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Tax transparent entities

Applies
FY2024 onwards
Reviewed
Rule
P2-TTE-2024.1
By

How is a tax transparent entity treated under Pillar Two?

After outside owners' share and any PE, its income passes to its group owners with the taxes on it. A tax transparent UPE keeps its own income.

Per GloBE Model Rules (Pillar Two), December 2021, Article 10.2, Definitions of Flow-through Entity, Tax Transparent Entity, Reverse Hybrid Entity and Hybrid Entity

A Tax Transparent Entity is a Flow-through Entity — fiscally transparent where it was created, and not tax resident and taxed elsewhere — that is fiscally transparent where its owner is located; a Constituent Entity that is not tax resident and not subject to a Covered Tax or QDMTT is also treated as one to the extent its owners' jurisdiction treats it as transparent, it has no place of business where it was created, and its income is not attributable to a Permanent Establishment. Its Financial Accounting Net Income or Loss is reduced by the amount allocable to owners that are not Group Entities, then allocated to any Permanent Establishment, and the remainder to its Constituent Entity-owners in accordance with their Ownership Interests; the Covered Taxes in its accounts on that income are allocated to those owners. A Tax Transparent Entity that is the Ultimate Parent Entity keeps its income.

The income and taxes are tested where the owners are, not in the entity's own jurisdiction, and a transparent entity is often stateless.

What the result turns on

Classification

  • Fiscally transparent where it was created, unless it is tax resident and taxed elsewhere: a Flow-through Entity
  • Also fiscally transparent where its owner is: a Tax Transparent Entity; not: a Reverse Hybrid Entity
  • A separate taxable person where located that is transparent to its owner is a Hybrid Entity instead

The deemed case

A Constituent Entity that is neither tax resident nor subject to a Covered Tax or QDMTT is treated as a Flow-through and Tax Transparent Entity to the extent its owners' jurisdiction treats it as transparent, it has no place of business where it was created, and its income is not attributable to a Permanent Establishment.

What 'fiscally transparent' means

  • The jurisdiction's law must affirmatively treat the entity's income as the owner's for a Covered Tax. A jurisdiction with no corporate income tax cannot treat anything as transparent — which is why the deemed case exists
  • Where it was created: no Covered Tax on the entity, and the owners taxed on their shares as if they earned them. Losses need not pass through — a trust that passes income out and carries its own losses forward is still transparent
  • Where the owner is: the owner is taxed on its share of the entity's income in much the same way as if it had earned it directly
  • A Covered Tax at state or local level does not stop an entity being transparent under national law
  • Being absorbed into another company through a tax consolidated group is not fiscal transparency
  • An entity that is tax resident and subject to a Covered Tax somewhere else — incorporated in one country and managed in another that taxes it — is not a Flow-through Entity at all

Whose view counts — the Reference Entity

The test is made for each Ownership Interest, from the standpoint of the Reference Entity: the Constituent Entity-owner nearest in the chain that is not itself a Flow-through Entity or, if there is none, a Flow-through Ultimate Parent Entity. Its jurisdiction must treat as transparent both the tested entity and every entity through which it holds the interest. One entity can therefore be a Tax Transparent Entity for one owner and a Reverse Hybrid Entity for another, and a trust can be transparent for the income it passes to beneficiaries and not for what it is taxed on itself.

The allocation, in order

  • Reduced by the amount allocable to owners that are not Group Entities, who are taxed on it themselves
  • Then to any Permanent Establishment through which its business is carried out
  • Then the remainder to the Constituent Entity-owners by Ownership Interest — one owner's amount is the remainder times its interest over the Group owners' interests

The UPE is the exception

A Tax Transparent Entity that is the UPE, or owned by it, keeps its income and the reduction for non-Group owners does not apply. Article 7.1 gives the relief instead.

Covered Taxes follow

Covered Taxes in the entity's accounts on income allocated to an owner are allocated to that owner.

Order of testing

  1. 1

    The Article 10.2 classification

    Flow-through, transparent to its owner, or one of the others.

  2. 2

    Allocation of income under Article 3.5

    Non-Group owners, Permanent Establishments, then the Group's owners.

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.

Income allocated to an owner

A partnership with EUR 1,000 of income, 20% held by outside investors and no Permanent Establishment. This owner holds 40% of the whole, so half of the Group owners' 80%.

