The 130 members of the Organisation for Economic Cooperation and Development (OECD)/G20 Inclusive Framework on BEPS approved a statement on 1 July 2021 which provides a framework for reform of the international tax rules.
The agreement has two components which are referred to as Pillar 1 and Pillar 2:
For the purposes of this article, we have focused on some preliminary thoughts in relation to the potential application of the global minimum tax rules in Pillar Two with respect to Australian real estate investments.
For present purposes, we have assumed that Australian real estate is unlikely to be a relevant issue for an entity impacted by Pillar One.
The analysis below is based on the following assumptions:
In the first instance, the application of Pillar Two will depend upon whether the jurisdictions where the parent fund and/or the investors are based decide to enact these rules (they are not obliged to do so).
Let’s assume the rules are in place in one or more relevant jurisdiction (remembering that the rules are applicable on a top-down basis) and that there is a financial accounting consolidation outcome in that jurisdiction.
We haven’t focused on the factors around consolidation outcomes in this note but note in passing that IFRS 10 might provide an exemption for Investment Entities which meet its qualifying conditions.
There are a number of threshold issues which need to be considered:
We need to wait for confirmation of the exemption and some further analysis of the “trade or business” language.
It seems unlikely that the rules would adopt the Australian domestic (Division 6C) trading business test to determine what is a trade or business and perhaps the rules will leave it up to the implementing country to make a final decision on the scope and interpretation of this test.
A number of interesting questions arise in an Australian context including those below:
Let’s put the threshold issues to one side and consider the possible mechanics of the operation of the rules in an Australian context.
The headline tax rate is generally 15 percent (10 percent for a clean building managed investment trust MIT) but this rate is applied only to taxable income, which can be materially different from accounting income.
The major difference is that IFRS based accounting income is (unless the entity decides not to make a fair value election) calculated treating investment properties on a mark-to-market basis whereas taxable income works from cost and allows for depreciation.
Assuming a rising property market, accounting income will be usually be significantly higher than taxable income due to property revaluations which generally flow through the P&L and which will need to be excluded from the Pillar Two calculations in order to avoid significant tax being paid on unrealised gains.
We understand that OECD is aware of the mark to market accounting issue but not specifically in the property context and it would seem sensible to make sure that this issue is properly considered, especially if the scope of the fund exemption is not all encompassing.
Another way of dealing with this issue might be to allow a credit for the deferred taxes given that the gains are currently unrealised and will eventually be subject to tax i.e. it is a genuine timing mis-match not a difference arising from the non-taxation of the gain or the operation of a specific tax incentive.
However, most Australian property trusts do not currently recognise deferred tax as they are flow through vehicles, rather it is the holding entities that may recognise any deferred taxes.
Some other items which will need to be considered include:
If these structural issues can be dealt with then, leaving aside ordinary timing differences, the main issue will generally be tax deprecation.
It would seem a little unusual if the impact of the rules is to reverse such depreciation (especially where is it based on a useful life calculation rather than being an accelerated tax incentive) and it would seem that the proposed rules recognise this in relation to physical assets insofar as they suggest that you can use tax depreciation instead of book depreciation.
It would be sensible to confirm that this outcome persists where the tax depreciation rate is incentivised rather than being simple useful life outcomes.
The headline tax rate here will generally be 30 percent and subject to the issues relating to the accounting treatment of properties referred to above, one might expect that the Effective Tax Rate would be above 15 percent.