What does the substance-based income exclusion actually take out?
It removes a return on two things a jurisdiction can be seen to have: the people employed there and the tangible assets located there. Profit in that jurisdiction is reduced by that return before any top-up amount is worked out, so the charge falls on the profit sitting above it. The consequence for a file is that the carve-out is only as good as the two figures underneath it. Payroll has to be attributed to the place the work is done, and tangible assets to the place they sit, and neither of those is how most groups keep their records.
Why is our top-up tax high when profit in that country is modest?
Because the carve-out is measured on payroll and tangible assets rather than on profit. A jurisdiction holding a large share of the group profit with few employees and little equipment has very little to subtract, so most of that profit stays in the base. The reverse also holds: a manufacturing location with plant and a workforce can carve out a substantial return even in a weak year. Before assuming the computation is wrong, check whether the profit has been recorded in a place where the group has anything to show for it.
Do contractors and seconded staff count towards the payroll figure?
This is the question that takes the most time in practice. The carve-out is built on employment costs for work performed in the jurisdiction, so the test is where the person actually worked and which entity bore the cost, not which payroll system issued the payment. Groups that second engineers between companies, or that engage individuals through a service company, usually have to rebuild the figure from contracts and time records rather than lift it from a ledger. The same cost must not be counted in two jurisdictions, which is the error we see most often.
Is intellectual property covered by the substance-based income exclusion?
No. The carve-out is defined by payroll and tangible assets, and intangibles are neither. A subsidiary whose value is a patent portfolio or a software licence can be profitable, thinly staffed, and hold almost nothing that reduces its base. That is a feature of the design rather than an oversight, and it is why the exclusion tends to disappoint groups whose profit sits with rights rather than with plant. If a structure was built on the assumption that the carve-out would soften the result, test that assumption on paper before relying on it.
Which entity claims the exclusion when the assets are leased?
It turns on who is treated as holding the asset for accounting purposes and where the asset is used, and those are not always the same party or the same place. An operating lease, a finance lease and a sale and leaseback can each put the carrying value in a different set of books. We start from the fixed asset register and the lease documents together, because the register on its own often records an asset the group uses but does not carry, or carries one it has placed with somebody else.
What if we have no employees or equipment in that country?
Then there is nothing for the carve-out to work on, and the exclusion contributes nothing in that jurisdiction. That is a real answer rather than a failure of the computation, and it is useful information: it says the profit there is supported by neither people nor assets, which is the conclusion other parts of the international rules tend to reach about such a place as well. The practical step is to establish whether the profit belongs there at all under the group transfer pricing, because settling that question addresses more than this one computation.
Which countries have a tax treaty with the United States?
Around sixty, including Canada, the United Kingdom, India, Australia and most of western Europe — but the list matters less than the terms, because each treaty caps rates and allocates income differently. Two countries with treaties can produce opposite answers on the same pension or the same royalty. What decides your position is the specific article covering your income type. See our country guides.
What is a double tax treaty and what does it actually do?
It is an agreement between two countries that divides up the right to tax. Article by article it decides which country taxes employment income, dividends, interest, royalties, pensions, property and business profits — and where both may tax, it caps what the source country can withhold and tells the other to give credit. It also breaks residence ties and opens a government-to-government channel for disputes. What it never does is apply itself: a treaty position is claimed. See our treaty work.
