How BEPS 2.0 could impact the wealth and asset management industry

The potential impact of the Pillar Two rules could influence both fund structuring and investment choices.

In brief

• Alternative investment managers, funds and portfolio companies must consider the impact of the new Pillar Two rules starting in 2024.
• The scope of these rules and whether an exemption is possible could create challenges.

Finally, to the extent a jurisdiction has implemented a minimum tax that generally calculates profits and any top-up tax due in a similar manner as the Pillar Two rules, such tax may be treated as a QDMTT under the Pillar Two rules.

While jurisdictions are not required to implement a QDMTT, the tax ensures that the Pillar Two top-up tax is paid in the jurisdiction where the relevant income is earned, rather than in other jurisdictions that could otherwise tax such income under an IIR or a UTPR (i.e., thus benefiting the jurisdiction that has implemented the QDMTT).

The potential impact of the Pillar Two rules is likely to influence fund structuring and investment choices. The implications of the Pillar Two rules may also result in an expanded scope for tax due diligence and financial modeling considerations.

The Pillar Two rules include certain transitional safe harbors that could help taxpayers with their compliance obligations and reduce the risk of top-up taxes being applied to them in the first three years of the Pillar Two rules.

In order to prepare for and understand how they may be impacted by the Pillar Two rules, alternative investment funds have been considering the following steps:

• Document fund structures, management companies and portfolio companies.

Analyze internal organizational structures to determine ultimate parent entities, constituent entities and financial consolidations that meet the EUR750m threshold, if any.

• Determine applicability of transitional safe harbor rules (transitional SHR).

Identify jurisdictions that qualify for temporary exemption under the transitional SHR based on revenue, income and simplified effective tax rate measures.

• Evaluate the potential impact of the Pillar Two charging provisions:

o Consideration of any QDMTT implemented

o Application of the IIR

o Allocation of the top-up tax under the IIR

o Application of the IIR offset mechanism as appropriate

o Application of the UTPR

o Determination of the UTPR top-up amount 

o Allocation of the top-up tax under the UTPR

• Prepare ASC 740 documentation.

While many exceptions could apply, these exceptions would need to be analyzed and documented to support the financial statements. 

• Annual filings.

Prepare for annual filings (starting in 2025 or 2026).

The rest of this article provides a summary of the application of the accounting guidance as well as certain fund, management company, portfolio company and transaction tax considerations.

Brief overview of the application of consolidation accounting guidance to the wealth and asset management industry

If the EUR750m revenue threshold is met, the Pillar Two rules generally apply to multinational enterprise groups that operate in at least two jurisdictions and that consolidate (or would consolidate if financial statements were required to be prepared) under the applicable financial reporting framework.

Under US generally accepted accounting principles (US GAAP) Accounting Standards Codification (ASC) 810 and International Financial Reporting Standards (IFRS) 10 accounting guidance, a consolidation assessment would be performed starting with the lowest entity in the structure.

Under both US GAAP and IFRS consolidation frameworks, all entities controlled by the reporting entity are generally consolidated. US GAAP includes the variable interest model and the voting interest model, while IFRS has a single control model.

As part of the consolidation analysis, the following is a starting place of what must be analyzed:

• All financial interests, both direct and indirect
• Contractual interests through management contracts and compensation arrangements
• Related-party and common control relationships
• Shareholder rights, including kick-out rights, participating rights or protective rights

However, entities that meet the definition of an investment company under US GAAP or IFRS apply specialized accounting guidance. These entities account for their investments at fair value and are not subject to consolidation and, therefore, may be generally excluded from the scope of the Pillar Two rules if certain conditions exist, as discussed further below.

Certain exceptions exist in accounting for investments by investment companies (entities) and consolidation conclusions may differ between US GAAP and IFRS. For example, under both standards, non-investment companies that provide services to the investment company may need to be consolidated on a line-by-line basis and, as such, would be included in the scope of the Pillar Two rules.

Fund and asset holding companies considerations

Funds and their asset holding company platform (e.g., Luxembourg, UK) may potentially fall outside the scope of the Pillar Two rules,  assuming certain conditions, as provided in the GloBE rules, are met. These include:

1. The fund is designed to pool assets (which may be financial and nonfinancial) from a number of investors (some of which are not connected).
2. The fund invests in accordance with a defined investment policy.
3. The fund allows investors to reduce transaction, research and analytical costs, or to spread risk collectively.
4. It is primarily designed to generate investment income or gains, or to provide protection against a particular or general event or outcome.
5. Investors have a right to return from the assets of a master limited partnership or income earned on those assets, based on the contributions made by those investors.
6. The fund or its management is subject to a regulatory regime in the jurisdiction in which it is established or managed (including appropriate anti-money laundering and investor protection regulation).
7. The fund is managed by investment fund management professionals on behalf of the investors.

A fund’s asset holding companies may also be excluded if they generally meet the following conditions:

i. Where at least 95% of the value of the entity is owned (directly or through a chain of excluded entities) by one or more excluded entities referred to in Article 1.5.1 of the GloBE model rules (other than a pension services entity) and where that entity:

a. Operates exclusively or almost exclusively to hold assets or invest funds for the benefit of the excluded entity or entities

Or

b. Only carries out activities that are ancillary to those carried out by the excluded entity or entities

ii. Where at least 85% of the value of the entity is owned (directly or through a chain of excluded entities) by one or more excluded entities referred to in Article 1.5.1 (other than a pension services entity), provided that substantially all of the entity’s income is excluded dividends or excluded equity gain or loss that is excluded from the computation of Pillar Two income or loss in accordance with Articles 3.2.1(b) or (c) of the GloBE model rules.

Management company considerations

Management companies may potentially fall within the scope of the Pillar Two rules, assuming the management company has, on a consolidated basis, generated EUR750m of annual revenue in at least two of the four preceding tax years.

Whether Pillar Two rules are applicable to certain investments held by management companies (including corporate carry, and coinvest vehicles, which are generally structured in low-/no-tax or offshore structures) will be contingent on the treatment of those vehicles for consolidation purposes.

As applicable, consideration should be given to the consolidation guidance under US GAAP and IFRS when evaluating, for instance, whether the management company should consolidate the underlying fund.

Furthermore, it is important to consider that to the extent the investment management structure is organized as a fiscally transparent structure (e.g., a limited partnership), there is a specific rule for flow-through UPEs in the Pillar Two rules which provides that the Pillar Two Income of the UPE in the form of a limited partnership (LP) is, generally, only reduced to the extent that partners in the LP have been subject to at least 15% tax on the Pillar Two income of the LP (additional exceptions exist for specific minority shareholders).

Portfolio company considerations

Portfolio companies may fall within the scope of the Pillar Two rules to the extent the portfolio groups have consolidated revenue of at least EUR750m. It is important to note that transitional rules apply until a portfolio group falls within Pillar Two rules.

These transitional rules generally require tracking of certain transactions from December 2021 onward. It is also important to note that to the extent certain portfolio companies are not wholly owned or are otherwise considered joint ventures, additional complexity exists.

Transaction considerations

The potential impact of the application of the Pillar Two rules may impact fund structuring and investment choices. In addition, the implications of the Pillar Two rules may result in an expanded scope for tax due diligence and financial modeling considerations.

This article was originally published in Thomson Reuters Journal of International Taxation, 34 JOIT 64 (November 2023).

Alex Pouchard, Partner, Tax also contributed to the article.