Entities and groups under Pillar 2 – which entities form a group?

This article answers the following questions:

• How to define a group within the meaning of Pillar 2?  
• Which entities form a group under the GloBE Rules?  
• Why is it important in practice to correctly identify the structure of a group?

The entry into force of the Act on Top-up Tax Levied on Constituent Entities of Multinational and Domestic Groups has led to many questions. One of the key issues raised by taxpayers is which entities actually form a group within the meaning of these regulations.

Establishing group affiliation in accordance with Pillar 2 is not merely a formal matter – it has a number of serious implications, affecting the following:  

• whether the law applies to the given structure,
• in which country top-up tax should be paid, and
• which entities should be accounted for in tax computations.

How to define a group within the meaning of Pillar 2?

In accordance with the Act on Top-up Tax Levied on Constituent Entities of Multinational and Domestic Groups, a group is formed by minimum two entities related through ownership or control whose financial data is – or could be – included in the consolidated financial statements of the ultimate parent entity.

This means that the main criterion for the identification of a group is the consolidation test which can determine whether there are relations between the entities which provide grounds for consolidation of their financial results.

Importantly, with respect to Pillar 2, it is irrelevant if such statements have actually been prepared. A determining factor is that the entity would be obliged to prepare consolidated financial statements if it adopted the accounting standards acceptable by the law. In such a scenario, a group is considered to exist under the provisions of the statute – it is referred to as the so-called hypothetical consolidation test.

Another very important aspect is the fact that even entities which are not formally included in the consolidated statements (for example, because they are irrelevant or intended for sale) may be treated as members of the group.

Depending on the scope of activity, groups may be multinational or domestic. The Act on Top-up Tax Levied on Constituent Entities of Multinational and Domestic Groups mostly applies to multinational groups, whose entities operate in more than one jurisdiction, as they are more likely to be subject to additional taxation due to their size than domestic groups (whose entities operate only within the territory of one jurisdiction).

Nevertheless, the regulations of the said statute apply to both groups if their consolidated revenue was EUR 750 million or more in at least two of the four preceding fiscal years. More information can be found in our article about the methods of calculating group revenue.

Structure and members of a group subject to top-up tax

If the test of group revenue, which is used to identify groups which are subject to top-up tax, is positive, it is then really important to adequately establish the relations between the constituent entities of the group (i.e. determining the structure of the group).

The above is significant because the top-up tax system is based on a hierarchy in which specific entities are responsible for computing and reporting appropriate top-up tax (the income inclusion rule, under-taxed profit rule, or qualified domestic minimum top-up tax). In principle, the income inclusion rule applies to the controlling entity, although the obligation to pay top-up tax can be in certain cases transferred to entities which are lower in the hierarchy. Regardless, qualified domestic minimum top-up tax may be paid even by the entities which are at the lowest level of the group structure.

At the top of the hierarchy is the ultimate parent entity (UPE), which is an entity having controlling interest in other entities, without being controlled by any entity itself. It is the UPE which is the primary subject of Pillar 2 obligations, responsible particularly for the computation and payment of top-up tax (in this case, the income inclusion rule applies).

Below the UPE there may be intermediate parent entities (IPE), which are entities having interest in other entities in the group, but are controlled by another entity being higher in the hierarchy. In certain situations – especially when the UPE is an exempt entity or located in a state which has not adopted the Pillar 2 rules – it is the IPE that assumes the obligation to pay top-up tax (under the income inclusion rule).

Another case in which it is not the UPE that is responsible for paying top-up tax under the income inclusion rule is where there are structures with partially-owned parent entities (POPE), which are entities that are more than 20% owned by interest holders outside the group. Such entities are obliged to autonomously calculate top-up tax (under the income inclusion rule) for themselves and their subsidiaries.

Lastly, other entities (constituent entities) may also be obliged to pay top-up tax; in such cases, the qualified domestic minimum top-up tax or the under-taxed profit rule may apply.

It is also worth noting that the legislation provides for more complex structures and relations, such as structures with joint ventures or minority-owned constituent entities, which – despite forming parts of group structures – are subject to separate rules of reporting and computation of top-up tax.

Certain special and exempt entities

Not every entity can be uniquely allocated to one group. The top-up tax legislation lists them to ensure that the Pillar 2 rules are applied adequately to the type of the entity and the extent of control within the group.

This list includes certain special entities, such as joint ventures or partially-owned constituent entities. 

• Joint ventures are entities controlled by at least two groups together. Since none of the groups has full control of the financial results of such entities, the law requires that these groups should be treated as separate groups under the Pillar 2 regulations. This means that the computation of the top-up tax (the income inclusion rule) of such entities and their subsidiaries is made as if they were members of a separate group and the joint venture was the UPE of that group. Then, the top-up tax is computed by the actual UPE on a pro rata basis to their share in the "joint venture group".
• Minority-owned constituent entities are such constituent entities in which the UPE has a direct or indirect ownership interest of 30% or less. Here, top-up tax is calculated for and paid by each entity separately (unless such entities form a minority-owned subgroup; then, top-up taxation applies to that subgroup).

In addition to the said special cases, the law provides for a list of exempt entities which are not subject to Pillar 2 even though they could be formally treated as constituent entities. Such entities, among others, are:

• government units,
• international organisations,
• pension funds,
• non-profit organisations,
• investment funds and real estate investment firms (but only in specific cases).

These entities typically conduct non-commercial activity, and their income is taxable at the investor level, hence they fall outside the scope of the top-up tax regime.

The issue of exempt entities was covered in detail in one of our previous articles about the Pillar 2 Rules. On that point, it is worth remembering that if a group consists only of exempt entities, it is in its entirety not subject to top-up tax.

Bottom line

The correct identification of entities forming a group within the meaning of Pillar 2 is the first and one of the most important steps which taxpayers need to take to work their way around the top-up tax regime. It affects not only the tax obligation itself, but also the method of computation and payment of this tax.

In practice, it means that every group – regardless of the extent of its activity – should start with mapping its structure as part of implementing the Pillar 2 accounting mechanism. Only the accurate identification of constituent, parent, exempt, and special entities will ensure that the computation of top-up tax and reporting in compliance with the Pillar 2 Rules is free of any errors.