Pillar Two and IFRS: when consolidation is not enough

Facts

An individual resident in the United States holds 100% of the shares in two legally independent companies:

• Indian Co incorporated and tax resident in India. It is engaged in the extraction and processing of mineral resources into tradable commodities.
• UAE Co incorporated and tax resident in the United Arab Emirates (UAE). It is exclusively engaged in purchasing and trading the commodities produced by Indian Co.

There is no legal holding company. The companies are sister entities, owned directly by the individual.

While each company individually falls below the EUR 750 million revenue threshold, their combined revenues exceed EUR 750 million in each of the two most recent fiscal years.

Indian Co does not hold any equity interest in UAE Co. However, the two entities operate under a set of binding contractual and commercial arrangements that give Indian Co control over UAE Co’s relevant activities:

1. Indian Co and UAE Co have entered into a Master Operating and Supply Agreement, under which Indian Co:
   1. Has the exclusive right to direct UAE Co’s operational and commercial policies, including customer acceptance, pricing strategy, and product delivery terms;
   2. Provides all core management personnel seconded to UAE Co, including the CEO and finance lead, under a renewable 7-year contract;
   3. Approves UAE Co’s annual operating budget and strategic plan as a precondition for continued supply and financing;
2. Indian Co supplies 100% of UAE Co’s inventory under a 10-year exclusive agreement, and provides all working capital loans;
3. Indian Co receives a variable, performance-based margin linked to UAE Co’s financial results, i.e. Indian Co is entitled to receive a percentage of UAE Co’s net profit or gross trading margin;
4. Indian Co provides back-to-back guarantees to customers and absorbs major trading risks.

Questions

1. Can Indian Co be considered the Ultimate Parent Entity (UPE) under IFRS 10 and required to consolidate UAE Co?
2. Does the group meet the definition of an MNE Group under the UAE Domestic Minimum Top-Up Tax (DMTT) regime, such that the UAE Co is subject to DMTT?

Summary

Upon examination of the applicable accounting and tax standards, we concluded that:

1. Indian Co qualifies as a Parent under IFRS 10, despite holding no equity interest in UAE Co, because it exercises control over UAE Co’s relevant activities via enforceable contractual arrangements and is exposed to variable returns from its involvement.
2. However, Indian Co does not qualify as a UPE under UAE Domestic Minimum Top-Up Tax (DMTT) rules, which conditions the status of UPE on the existence of a Controlling Interest derived from equity ownership.
3. Consequently, despite the group’s consolidated revenues exceeding EUR 750 million in each of the two most recent fiscal years, the group does not meet the definition of an MNE Group under UAE DMTT law, and UAE Co is not subject to the Domestic Minimum Top-Up Tax.
4. As with all scenarios where there is no clear-cut guidance in the law, regulations, public clarifications, or authorized guides, there is a risk of disagreement with the FTA. Therefore, it is advisable to seek verification of the above position through a private clarification with the FTA. When doing so, the taxpayer must present a favorable tax position, propose alternatives (where applicable), and provide a detailed analysis of these positions. A relevant tax opinion should also be submitted. The arguments outlined below can support a favorable interpretation, but additional arguments tailored to the specific facts of each case should be thoroughly developed and included in the technical position.

Analysis

The obligation to prepare consolidated financial statements is governed by IFRS 10 “Consolidated Financial Statements”, issued by the International Accounting Standards Board (IASB).

Under para 4 of IFRS 10, ‘an entity that is a parent shall present consolidated financial statements’. Appendix A of IFRS 10 defines a “Parent” as ‘an entity that controls one or more entities’. Control, which is the core criterion for establishing parent status, is defined in Appendix A (term 7) as follows: ‘An investor controls an investee when the investor is exposed, or has rights, to variable returns from its involvement with the investee and has the ability to affect those returns through its power over the investee’.

Thus, control for the purposes of consolidation is not contingent upon legal ownership or equity participation but is instead assessed functionally, based on the substance of the relationship between the parties.

The factual matrix indicates that Indian Co does not hold equity in UAE Co. However, the substance of its relationship with UAE Co is characterized by the following:

• Contractual rights to direct relevant activities.

