Revenue Note for Guidance

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Revenue Note for Guidance

111AE Substance-based income exclusion

Summary

This section provides for a substance-based carve-out, based on payroll and tangible assets, to exclude a fixed return for substantive activities within a jurisdiction from the application of the Pillar Two Rules. The Substance-based Income Exclusion only affects those groups with operations in jurisdictions that are taxed below the Minimum Rate.

Details

Definitions

(1) Introduces definitions relating to employee related expenses and tangible assets for the purposes of calculating the substance based income exclusion.

“eligible employees” means full-time or part-time employees of a constituent entity, and independent contractors participating in the ordinary operating activities of the MNE group or large-scale domestic group under the direction and control of the MNE group or large-scale domestic group;

“eligible payroll costs” means employee compensation expenditures, including:

  1. salaries,
  2. wages,
  3. other expenditures that provide a direct and separate personal benefit to the employee, including health insurance, pension contributions and stock-based compensation,
  4. payroll and employment taxes, and
  5. employer social security contributions;

“eligible tangible assets” means:

  1. property, plant and equipment located in the jurisdiction,
  2. natural resources located in the jurisdiction,
  3. a lessee’s right of use of tangible assets located in the jurisdiction, or
  4. a licence or similar arrangement from the government for the use of immovable property or exploitation of natural resources that entails significant investment in tangible assets.

Application

(2)(a) This subsection provides for a substance-based income exclusion. The net qualifying income for a jurisdiction shall be reduced by an amount equal to the sum of the payroll carve-out calculated in accordance with subsection (3), and the tangible asset carve-out calculated in accordance with subsection (4), (referred to as the ‘substance-based income exclusion amount’) for each constituent entity located in the jurisdiction.

(2)(b) Where a constituent entity chooses not to apply the substance-based income exclusion for the fiscal year an election may be made in accordance with section 111AAAD not to apply the SBIE.

Payroll Carve Out

(3)(a) The payroll carve-out, referred to in subsection (2), of a constituent entity shall be equal to 5% of its eligible payroll costs for a fiscal year, which relate to eligible employees, who perform activities for the MNE group or large-scale domestic group in the jurisdiction in which the constituent entity is located. However, please note the percentage that will apply under the transitional relief for SBIE provided for under section 111AX.

(3)(b) For the purposes of paragraph (a) no account shall be taken of eligible payroll costs which are capitalised and included in the carrying value of eligible tangible assets, or attributable to income that is excluded in accordance with section 111Q (international shipping income exclusion).

(3)(c) For the purposes of paragraph (a):

  • an eligible employee shall be considered to perform activities for the MNE group or large-scale domestic group, in the jurisdiction in which the constituent entity is located, where the eligible employee is located within that jurisdiction for greater than 50 per cent of their working time in a fiscal year, and
  • a constituent entity shall include only the proportionate share of the eligible payroll costs for a fiscal year for an eligible employee in the calculation of the payroll carve-out where that eligible employee is located within the jurisdiction of the constituent entity employer for 50 per cent, or less, of their working time in that fiscal year.

Tangible Asset Carve Out

(4)(a) The tangible asset carve-out, referred to in subsection (2), of a constituent entity shall be equal to 5% of the carrying value of its eligible tangible assets for a fiscal year located in the jurisdiction in which the constituent entity is located. However, please note the percentage that will apply under the transitional relief for SBIE provided for under section 111AX.

(4)(b) For the purposes of paragraph (a):

  • no account shall be taken of:
    1. the carrying value of property, including land and buildings, that is held for sale, lease or investment, or
    2. the carrying value of tangible assets used to derive income that is excluded in accordance with section 111Q,
  • an eligible tangible asset shall be considered to be located in the jurisdiction in which the constituent entity is located where the eligible tangible asset is located within that jurisdiction more than 50 per cent of the time in a fiscal year, and
  • a constituent entity shall include only the proportionate share of the carrying value of the eligible tangible asset for a fiscal year in the calculation of the tangible asset carve-out where the eligible tangible asset is located in the jurisdiction of the constituent entity for 50 per cent, or less, of the time in that fiscal year.

(5) For the purpose of subsection (4), and subject to subsection (11), the carrying value of eligible tangible assets shall be the average of the carrying value of eligible tangible assets at the beginning of the fiscal year, and the carrying value of eligible tangible assets at the end of the fiscal year, reduced by any accumulated depreciation, amortisation and depletion and increased by any amount attributable to the capitalisation of payroll expenses, as recorded for the purposes of preparing the consolidated financial statements of the ultimate parent entity.

Permanent Establishment

(6)(a) For the purpose of subsections (3) and (4) with regards to a constituent entity which is a permanent establishment, the eligible payroll costs and eligible tangible assets, as the case may be, shall be those that are included in its separate financial accounts in accordance with section 111R(1), provided that the eligible payroll costs and eligible tangible assets, are located in the same jurisdiction as the permanent establishment.

