;
• Mortgage Institutions;
• Investment Institutions;
• Insurance institutions;
• Asset managers;
• A mixed financial institution; and
• A regulated financial institution service entity (ie a group entity that exclusively services other regulated entities within the group where those services are necessary for the carrying out of the regulated activities).

Each of these categories is further defined in the consultation and the Commentary would explain that the term “regulated” is specific to financial services in this context, using a high-level and principles based approach. However, the consultation contemplates that regulation in this context may be tied to “requirements based on capital adequacy” using a risk based approach. It is far from clear at this stage that contemplated financial activities in all jurisdictions that are “regulated” would meet this definition.

Equally the consultation points out that this is not an area on which agreement has yet been reached and, in particular, some members of the Inclusive Framework hold the view that reinsurance and asset management should not be excluded from Amount A, for example.

Comments

The consultation is open until 20 May 2022 and comments should be sent to tfde@oecd.org.