Under IFRS 10:B14, ‘power arises from rights. To have power over an investee, an investor must have existing rights that give the investor the current ability to direct the relevant activities’. According to IFRS 10:11, ‘sometimes assessing power is straightforward, such as when power over an investee is obtained directly and solely from the voting rights granted by equity instruments such as shares, and can be assessed by considering the voting rights from those shareholdings. In other cases, the assessment will be more complex and require more than one factor to be considered, for example when power results from one or more contractual arrangements’. This paragraph expressly affirms that contractual arrangements are a valid source of power.

Indian Co holds substantive rights under a Master Operating and Supply Agreement, granting it the ability to:

1. Approve or reject UAE Co’s operating and strategic plans,
2. Dictate pricing, customer policies, and marketing strategies,
3. Second key management personnel to UAE Co, including the CEO and finance director.

These rights are enforceable and unilateral, and therefore meet the “power” threshold under IFRS 10:B11–B13.

• Exposure to Variable Returns.

Under IFRS 10:6, ‘an investor controls an investee when it is exposed, or has rights, to variable returns from its involvement with the investee and has the ability to affect those returns through its power over the investee’.

Indian Co derives performance-based margins from UAE Co’s results, i.e. variable income that is directly linked to the financial or operational performance of UAE Co.

Indian Co also provides all working capital funding, and assumes market and credit risks via back-to-back trading guarantees. This matters significantly under IFRS 10 because providing working capital funding and assuming market and credit risks, especially through back-to-back guarantees, are strong indicators of exposure to variable returns, and economic dependence that enhances the Indian Co’s ability to affect those returns.

This is consistent with IFRS 10:B55-56, which notes that:

1. When assessing whether an investor has control of an investee, the investor determines whether it is exposed, or has rights, to variable returns from its involvement with the investee.
2. Variable returns are returns that are not fixed and have the potential to vary as a result of the performance of an investee. Variable returns can be only positive, only negative or both positive and negative.
3. An investor assesses whether returns from an investee are variable and how variable those returns are on the basis of the substance of the arrangement and regardless of the legal form of the returns.

• Ability to use power to affect returns.

Under the third limb of the control test in IFRS 10, even if an investor has power over an investee and is exposed to variable returns, it must also demonstrate a functional linkage between that power and the investor’s own economic outcome. This requirement is set out in para 17 of IFRS 10, which provides ‘an investor controls an investee if the investor not only has power over the investee and exposure or rights to variable returns from its involvement with the investee, but also has the ability to use its power to affect the investor’s returns from its involvement with the investee’.

This requirement ensures that power is substantive, and not merely nominal or theoretical. It must be exercisable in such a way that it enables the investor to direct the relevant activities that significantly affect the variability of its own returns.

Critically, this third prong also serves to distinguish principals from agents under IFRS 10. As explained in para 18: ‘… an investor with decision-making rights shall determine whether it is a principal or an agent. An investor that is an agent … does not control an investee when it exercises decisionmaking rights delegated to it’. Only a principal has the ability to use its power to affect its own returns; an agent exercises power on behalf of another and thus does not control the investee. Accordingly, establishing this functional linkage is decisive in determining whether control exists for consolidation purposes.

In the present case, Indian Co’s power is not passive, contingent, or held in reserve. It is exercised actively and unilaterally through a set of enforceable contractual rights that affect UAE Co’s relevant activities. Indian Co performs the following functions:

1. It sets or approves pricing policies, directly influencing UAE Co’s gross margins and trading outcomes;
2. It determines customer selection and credit terms, affecting sales volumes and credit exposure;
3. It controls strategic and operational planning, including budget approval, thereby shaping UAE Co’s commercial strategy;
4. It receives performance-based financial returns that vary with UAE Co’s success, creating financial interdependence;
5. It provides financial guarantees and full working capital funding, meaning its balance sheet is directly exposed to UAE Co’s operational performance.

These powers are exercised in real-time, with direct financial consequences for Indian Co. They form a causal and dynamic link (a “feedback loop”) whereby Indian Co’s use of power materially influences its own financial outcomes. This closed loop of influence is precisely what IFRS 10 contemplates as satisfying the third control element.

Accordingly, Indian Co does not act as an agent, but as a principal in its relationship with UAE Co:

1. It is not executing decisions for the benefit of another party, but rather exercising power in pursuit of its own economic interest.
2. The nature and extent of Indian Co’s influence over UAE Co’s relevant activities, combined with its direct economic exposure, demonstrate that Indian Co has the ability to use its power to affect the amount of its returns, as required under IFRS 10.17.
3. Indian Co’s ability to direct UAE Co’s relevant activities is not merely coincidental to its return profile, but is the primary driver of it. Indian Co’s returns do not arise independently of UAE Co’s activities, but rather as a direct function of the power Indian Co exercises over those activities.

