Under P2, a top-up tax (‘TT’) is imposed on the profits of low-taxed constituent entities (‘LTCE’) of in-scope multinational groups (‘MNEs’). Pursuant to the income inclusion rule (‘IIR’), the TT is levied by the country of the ultimate parent entity (‘UPE’) or, if such country has not adopted P2, at the level of the first subsidiary down the chain located in a country that has adopted P2 (‘P2 Sub’).
If the UPE country has not adopted P2 and there’s no P2 Sub, the LTCE’s undertaxed profits are subject to TT on a pro-rata basis at the level of group companies located in countries that have adopted P2 (‘P2 Country’) pursuant to the undertaxed profits rule (‘UTPR’). The pro-rata share is based on an allocation key taking into account employees and tangible assets in P2 Countries.
The IIR and the UTPR will enter into force in the EU for book years starting as from Dec 31, 2023 and Dec 31, 2024, respectively.
If an MNE holds its non-US subs via an EU holding company (‘EU HoldCo’), it may consider a P2 restructuring (‘Reorg’) before the IIR becomes effective such that LTCEs are not held, directly or indirectly, by an entity located in a P2 Country.
Absent the ‘Reorg’, the undertaxed profits of the LTCEs would be subject to TT under the IIR at the level of EU HoldCo as from 2024. The short-term benefit of the Reorg is that the LTCEs’ undertaxed 2024 profits are no longer subject to TT under the IIR (no P2 Country in the LTCE chain) while the UTPR is not effective with regard to 2024.
However, the Reorg may have long-term disadvantages.
Without the Reorg, once the UTPR is effective, TT can still only be levied by the EU HoldCo country under the IIR. Following the Reorg, once the UTPR is effective, all P2 Countries where group companies are located may levy TT under the UTPR based on an allocation key. That allocation could result in disputes and will result in P2 filing obligations in all those P2 Countries. The long-term benefit of holding LTCEs via EU HoldCo is that it’s clear in which P2 Country the TT is due and for which amount.
If a third party holds a minority interest (<20%) in an LTCE, the Reorg may result in additional TT once the UTPR is effective. This can be illustrated as follows. Assume that 90% of the LTCE shares are held by a US MNE and 10% by a third party. In case the 90% interest is owned by EU HoldCo, only 90% of the LTCE’s undertaxed profits are subject to TT under the IIR (with the remaining 10% untaxed). However, in case the 90% interest is not held directly or indirectly by an entity located in a P2 Country (e.g., it is owned by a US group company), 100% of the LTCE’s undertaxed profits are subject to TT under the UTPR.
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