(6)(b) The eligible payroll costs and eligible tangible assets shall not be taken into account in the calculation of eligible payroll costs and eligible tangible assets the main entity.

(6)(c) Where the income of a permanent establishment was wholly or partially reduced pursuant to section 111S(1) (in relation to a flow-through entity) or section 111AQ(5) (in relation to a UPE that is a flow through entity) as the case may be, the eligible payroll costs and eligible tangible assets of such permanent establishment shall be reduced in the same proportion from the calculation of the substance-based income exclusion amount for a jurisdiction for a fiscal year under this section for the MNE group or large-scale domestic group.

Flow-through entity

(7)(a) For the purpose of subsections (3) and (4), eligible payroll costs of eligible employees paid by a flow-through entity, and eligible tangible assets owned by a flow-through entity, that are not allocated under subsection (6), shall be allocated to:

  • the constituent entity-owners of the flow-through entity, in proportion to the amount allocated to them pursuant to section 111S(4), provided that the eligible employees and eligible tangible assets, as the case may be, are located in the jurisdiction of the constituent entity-owners, and
  • the flow-through entity if it is the ultimate parent entity, reduced in proportion to the income excluded from the calculation of the qualifying income of the flow-through entity pursuant to section 111AQ (1) and (2), provided that the eligible employees and eligible tangible assets, as the case may be, are located in the jurisdiction of the flow-through entity.

(7)(b) All eligible payroll costs and eligible tangible assets of a flow-through entity that are not allocated for a fiscal year under subsection 6 or paragraph (a) shall be excluded from the calculation of the substance-based income exclusion amount of the MNE group or large-scale domestic group.

Stateless constituent entity

(8) The substance-based income exclusion amount of each stateless constituent entity shall be calculated for each fiscal year separately from the substance-based income exclusion amount of all other constituent entities.

Investment entity

(9) The substance-based income exclusion amount calculated under this section shall not include the payroll or tangible asset carve-outs of constituent entities that are investment entities in that jurisdiction.

Leasing

(10)(a) Subject to subjection (11), for the purposes of subsection (4) and notwithstanding section (4)(b)(i), a constituent entity that is the lessor of property, plant or equipment leased under an operating lease may calculate a tangible asset carve-out in respect of the leased property, plant or equipment in accordance with paragraph (b) where the property, plant or equipment is located in the same jurisdiction as the constituent entity.

(10)(b) The amount of tangible asset carve-out referred to in paragraph (a) is an amount equal to the excess, if any, of the constituent entity’s average carrying value of the property, plant or equipment concerned determined at the beginning and end of the fiscal year over the average amount of the lessee’s right-of-use asset in respect of the property, plant or equipment determined at the beginning and end of the fiscal year.

(10)(c) For the purposes of paragraph (b) and subject to paragraph (d), where the lessee is not a constituent entity, the lessee’s right-of-use asset shall be equal to the undiscounted amount of payments remaining due under the operating lease, including any extensions that would be taken into account in determining a right-of-use asset under the financial accounting standard used to determine the qualifying income of the constituent entity.

(10)(d) For the purposes of paragraph (c), the value of the lessee’s right-of-use asset shall be deemed to be nil where the property, plant or equipment subject to the operating lease is regularly leased several times to different lessees during the fiscal year and the average lease period, including any renewals and extensions, with respect to lessee is 30 days, or less.

(11) For the purposes of subsections (5) and (10), where a lessor leases a part of an eligible tangible asset to a lessee whilst retaining the residual part of the asset for its own use, then the carrying value of the asset shall be allocated between the different uses of the asset on a just and reasonable basis.

Deductible dividend regime

(12)(a) Where an adjustment to the computation of qualifying income or loss of a constituent entity for a fiscal year has been made in accordance with section 111AR (UPE subject to a deductible dividend regime), the payroll carve-out for that constituent entity shall be reduced by the amount calculated in

accordance with the formula:

A x (B/C)

where-

A is the total eligible payroll costs of the constituent entity for the fiscal year,

B is the total qualifying income of the constituent entity excluded by section 111AR for the fiscal year, and

C is the total qualifying income of the constituent entity for the fiscal year as calculated under Chapter 3.

(12)(b) Where an adjustment to the computation of qualifying income or loss of a constituent entity for a fiscal year has been made in accordance with section 111AR then the tangible asset carve-out for that constituent entity shall be reduced by the amount calculated in accordance with the formula:

A x (B/C)

where-

A is the total eligible tangible assets of the constituent entity for the fiscal year,

B is the total qualifying income of the constituent entity excluded by section 111AR for the fiscal year, and

C is the total qualifying income of the constituent entity for the fiscal year as calculated under Chapter 3.

Relevant Date: Finance Act 2024