The OECD (Organisation for Economic Cooperation and Development) Pillar Two framework seeks to address the tax challenges arising from the digitalisation of the economy with wide-reaching implications for many international businesses. The main purpose is to reduce incentives for base erosion and profit shifting by limiting tax competition among countries, this is to be achieved through ensuring that large multinational groups pay a minimum level of tax on the profits arising in each jurisdiction in which they operate.
Which businesses do OECD Pillar Two rules apply to?
The rules apply to multi-national enterprises (MNEs) with annual consolidated revenues of at least €750 million in at least two out of the prior four accounting periods. Common structures likely to be impacted are those involving:
- Tax havens, low-tax jurisdictions and jurisdictions with territorial regimes
- Notional interest deduction regimes
- IP (Intellectual Property) boxes and other similar incentives regimes including tax holidays
- Certain tax credit regimes
- Low-taxed financing, IP and global centralisation arrangements.
Every global organisation with global revenues of €750m or more will need to act to be compliant with Pillar Two. In addition, organisations that are close to the threshold will need to actively monitor whether they continue to fall outside of scope and, if on a growth trajectory, take action to prepare for Pillar Two compliance when they cross the revenue threshold.
The impact of M&A activity may bring groups or entities in scope, or take them out of scope, and the impact if this will need to be considered in transactional documentation and processes, such as due diligence.
Do you have a plan in place to prepare?
Pillar Two will have both short and long-term impacts. In scope MNEs should expect a significant increase in their compliance burden as the calculations needed are complex and many of the data points required may not currently be tracked, requiring updates to your systems and changes to existing compliance processes.
"We have a dedicated global team made up of International Corporate Tax, Tax Accounting and Tax Technology experts who can advise and assist you and your business with planning for Pillar Two compliance. Through our global network, we can provide consistency and a joined-up approach to Pillar Two."
ROSS ROBERTSON
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What are the Pillar Two Rules?
The OECD’s Pillar Two framework aims to ensure MNEs with global revenues above €750 million pay a minimum effective tax rate on income within each jurisdiction in which they operate. Commonly referred to as BEPS (Base Erosion and Profit Shifting) 2.0, the framework imposes a Top-Up Tax on profits arising in jurisdictions where the effective tax rate (ETR) is below 15%.
When will the new rules come into effect?
The core elements of Pillar Two are:
- An Income Inclusion Rule (IIR)
- An Undertaxed Profits Rule (UTPR)
Under the IIR, where an entity’s ETR in any jurisdiction is below the minimum 15% rate, the ultimate parent entity is primarily liable for a ‘top-up tax’ to bring the rate up to 15%.
As a backstop, the UTPR can apply, through allocation of a top up tax to a sibling entity in respect of profits which are not subject to the charge under an IIR.
A country may also choose to implement a Qualified Domestic Minimum Top-up Tax (QDMTT), alongside the IIR. This would enable the relevant territory to retain taxing rights in respect of low taxed profits (rather than the relevant profits being tax in the parent entity’s jurisdiction under IIR or a sister jurisdiction under UTPR).
The calculation mechanism for determining the effective tax rate is broadly the same under all three elements. It blends elements of current and deferred tax in determination of the ETR and, therefore, requires understanding of international tax principles as well as deferred tax accounting in undertaking the calculations.
What is the Subject to Tax Rule Multilateral Instrument (STTR MLI)?
In addition to the above, a multilateral instrument on the subject to tax rule (the STTR MLI) was recently adopted by the OECD Framework to facilitate the implementation of the Pillar Two STTR rule. This is a treaty-based rule which allows the source (or payor) jurisdictions to impose additional tax on several categories of cross-border intragroup payments when such payments are subject to a nominal corporate income tax rate of below 9% in the residence (or payee) state and is expected to be most beneficial to developing countries.
The MLI will allow the STTR rule to be included within the existing bilateral agreement without the need to make any amendments to those treaties provided that both jurisdictions to the treaty sign up to the MLI. The MLI is currently open for signature, and it is yet to be seen how many jurisdictions will sign up to it.
When will Pillar Two be implemented?
The timing of implementation for each element varies by territory. Most territories have opted to implement the IIR first with the earliest movers having legislated for implementation from 1 January 2024 (accounting periods beginning on or after 31 December 2023). Implementation of the UTPR is expected to follow 12 months later i.e. from 1 January 2025 at the earliest. Several territories have now legislated for QDMTT with commencement date generally aligned to the IIR to protect domestic taxing rights.
Has the UK implemented the rules?
The Pillar Two rules are now included within Finance Act (no.2) Act 2023 and will come into effected for accounting periods beginning on or after 31 December 2023. The UK government has sought to follow the intent of the Model Rules as closely as possible, both from a policy perspective, and to ensure that the UK’s regime is recognised as a ‘qualifying’ regime by other territories introducing the rules.
The enacted legislation includes the IIR, referred to as the ‘multinational top up tax’ or MTT, and a QDMTT, referred to as ‘domestic top up tax’ or DTT. MTT will apply to MNEs with global revenues exceeding EUR 750m in two of the previous four years, for accounting periods beginning on or after 31 December 2023.
Draft legislation has also been published to include the UTPR, which was announced in the Autumn Statement 2023, and which will come into effect from accounting periods ending on or after 31 December 2024.
The enacted legislation also includes the safe harbour provisions in line with the OECD rules such as the temporary Country by Country reporting (CbCr) safe harbour provision, QDMTT and UTPR including a simplified calculation approach for non-material and non-consolidated entities.
The enacted legislation also sets out the following reporting framework:
A one-time requirement for relevant groups, the ultimate parent entity or a filing member, to register with HMRC) when they first come into scope of the rules
An annual domestic information return/overseas return notification, to confirm entities’ UK top-up tax liabilities, to be submitted to HMRC within 15 months after the end of the accounting period (extended to 18 months for a group’s first return).
Payment of the UK top-up tax liability in a single instalment due 15 months after the end of the accounting period (18 months for a group’s first return).
Irrespective of whether any top-up tax becomes payable, the compliance burden for affected organisations will be significant, as there are many data points that will be required to be incorporated into determination of the effective tax rate of a territory under the rules.
Disclosures in financial statements for the year ended 31 December 2023
It should be noted that while the rules are effective for accounting periods commencing after 31 December 2023, “in scope” groups are required to include disclosures of the expected Pillar Two impact within their financial statements for the year ended 31 December 2023.
We are currently supporting “in scope” groups by undertaking impact assessments which broadly involves a review of the safe harbours/de minimis limits and their application to the group as an initial phase, and determination of ETR and the resulting top up tax on a jurisdictional basis as the next phase, where the safe harbours are not applicable or a group chooses not to rely upon the safe harbours.
This will allow the correct disclosures to be made in financial statements and will also provide a working assessment of future Pillar Two tax exposures. Additionally, it will also identify and address data gaps that will be required to complete the full calculations, either where a safe harbour is not applicable (or not elected for) or post expiry of the current temporary safe harbours.
We are also supporting UK subsidiaries and sub-groups of over overseas parented groups by reviewing and leveraging any work that has been undertaken by the overseas parent to assess impact on the UK subgroup. In some instances, no work may have been undertaken in the parent jurisdiction as some notable countries, such as the US, are not currently progressing with implementation of the Pillar Two rules.
"We have a dedicated global team made up of International Corporate Tax, Tax Accounting and Tax Technology experts who can advise and assist you and your business with planning for Pillar Two compliance. Through our global network, we can provide consistency and a joined-up approach to Pillar Two."
ROSS ROBERTSON
