Loyens & Loeff New York regularly posts 'Snippets' on a range of EU tax and legal topics. This Snippet describes the treatment of reverse hybrid entities under Pillar Two.
P2 applies to all entities that form part of a multinational group with annual revenues of at least €750M. This includes entities that are treated as transparent for local tax purposes. P2 uses the term Flow-Through Entities (FTEs) for entities that are fiscally transparent in the jurisdiction in which they are created. P2 contains two types of FTEs, depending on the treatment in the jurisdiction of its owners: (i) Tax Transparent Entities (TTEs) and (ii) Reverse Hybrid Entities (RHEs):
- If the FTE is treated as transparent by its owner, it is a TTE.
- If the FTE is treated as opaque by its owner, it is an RHE.
If an FTE has multiple owners that classify the entity
differently for tax purposes, it will be treated as a TTE to the
extent its owners classify it as tax transparent and as an RHE to
the extent its owners classify it as opaque.
The main difference between TTEs and RHEs is the allocation of
income and taxes for P2 purposes. In this Snippet, we focus on the
treatment of RHEs.
The P2 rules contain three steps for allocating income and taxes of an RHE:
- The income and taxes are reduced to the extent allocable to owners that are not group entities.
- If the activities give rise to a permanent establishment (PE), the income and taxes are allocated to such PE.
- The remaining income and taxes of a RHE are allocated to the RHE itself.
As a result of these steps, the income and taxes of an RHE without a PE is allocated to the RHE. An RHE is considered a 'stateless' entity for P2 purposes. The income and taxes of a stateless entity are not part of the effective tax rate (ETR) in any jurisdiction but should be calculated separately (no blending with results of group companies). As an RHE is typically not subject to tax, this would generally lead to an ETR of 0% and Top-up Tax (TT) due. The OECD administrative guidance from June 2024 (AG) provides relief for situations where tax is paid on an RHE's income by a(n) (in)direct owner. Such tax paid by the (in)direct shareholder should be allocated to the RHE.
An example of an RHE is a disregarded US LLC (LLC) held by a Dutch BV (BV). As LLC is transparent in the US and opaque in the Netherlands, it is an RHE. This could give rise to TT as income is allocated to the LLC subject to a separate ETR calculation (even though the LLC is not subject to tax).
If BV is held by a US Inc and BV is (also) disregarded for US tax purposes, the income of LLC would be taxable at US Inc. The AG allows this tax paid by US Inc to be allocated to the LLC. As a result, both the income and taxes are part of the ETR calculation of LLC which mitigates the TT exposure.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