This confirms the third condition for control is met, and that Indian Co must be treated as the Parent for consolidation purposes under IFRS.

In light of the above, Indian Co meets the functional test of “control” under IFRS 10 and is thereby classified as a Parent for accounting purposes. Accordingly, Indian Co is required to consolidate UAE Co in its consolidated financial statements, even though it holds no equity interest in that entity.

UAE Domestic Minimum Top-Up Tax Exposure

The UAE has implemented its version of the Pillar Two Global Anti-Base Erosion Rules via Cabinet Decision No. 142 of 31 December 2024, supplemented by Ministerial Decision No. 88 of 18 March 2025, which authorizes the use of the OECD/G20 Inclusive Framework Commentary and Administrative Guidance for the purposes of applying the UAE Domestic Minimum Top-Up Tax (DMTT).

Article 1.1.1 of the Cabinet DMTT Rules restricting the scope of the DMTT by ‘Constituent Entities that are members of an MNE Group that has annual revenue of EUR 750 million or more in the Consolidated Financial Statements of the Ultimate Parent Entity in at least two of the four Fiscal Years immediately preceding the tested Fiscal Year’.

This means that for the DMTT to apply, there must first exist a group headed by an Ultimate Parent Entity (UPE) whose consolidated revenue meets the threshold. Accordingly, the threshold test under Article 1.1.1 can only be applied if an entity qualifies as the UPE, which requires further examination of the relevant definitions.

An Ultimate Parent Entity (UPE) is further defined under Article 1.1.1(c) as ‘an Entity that owns directly or indirectly a Controlling Interest in any other Entity, and is not owned, with a Controlling Interest, directly or indirectly by another Entity’.

This means the UPE must own a Controlling Interest which leads to the next layer of the definition.

The term “Controlling Interest” is defined in the same Decision as ‘…an Ownership Interest in an Entity such that the interest holder … is required to consolidate the assets, liabilities, income, expenses and cash flows of the Entity on a line-by-line basis…’.

Hence, consolidation is not enough by itself. The requirement to consolidate must arise by virtue of having an Ownership Interest.

Finally, Ownership Interest is defined to mean:’…any equity interest that carries rights to the profits, capital or reserves of an Entity…’. This excludes non-equity control (e.g. control through contracts, management rights, financial arrangements) from qualifying as an Ownership Interest — and, by extension, from being a Controlling Interest.

So, in our view, an entity that consolidates another entity solely on the basis of control (e.g. contractual control under IFRS 10) but does not hold an equity interest in that entity, cannot be considered a UPE under the UAE DMTT rules.

Although Indian Co consolidates UAE Co under IFRS 10, it does not hold any equity interest in UAE Co. As such Indian Co does not possess an Ownership Interest as defined. Therefore, it cannot be said to hold a Controlling Interest under UAE DMTT rules.

Accordingly, it does not qualify as an Ultimate Parent Entity (UPE). Without a UPE, no MNE Group exists for the purposes of Article 1.1.1, regardless of whether the group’s revenue exceeds EUR 750 million. Therefore, Indian Co does not meet the statutory definition of a UPE due to the absence of equity-based control, and therefore the group is outside the scope of the UAE DMTT regime. UAE Co is not subject to Top-Up Tax, notwithstanding its role in a consolidated group under IFRS.

The disclaimer

Pursuant to the MoF’s press-release issued on 19 May 2023 “a number of posts circulating on social media and other platforms that are issued by private parties, contain inaccurate and unreliable interpretations and analyses of Corporate Tax”.

The Ministry issued a reminder that official sources of information on Federal Taxes in the UAE are the MoF and FTA only. Therefore, analyses that are not based on official publications by the MoF and FTA, or have not been commissioned by them, are unreliable and may contain misleading interpretations of the law. See the full press release here.

You should factor this in when dealing with this article as well. It is not commissioned by the MoF or FTA. The interpretation, conclusions, proposals, surmises, guesswork, etc., it comprises have the status of the author’s opinion only. Furthermore, it is not legal or tax advice. Like any human job, it may contain inaccuracies and mistakes that I have tried my best to avoid. If you find any inaccuracies or errors, please let me know so that I can make corrections.