I have put off writing about Amount A of the first international tax reform Pillar for two reasons.
The main reason is the concern that it might not actually ever happen. Since international agreement in principle was reached in October 2021, the OECD/Inclusive Framework have been working hard to consult on the technical details and practical implications of each of the building blocks of Amount A which introduces a new taxing right for market jurisdictions over a portion of the profits of the largest and most highly profitable enterprises. But even if all the details can be agreed at the Inclusive Framework level, there are huge obstacles to global implementation. In particular, it is highly unlikely that the US would be able to make the necessary changes to domestic legislation to be able to collect the revenue under the new taxing right.
The other reason is that, until all the moving parts have come to rest and we see the whole picture, it is difficult to write anything meaningful.
The recent consultation on the exclusion from Amount A for Regulated Financial Services (RFS) did, however, catch my eye. So I have suspended my disbelief and assumed for now that the practicalities of implementation can be solved and that Amount A will happen at some point, in which case it is worth having a look at this exclusion.
The UK was vocal early on about the importance of an exclusion for financial services. The key driver for Pillar One was the concern that international tax rules based on physical presence do not work well for modern ways of doing business which do not rely on a physical presence in a market jurisdiction. Banking and insurance, however, are highly regulated in the market jurisdiction and the lack of physical presence is a low risk. It is also difficult to apply to financial services businesses the same measures and principles you would to a non-financial services business to do the calculations required for Amount A. So an exclusion makes sense, both practically and politically, but that doesn’t mean it will be easy to apply.
The revenues and profits from Regulated Financial Institutions (RFIs) will be excluded from the scope of Amount A but there is no consensus yet as to whether or not reinsurance and asset management ought to be excluded. There are seven types of RFI, each of which is separately defined, and apart from the seventh category, each of these definitions is broadly made up of three elements: a licensing requirement, a regulatory requirement and an activities requirement.
Group treasury centres and captive insurers whose business consists to a substantial extent in the provision of services to non-RFI group members are explicitly excluded from falling within any of the RFI categories, and this will be further explained in the Commentary.
Group members providing administrative services to an associated RFI, on the other hand, could fall within the exclusion. The seventh category of RFI is that of an “RFI Service Entity” which exclusively performs functions for an RFI that are necessary to the carrying out of activities of the RFI. The Commentary on the rules will explain that the focus of the RFI Service Entity category is on administrative services that would typically be remunerated on a cost-plus basis, such as providing payroll functions for employees performing solely for the RFI, holding real estate invested in or used by the RFI as part of its business and performing other back office and procurement functions for the sole benefit of the RFI. Conduct of customer-facing activities or fintech or payment processing services would not be covered in this category of RFI.
The effect of the RFS exclusion is to treat the in-scope part of any Group as a standalone business from the RFS part so that the revenues and profits of in-scope entities can be isolated. Getting to this stage is not straightforward and there are different options for combining the in-scope entities into one consolidated bespoke group.
A group would not need to rely on the RFS exclusion if the group on a consolidated basis does not meet the EUR 20 billion threshold and profit margin above 10%. If these general scope thresholds are met, however, the two thresholds are then reapplied testing only non-RFS revenue and profits. Assuming both thresholds are still met in respect of the non-RFS revenue and profits, the nexus and revenue sourcing rules are then applied to the in-scope revenues to determine taxable profit and the ordinary profit allocation formula that applies for Amount A will be applied to allocate the taxable profit to a particular jurisdiction.
For more details on the RFS exclusion, see the consultation (closing date: 20 May). It is one of several parts to the implementation of Amount A which are in progress. It is intended that, eventually, there will be a multilateral instrument with an explanatory statement as well as model rules for domestic legislation and commentary on those rules. The RFS exclusion would form a schedule to the model rules.