Computed

The Entity is a Tax Transparent Entity: a Flow-through Entity that is fiscally transparent where its owner is located (Article 10.2.1(a)). EUR 400 of its income is allocated to this Constituent Entity-owner as computed: after reducing EUR 1,000 for owners that are not Group Entities, and any Permanent Establishment amount, the remainder of EUR 800 is allocated to the Group's owners in proportion to their Ownership Interests. Covered Taxes in its accounts on income allocated to a Constituent Entity-owner are allocated to that owner (Article 4.3.2(b)). A Flow-through Entity that is not the UPE and is not required to apply an IIR is stateless (Article 10.3.2(b)). Based on what 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)
Remainder for the Constituent Entity-ownersArticle 3.5.1(b)
EUR 800
Allocated to this ownerArticle 3.5.1(b) — the remainder times 40% over the Group owners' 80%
EUR 400

Decided by the allocation of income under article 3.5

A Permanent Establishment takes some

The same, but EUR 200 is allocated to a Permanent Establishment.

Computed

The Entity is a Tax Transparent Entity: a Flow-through Entity that is fiscally transparent where its owner is located (Article 10.2.1(a)). EUR 300 of its income is allocated to this Constituent Entity-owner as computed: after reducing EUR 1,000 for owners that are not Group Entities, and any Permanent Establishment amount, the remainder of EUR 600 is allocated to the Group's owners in proportion to their Ownership Interests. Covered Taxes in its accounts on income allocated to a Constituent Entity-owner are allocated to that owner (Article 4.3.2(b)). A Flow-through Entity that is not the UPE and is not required to apply an IIR is stateless (Article 10.3.2(b)). Based on what 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 200)
Remainder for the Constituent Entity-ownersArticle 3.5.1(b)
EUR 600
Allocated to this ownerArticle 3.5.1(b) — the remainder times 40% over the Group owners' 80%
EUR 300

Decided by the allocation of income under article 3.5

The UPE itself

A transparent entity that is the Ultimate Parent Entity keeps its income.

Computed

The Entity is a Tax Transparent Entity: a Flow-through Entity that is fiscally transparent where its owner is located (Article 10.2.1(a)). It is the Ultimate Parent Entity or owned by it, so Article 3.5.1(c) allocates its income to itself and the reduction for non-Group owners in Article 3.5.3 does not apply; Article 7.1 gives the relief instead (see upe-flow-through-entity). Covered Taxes in its accounts on income allocated to a Constituent Entity-owner are allocated to that owner (Article 4.3.2(b)). A Flow-through Entity that is not the UPE and is not required to apply an IIR is stateless (Article 10.3.2(b)). Based on what you supplied.

Decided by the allocation of income under article 3.5

A company in a no-tax jurisdiction, transparent to one of two owners

The Commentary's C Co: created where there is no corporate income tax, with no place of business there and no Permanent Establishment, owned equally by A Co and B Co. For A Co, whose jurisdiction looks through it, it is deemed a Tax Transparent Entity; this is A Co's half. For B Co's half it is not a Flow-through Entity at all.

Computed

The Entity is a Flow-through Entity and Tax Transparent Entity by Article 10.2.4: it is neither tax resident nor subject to a Covered Tax or QDMTT, its owners' jurisdiction treats it as transparent, and it has no place of business where it was created. Its Financial Accounting Net Income or Loss is allocated under Article 3.5: reduced for owners that are not Group Entities, then to any Permanent Establishment, then the remainder to the Constituent Entity-owners by Ownership Interest. Supply the income, the non-Group share and this owner's share to see the amount. Covered Taxes in its accounts on income allocated to a Constituent Entity-owner are allocated to that owner (Article 4.3.2(b)). A Flow-through Entity that is not the UPE and is not required to apply an IIR is stateless (Article 10.3.2(b)). Based on what you supplied.

Decided by the article 10.2 classification

Not transparent to its owner

Transparent where created but not where its owner is: a Reverse Hybrid Entity.

Computed

The Entity is not a Tax Transparent Entity as computed: it is a Reverse Hybrid Entity: a Flow-through Entity that is not fiscally transparent where its owner is located (Article 10.2.1(b)). See the reverse-hybrid-entities rule for what follows. Classification is by income, expenditure, profit or loss "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