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Reverse hybrid entities

Applies
FY2024 onwards
Reviewed
Rule
P2-RHE-2024.1
By

How are reverse hybrid entities treated under Pillar Two?

The income of an entity transparent where it was created but not in its owner's country stays with the entity, which is usually stateless.

Per GloBE Model Rules (Pillar Two), December 2021, Article 10.2.1, Reverse Hybrid Entity

A Reverse Hybrid Entity is a Flow-through Entity — fiscally transparent where it was created, and not tax resident and taxed elsewhere — that is not fiscally transparent where its owner is located. Its Financial Accounting Net Income or Loss is not allocated to its owners: after the reduction for owners that are not Group Entities and any amount allocated to a Permanent Establishment, it is allocated to the Entity itself. A Flow-through Entity is located where it was created only if it is the Ultimate Parent Entity or required to apply an IIR; otherwise it is stateless.

Without this, income that neither the creating jurisdiction nor the owner's jurisdiction taxes in the entity's hands would fall outside the rules.

What the result turns on

The mismatch

The creating jurisdiction treats the entity as transparent, so it does not tax it. The owner's jurisdiction does not, so the owner is not taxed on the income as its own either.

Income stays in the entity

Under Article 3.5.1(c) it is allocated to the entity itself, after the non-Group owners' part and any Permanent Establishment amount.

Usually stateless

It is located where it was created only if it is the UPE or must apply an IIR. Otherwise it is a Stateless Constituent Entity with its own stand-alone ETR.

Not the same as a hybrid

A Hybrid Entity is a separate taxable person in its own jurisdiction and transparent to its owner. A Reverse Hybrid is transparent where created and not to its owner.

Points the Commentary settles

  • The owner whose view counts is the Reference Entity: the nearest Constituent Entity-owner in the chain that is not itself a Flow-through Entity. Its jurisdiction must treat the entity, or an entity between them, as opaque
  • The classification is made interest by interest, so an entity can be a reverse hybrid for one owner and tax transparent for another; the income of each interest is allocated accordingly
  • An entity created where there is no corporate income tax is not a Flow-through Entity, and so cannot be a reverse hybrid — it is either deemed tax transparent, a Hybrid Entity, or an ordinary entity located where it was created
  • In practice a reverse hybrid is the one case in which income allocated to a Flow-through Entity is stateless: neither the creating jurisdiction nor the owner's treats it as income of a resident
  • A jurisdiction may choose to require a Flow-through parent to apply the Income Inclusion Rule, in which case the entity is located where it was created

Order of testing

  1. 1

    The Article 10.2 classification

    Reverse hybrid, or one of the others.

  2. 2

    Allocation of income under Article 3.5

    The income that stays in the entity.

Examples

Illustrative scenarios — ours, not the authority’s — each computed live by this rule. Change any fact and the outcome is the rule’s, not a hand-written answer.

A reverse hybrid, stateless

Transparent where created, taxed as a company by its owner's jurisdiction, not the UPE and not required to apply an IIR.

Computed

The Entity is a Reverse Hybrid Entity: a Flow-through Entity that is not fiscally transparent where its owner is located (Article 10.2.1(b)). Its income is allocated to the Entity itself under Article 3.5.1(c), not to its owners. It is not the UPE and not required to apply an IIR, so it is a Stateless Constituent Entity (Article 10.3.2(b)) with its own stand-alone Effective Tax Rate (Article 5.1.1). Supply its Financial Accounting Net Income or Loss and the non-Group owners' share to see the amount retained. Based on what you supplied.

Decided by the allocation of income under article 3.5

The income that stays

The same with EUR 1,000 of income, 20% held by outside investors and EUR 100 allocated to a Permanent Establishment.

Computed

The Entity is a Reverse Hybrid Entity: a Flow-through Entity that is not fiscally transparent where its owner is located (Article 10.2.1(b)). Its income is allocated to the Entity itself under Article 3.5.1(c), not to its owners. EUR 700 stays in the Entity as computed, after reducing EUR 1,000 for owners that are not Group Entities and the amount allocated to Permanent Establishments. It is not the UPE and not required to apply an IIR, so it is a Stateless Constituent Entity (Article 10.3.2(b)) with its own stand-alone Effective Tax Rate (Article 5.1.1). Based on the figures you supplied.

Workings

Financial Accounting Net Income or (Loss)Article 3.5 — as supplied
EUR 1,000
Reduced for owners that are not Group EntitiesArticle 3.5.3 — 20% of the Ownership Interests
(EUR 200)
Allocated to Permanent EstablishmentsArticle 3.5.1(a) — as supplied, under Article 3.4
(EUR 100)
Allocated to the Entity itselfArticle 3.5.1(c)
EUR 700

Decided by the allocation of income under article 3.5

Transparent to its owner too

Where the owner's jurisdiction also treats it as transparent it is a Tax Transparent Entity, not a reverse hybrid.

Computed

The Entity is not a Reverse Hybrid Entity as computed: it is a Tax Transparent Entity: a Flow-through Entity that is fiscally transparent where its owner is located (Article 10.2.1(a)). See the tax-transparent-entities rule for what follows. Classification is "to the extent", so an Entity that is partly one and partly another must be split. Based on what you supplied.

Decided by the article 10.2 classification

Try it

Supply the facts and this rule computes the outcome in your browser, live. Leave a determination undecided and it blocks the result — it is never read as a no.

Not computed yet

1 input still need your determination:

  • Is the Entity fiscally transparent in the jurisdiction where it was created — does that jurisdiction treat its income, expenditure, profit or loss as derived or incurred by its direct owner in proportion to its interest?

Computed in your browser from the figures you supply. Nothing is sent anywhere, and the result is a computation against a rule — reference, not tax advice.

Sources

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Reference, not tax advice.

Pankaj Agarwal — Tax Technology Leader