With mergers and acquisitions picking up in 2024 and the OECD’s Global Anti-Base Erosion rules (GloBE, or “Pillar Two” rules) now effective for most large companies as of January 1 this year, many companies will be faced with a number of new considerations arising in the context of both acquisitions and dispositions.
To briefly recap, the GloBE rules are designed to ensure that large companies (with financial statement revenue in excess of €750 million) pay a minimum tax on profits of fifteen percent in each jurisdiction where they operate (taxes taken into account for this determination are referred to as “covered taxes”), which they accomplish through two primary mechanisms:
- the income inclusion rule (IIR) – permitting a parent or holding company jurisdiction to levy a top-up tax on the profits of their subsidiaries that are taxed below fifteen percent; and
- the undertaxed profits rule (UTPR) – permitting any implementing jurisdiction in which the group has a presence to levy top-up tax on the low-taxed profits of related group members.
In response to these rules, many jurisdictions have enacted domestic top-up taxes to ensure the fifteen percent minimum tax is collected locally (rather than in another jurisdiction under the IIR or UTPR). Although the United States is not expected to adopt the GloBE rules at this point, US companies will still be impacted if they operate in jurisdictions that have adopted the rules, expected to include most countries.
The effective tax rate (ETR) and top-up taxes are calculated based on financial statement income with several adjustments. This requires companies to prepare an entirely new set of calculations with information that may not be readily available, regardless of whether they are expected to owe any incremental tax. To mitigate the significant compliance burden in the short term, enacting jurisdictions are adopting transitional safe harbors to delay the effective date of the GloBE rules (potentially until 2027) for jurisdictions that are unlikely to result in material top-up tax. Companies can qualify for the transitional safe harbor by satisfying one of three tests. Two of the safe harbor tests apply to jurisdictions with limited profits. The third test allows taxpayers to exclude jurisdictions with an ETR above fifteen percent, increasing to seventeen percent for years beginning in 2026 (the ETR safe harbor). The ETR is determined using the income from the taxpayer’s qualifying country-by-country report (CbC report).
In the context of M&A transactions, buyers will need access to substantial additional information from the seller/target group in order to determine the impact of the acquisition on the buyer’s Pillar Two profile and to properly evaluate the associated risks. Due to the consolidated nature of the calculations, the modeling for both buyers and sellers to evaluate the impacts of transactions will be much more complex. There will also be additional challenges related to information sharing, indemnifications, and cooperation post-closing, which will need to be considered in the agreements between the parties.
The impact of Pillar Two, including the application of the transitional safe harbors, can differ significantly based on the particular structure of the deal. In addition to the safe harbors, there are special transition rules that apply for certain transactions occurring after November 30, 2021, and prior to the effective date of the full Pillar Two rules. These transition rules continue to apply as long as a jurisdiction qualifies for the transitional safe harbors. A few examples where both buyers and sellers may consider structural alternatives to achieve different outcomes under the Pillar Two rules are discussed below.
For sellers disposing of stock, gains and losses are typically expected to be “excluded equity gain or loss” and not taken into account in calculating GloBE income. Tax on the stock sale, if any, is also excluded from covered tax. However, there is no such rule for applying the ETR safe harbor test. Assume, for example, that a parent company in Country A owns a holding company in Country B (B Co) and B Co owns an operating entity in Country C (C Co), and that the group plans to sell C Co to an unrelated party. If B Co sells the shares of C Co, the gain is likely taken into account in determining whether Country B meets the ETR safe harbor (notwithstanding that it would be excluded if the full GloBE rules applied). Stock sales are often not subject to tax in the seller’s jurisdiction, which means the disposition may result in additional income with no additional tax for the ETR safe harbor, decreasing the ETR for the jurisdiction. Depending on the specific characteristics of the seller’s group, it may be preferable for the parent company to sell B Co and realize the gain in Country A for safe harbor purposes.
For many companies, qualifying for the transitional safe harbors may provide significant benefits not only from a compliance perspective but also in terms of tax savings. Continuing the above example, assume the seller group previously acquired the stock of another Country B company (that is, not B Co) and that there was a significant step-up and/or goodwill recorded through purchase accounting. For purposes of the GloBE calculations, the impact of purchase accounting is removed. This rule is intended to align the GloBE treatment with the local tax treatment, which generally does not provide for a step-up in the underlying assets of an entity when its stock is acquired. However, if a taxpayer has prepared its CbC report using financial statements that reflect purchase accounting pushed down to the jurisdictional level (and certain limited other requirements are met), it is generally not required to remove the purchase accounting step-up for purposes of the safe harbor calculations. In the above example, the seller group would have to determine its GloBE income for Country B using historical carrying values, but if the purchase accounting has been reflected in Country B on its CbC report, it may apply the ETR safe harbor without removing the purchase accounting. This could lead to a scenario where the seller group may have a higher ETR and qualify for the safe harbor, but could potentially owe top-up tax under the full GloBE rules, making it even more beneficial to maintain the safe harbor position in Country B.
Another potential structural issue, particularly for buyers, relates to Section 338 elections or other similar transactions that are stock sales but result in an adjustment to the tax basis in the underlying assets of the entity. As noted previously, purchase accounting adjustments are generally not taken into account under the GloBE rules. However, where the transaction results in an adjustment to the basis in the underlying assets for local tax purposes, the GloBE rules do allow an election to adjust the asset basis for GloBE purposes also. The election is only available once the entity is subject to the GloBE rules, and therefore appears not to be available during the transition period while the safe harbors apply. This can result in a situation where once the GloBE rules are applicable, the taxable income and covered tax of the target are reduced as a result of the additional amortization, yet the additional amortization is not taken into account for GloBE purposes, resulting in a lower ETR and potential top-up tax (and therefore reducing the benefit of making such an election).
These are only a few of the many examples of situations where transaction alternatives with similar tax outcomes prior to Pillar Two can result in different results under Pillar Two. This new regime adds significant complexity that must be carefully considered in M&A transactions—from the risk assessment and due diligence of targets to the modeling required to evaluate the tax impact of the transaction to the preferred structure for the deal. Companies will need to be nimble as these rules continue to evolve and ensure that the Pillar Two implications are taken into account in all aspects of the M&A process.
Cara Harrison is a principal tax advisor in Baker McKenzie’s Chicago office.
